Question

Window dressing leads to creating bad loans if not discovered by the lender. Explain this statement using what you learned in the course.

Answer 1

Window dressing is actions taken to improve the appearance of company financial's statements.Corporations naturally want to look their best to shareholders and lenders.One way for them to present a good appearance is to window dresss their fianancial statements,which require taking certain actions that enhance financial results and ratio.The risk of window dressing is that what start as white lies in one period might eventually corrode  the ethical standard of a company's executive and spiral down into illegal practices,fraud and prison sentences.

A company can improve its financial results in numerous ways.It can postpone payments to enhance its cash balance and record a low bad debt reserves to make accounts receivable look stronger.Corporations might offer discounts to accelerate purchases and increase the period's revenue.Another ploy is to defer supplier expenses until a later period.

One motivation for gussying up a balance sheet is to help qualify for bank loan.Financial institutions set standards that borrowers must meet to qualify for the lowest rate loans.For example,the bank might require a strong current ratio(the ratio of current assets to current liablities).A high ratio indicates the company has enough cash and short term assets to pay interest charges.However,loans obtained in this way might cause an actual cash crunch when window dressing can no longer hide anemic cash flows.This increases the risk of default.