· One of these simple ploys to predict future downwards earnings revisions by dalal Street security analysts is a careful analysis of accounts receivable and inventories a larger than average accounts receivable situation, and/or a bloated inventory. When U see these, bells go off in my head telling me to analyze that particular stock in a devil's advocate manner. accounts receivable and inventories analysis can be a terrific barometer for forecasting negative earnings surprises, usually well before Wall Street analysts come to the party.
· QUESTION: Why is accounts receivable analysis so important?
ANSWER: Conventional accounts receivable analysis involves running a ratio called days sales in accounts receivable. This ratio, which indicates receivable turnover, can illustrate the granting of more liberal credit terms and/or difficulty in obtaining payment from customers. However, even more importantly, the analysis of sale$ and accounts receivable may provide a clue as to whether a company is merely shifting inventory from the corporate level to its customers because of a "hard sell" sales campaign or costly incentives. In such an instance, this type of sales may constitute "borrowing from the future." Within this context, it is important to note that in most instances, a sale is recorded by a company when the goods are shipped to the customer. Also, there is an added cost to the company in carrying an above-average amount of accounts receivable.
· QUESTION: Why is inventory analysis so important?
ANSWER: Obviously, higher trending inventories in relation to sales can lead to inventory markdowns, write-offs, etc. In addition, it is important to note that an excess of inventories, time and time again, is a good indicator of future slowdown in production. Within this context, it is important to analyze the components of inventories. If the finished goods segment of inventories is rising much more rapidly than raw materials andl or work-in-process, it is likely that the company has an abundance of finished goods and will have to slow down production. Akin to accounts receivable, bulging inventories are costly to carry.
· The difficulty comes when accounts receivable rise substantially over what they had been in the same reporting period during previous years. This can result from any of several factors. A spell of economic hard times for the country, industry, or region will often cause stretchouts in payments. A poor collection job might be another reason. Perhaps the retailer, his back against the wall and eager to make sales, has offered his customers liberal credit terms. This often happens in the auto industry during slack periods. In retail business, this is the equivalent of end-of-season sales and the dumping of unfashionable merchandise.
. Whatever the cause, major increases in accounts receivable is a danger sign.
· An analysis of the relationships between sales, accounts receivable, and inventories may provide a clue as to whether a company is merely shifting inventory from the warehouses to its customers due to "hard sell" campaigns or costly incentives. incentives. In such an instance, these kinds of sales may constitute borrowing from the future or rectifying past errors. In this context it is important to recall that in most instances, revenues are recorded by a company when the goods are shipped to the customer. Also, there are the added money costs of carrying accounts receivable
· for inventories. These are stores of raw materials and finished and semifinished products. Manufacturing concerns may have very large inventories as a ratio to sales, while service companies have smaller ones. Indeed, the key distinction between the manufacturing and service sectors is just that: companies can stockpile inventory products, but not services. For example, a stock market advisory service has an inventory of paper, back copies, postage stamps, and the like, which can be quite minor when set beside gross income. Knowing the inventory for such an operation isn't very useful. On the other hand, a furniture factory can have an inventory larger than annual sales. As , the specific amount of inventory is not particularly meaningful in and by itself. What matters is comparisons with the same reporting period in previous years.
· Sometimes a phenomenon exists which I call "positive inventory component divergence," meaning simply the reverse of some of the illustrations described thus far, which were of negative inventory divergences. The positive version transpires when the raw materials component of inventories is advancing much more rapidly than the work-in-process and finished goods components. Imagine what this might mean. The company receives many new orders, and management realizes that an inventories buildup is required. So it simultaneously ships products from -its finished goods inventory (which declines) while ordering raw materials in larger amounts (so this component of inventories is enlarged). This, of course, is good news, and should trigger the bullish impulses in your psyche.
Investors who ignore accounts receivables and inventories especially in high tech and consumer-sensitive industries-run unnecessary risks without the chance of commensurate rewards. Next time you hear some wild story about a glamour stock and are tempted to buy without investigating, think about Ben Smith and that factory with the smokeless smokestacks
No comments:
Post a Comment