We penalise companies which have a high level of debt repayment relative to short term debt at the beginning of the financial period as it could indicate that they are window dressing their financial statements. In order to window dress financial statements, a company will sell short-term liquid assets to repay debt just before the end of the financial period, and then repurchase it immediately afterwards.

Window dressing is difficult to spot. In addition to an overly liquid balance sheet, other indicators include the factoring of receivables and/or inventories. There should be some mention of the amounts factored or sold in the respective accounting notes although often this is not the case owing to sloppy audits. Failing that, the amounts factored should appear either in the operating cash flow or the financing section of the cash flow statement. If there is no mention in the notes to the accounts, the discount at which the receivables or inventories are sold may be disclosed in the interest expenses note.

Proceeds from the factoring of short-term assets are used to repay debt just before the accounting period ends. This creates a debt repayment entry in the financing section of the financial statements. As such, a high level of short-term debt repayment relative to the short-term debt disclosed at the beginning of the financial period can indicate that companies are window dressing. Furthermore, a high effective interest rate can be added confirmation that debt churn has been taking place. This is because the average debt level throughout the reporting period is actually far higher than disclosed at the period-end. For example, during 2012, Noble Group repaid US$4.3bn in debt versus short-term debt of US$655m. In other words, debt repayment was 6.5x short term debt. This resulted in an effective interest rate of 7.1% for a company that was of investment grade, and should have been paying half that amount.

Short term debt repayment for our sample of 16,000 companies came in at a median average of 88% to short term debt at the beginning of the financial period. Our accounting screen is set to trigger a red flag when debt repayment/short term debt is in the highest 80th percentile relative to global peers (i.e. it is very high), and/or when there is an abnormally large increase relative to the normal rate of change amongst industry peers over one and three years. This latter red flag is triggered when the increase in debt repayment/short term debt is in the 80th percentile relative to the change experienced by industry peers between 2010 and 2015.