This section discusses the critical role financial statements play for companies, investors, and creditors, and explores why management might take steps to improve how a company's financial position appears in these reports.
Financial statements are essential for investors and creditors as they rely on these documents to evaluate the potential future cash flows from the enterprise. These users assess the financial health of a company to make informed decisions about investing or extending credit.
Management is highly invested in ensuring that financial statements reflect the company in the best possible light. This is because stronger financial statements can enhance the company’s ability to secure credit, attract investors, and meet its financial objectives.
The term "window dressing" refers to actions taken by management specifically intended to make the company's financial position and performance appear more favorable in the financial statements. This might involve delaying the purchase of assets or accelerating the payment of liabilities to adjust how cash flows and liabilities are presented.
Although financial statements are meant to be accurate reflections, these adjustments by management can make the financial situation seem more positive than it typically is during the reporting period.
There is a fine line between legitimate financial management and actions that could be considered unethical or even illegal. While certain measures to improve financial appearance are common, they must remain within ethical boundaries to ensure the integrity of financial reporting.