Window Dressing

If these methodological variations are not enough to make the would-be investor wary, he or she should be aware that those who prepare financial statements often have an intention to misinform rather than to inform. Reduction in discretionary costs (research, adverstising, maintenance, training, etc.) can increase net income while having a detrimental effect on future earnings potential. A new management may similarly write-down the value of assets to reduce depreciation and amortization expenses for future years. A businessman may avoid replenishing inventory during the period prior to closing the books so as to increase his current ratio. Temporary payment of a current debt just prior to the financial statement date will achieve the same result. Retained earnings can be appropriated for future inventory price decline and later reported as net profit. Often an analysis of a series of annual statements, rather than those of a single year, will highlight such methods. More extreme practices are generally avoided by firms that must answer to regulatory agencies to be quoted on the stock exchange.