Window Dressing, or Creative Accounting, includes presenting financial information of a business in a way that it improves only the ‘appearance’ of the firm’s performance, instead of showing the real objective performance.
So, how accurate the published Final Accounts of the company really are?
What is Window Dressing?
Window Dressing means presenting the company’s Final Accounts in unrealistically favorable way to please business stakeholders, especially current shareholders and potential investors. Making the numbers look better will flatter the business performance.
While the numbers are made to look better only artificially, making unethical changes to numbers, timelines, orders and charts distorts the real position of the business.
Where does Window Dressing come from?
Accounting decisions are not always based on the very precise science. And the accounting itself is not quite as objective as people tend to assume.
When preparing Final Accounts, there are many instances where estimations, predictions and best judgments need to be used. These personal judgements can lead to a difference of opinion between different accountants. When the company attempts to make judgements that present its financial reports in a very favorable way, then the accountants of this firm are ‘window dressing’ the Final Accounts.
Is Window Dressing legal?
No company can publish their Final Accounts that are known to be deliberately misleading. As they must be checked, approved and certified by an independent firm of accountants known as auditors. As a proof, there is an auditor’s report in every published account.
Window Dressing bends the rules of accounting without breaking the truth that would violate the law.
Despite the Final Accounts being legal, it is still important for investors, lenders and other stakeholders to remain realistic rather than overly optimistic.
Why companies do Window Dressing of their published Final Accounts?
Accountants usually window dress published Final Accounts for two reasons. First, to encourage investors to invest more money in the business by buying more shares.
And second, to influence banks and other lenders to lend more money to the business.
Why should stakeholders be concerned about Window Dressing?
Business stakeholders must always be concerned about the quality of the published Final Accounts and remain vigilant. Financial documents of the company should be as accurate as possible – every time the reports are made public throughout the company’s lifetime.
- Sales Revenue. Tweaking sales projections stating them as much higher than what sales are in reality will cause wrong amounts of raw materials to be ordered and wrong numbers of workers to be hired.
- Costs. The data given is based on all past data for the last financial year. There might higher prices already in the economy that are driving costs higher by the time the accounts are published.
- Profit. With wrong projections regarding Sales Revenue and Costs, the firm’s profit will never turn out to be accurate.
How is Window Dressing usually done?
There are indeed several ways how accountants can window dress the Final Accounts to make the short-term performance of a business look better without breaking the law regarding accounting disclosure.
The most common ways of Window Dressing include:
SALES REVENUE:
- Increasing sales revenue projections. This will possibly drive the stock price higher attracting more potential investors.
- Speeding up sales revenue by offering customers a discount to buy now. This will accelerate revenues from the future accounting period into the current accounting period.
CASH (LIQUIDITY):
- Selling Fixed Assets at the very end of the current financial year. This will inject Cash into the business boosting liquidity of the firm.
- Not reporting bad debts as unrecoverable. This will make Debtors (Account Receivables) look better increasing the value of Current Assets in Balance Sheet, hence maintaining appropriate Current Ratio.
- Delaying paying for supplies and other bills until the very beginning of the next financial year. This will keep more Cash in the business boosting liquidity of the firm.
- Not buying new raw materials until the very beginning of the next financial year. This will keep more Cash in the business boosting liquidity of the firm.
PROFIT (PROFITABILITY):
- Report expenditures as smaller than they really are to increase reported profits.
- Decreasing the amount of depreciation of Fixed Assets. This will decrease the costs boosting profitability of the firm.
To sum up, that is why any published Final Accounts of any business need to be used by business stakeholders with a considerable amount of caution. Final Accounts are of course the perfect starting point for investigating business performance of the firm, but need to be interpreted both in context as well as within longer timeframe.
