Investors: Beware of window-dressing!

We are well-aware that for investors seeking to learn more about the company or its performance, the financial statements of the company are the way to go. Investors rely on the annual report and statements such as the balance sheet, profit and loss account etc. to gain insight into how well the business is doing.

This dependence highlights a crucial need to be aware that not every figure in the accounts and not every word in the notes can be taken at face value. There are certain facts to be kept in mind for safeguarding the investors’ interests.

​Window-dressing

This is a term commonly used in the industry to denote falsified accounts that have been inflated to show more favourable results for a period of time.

There are times when the company feels the need to project a much better image of itself in the eyes of the public - perhaps, before an IPO is held or at the time of an AGM where an important business decision such as an amalgamation/merger/takeover is to be taken. At such times, the company’s accounts are shown with an inflated profits figure or inflated sales turnover figure. This presents a much rosier picture to the investors than the actual reality.

Cash Flow Statement

Along with the other more common account statements, the Cash Flow Statement is also an essential tool for financial analysis. This statement reflects the decisions impacting incoming and outgoing cash movements of the business, helping to analyse the liquidity component of the entity. It is a known fact that a business needs adequate liquidity for its survival, and a company with huge profitability but little to none liquidity will struggle to make its ends meet.

Past trends

A common practice of stakeholders is to observe past performance trends of the company to forecast future possibilities and likelihoods. Ratios such as Fixed Asset Turnover Ratio, Current Ratio etc. are calculated based on information provided in the financial statements. It is therefore, crucial to check the veracity of the facts and figures before using the given ratios to make important investment decisions. Any discrepancy in the numbers is bound to have a significant effect on the ratios.

These are just a few points to pay heed to before relying completely and basing decisions on data provided in the financials of companies, but they can make all the difference to your stakeholder experience.