window dressing

Window Dressing: It refers to the practice of manipulating accounts. Means to prepare financial statements in that way that they do not disclose the actual position of the concern. By doing this financial statements which are prepared in the end of the year may disclose a more favorable position than the actual position. For example, the purchases made at the end of the year may not be recorded or the closing stock may be over-valued. Hence, correct decisions cannot be taken on the basis of such financial statements.

Although window dressing is illegal or fraudulent, it is slightly dishonest and is usually done to mislead investors. 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 way the cash balance on the balance sheet appears to be at a normal amount. Window dressing is probably most commonly found in investment brokers and mutual fund houses. Mutual fund managers often sell off 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.

In short, window dressing 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.

·         Examples of window dressing are:

Cash: Postpone paying suppliers, so that the period-end cash balance appears higher than it should be.

 Accounts receivable: Record an unusually low bad debt expense, so that the accounts receivable (and therefore the current ratio) look better than is really the case.

 Fixed assets: Sell off those fixed assets with large amounts of accumulated depreciation associated with them, so the net book value of the remaining assets appears to indicate a relatively new cluster of assets.

 Revenue: Offer customers an early shipment discount, thereby accelerating revenues from a future period into the current period.

 Depreciation: Switch from accelerated to straight-line depreciation in order to reduce the amount of depreciation charged to expense in the current period.

 Expenses: Withhold supplier expenses, so that they are recorded in a later period.

How to spot Window Dressing

The ability to compare and attentiveness to detail can help recognize window dressing in a company or mutual fund’s reporting.

When analyzing overall management performance, business owners and shareholders should review all financial statements (i.e., balance sheet, income statement, statement of cash flows, and statement of changes in equity) and any additional available information to determine whether:

· A positive cash balance is a result of short-term borrowing or non-operating activities (refer to the statement of cash flows to see which activities generated cash)

· There is an abnormal increase or decrease in any balances

· The company’s policies were changed during the period

· Strong sales are accompanied by increases in accounts payable

When choosing a mutual fund, an investor should compare the year-end reports with the quarterly reports side by side to determine whether:

· The portfolio consists of only the most popular investments without any nonperforming investment

· There are abnormal period-end selling or purchase transactions

· The portfolio is diversified

· The portfolio structure and investment style are supported