Window dressing of the financial statements is the situation where a finance manager presented its financial statements better than the actual position of the company. When a borrower requires a fund from the bank or any other financial institution, he may tries to show better financial position of the company to get required fund easily. On the other hand, a publicly listed company may show better financial position to pretend investors to buy their shares. Though this a fraudulent act, most of the company doing this for getting extra benefit from the stakeholders.
Definition of Window dressing
Window dressing is a technique where a company presented its financial statements better than its actual position. The purpose of window dressing in financial statements is to attract new investors to invest in the company. Window dressing is illegal or fraudulent that usually mislead the investors.
In brief, this is a short-term strategy to make financial statements and financial portfolios appear more consistent and desirable than they really are. Although window dressing does not amount to fraud in most circumstances, it is usually done to mislead investors from the true company or fund performance.
The technique of Window dressing
Companies typically window dress their financial statements by selling off assets and either purchasing new assets or using this money to funds other operations. This technique applies to show sufficient Cash balance appears on the company’s balance sheet.
Unfortunately, this strategy can only fool novice investors. Experienced investors can analyze the statement of cash flows and long-term assets to see that the company is funding current operations by selling off assets.
However, here is some common window dressing technique that a financial manager may apply:
- Delaying Supplier’s Payment: A finance Manager may postpone the payments of the supplier so that the period ended cash balances appears higher than it should be.
- Hiding Doubtful Expenses: Though the Finance Manager know there is a large amount that cannot be recovered from the parties, don’t account for it as bad debt expenses to show excessive current assets that will make a higher current ratio.
- Sell Off Fixed Assets: Management sells off those fixed assets which have a large amount of accumulated depreciation. The net book value of the remaining assets appears to indicate a relatively new cluster of assets.
- Revenue collection: Collecting sales amount as early as possible by offering the customer a large amount of discount because the company wants to accelerate revenues from a future period into the current period.
- Changing the Depreciation Method: Switch from accelerated depreciation to Straight Line Depreciation in order to reduce the amount of depreciation charges as expenses in the current period.
Examples of Window Dressing
This technique is commonly found in investment brokers and mutual fund houses. Mutual fund managers often sell off the poor-performing stock and other investments near the end of a period and use the money to buy high performing stock. This way new investors see the portfolio of high performing stock and want to invest. Obviously, this is only a short-term strategy for new investors. Any experienced investor will analyze portfolio trends over the past few periods to see if the fund’s managers are investing wisely.
How to verify Window Dressing?
To verify window dressing an investor’s or a lender’s should have clear understanding about the comparison of financial statements and should know the technique of analyzing the financial statements.
To evaluate overall performance of the management, an investor should review the financial statements of the company. The financial statements comprises as Balance sheet, Income Statement, Statement of Cash flows, and Statement of changes inequity. The balance sheet of the company represents the financial position of the company, The income statement shows the performance of the management, Cash flow statements represents the overall movements of the cash flows and statement of changes in equity represents the equity injection and the movements of equity. Additionally following information to be collected to verify the window dressing of financial statements:
- Whether the positive cash balance represents in the balance sheet are the source of short term borrowings or from non-operating activities
- Whether the balance are increased abnormally
- Whether the company changed their policy unexpectedly
For mutual fund , an investor should compare the year end reports with the quarterly reports to determine:
- whether the portfolio consists of the popular investments without any non-performing assets
- Whether there is any abnormal sales or purchase
- Whether the portfolio is diversified
Window dressing is the short term strategy taken by the company to influence the investors to invest in the company’s share. Window dressing also help to get expected fund from the bank. Though window dressing can not be treated as fraud, but influence to mislead investors invest in the company.