Revenue (3)
2. Check against Cash Collected The second thing you can do is to check reported revenues against the actual cash received from customers. In the section on cash flow, we see that companies can show cash from operations (CFO) in either the direct or indirect format; unfortunately, almost all companies use the indirect method.
The virtue of the direct method is that it displays a separate line for “cash received from customers.” Such a line is not shown under the indirect method, but we only need three items to calculate the cash received from customers:
(1) Net sales
(2) Plus the decrease in accounts receivable (or minus the increase)
(3) Plus the increase in cash advances from customers (or minus the decrease) ____________________________________________________________
= Cash received from customers
We add the decrease in accounts receivable because it signifies cash received to pay down receivables. ‘Cash advances from customers’ represents cash received for services not yet rendered; this is also known as unearned or deferred revenue and is classified as a current liability on the balance sheet. Below, we do this calculation for Collins Industries.
We calculate ‘cash received from customers’ to compare the growth in cash received to the growth in reported revenues. If the growth in reported revenues jumps far ahead of cash received, we need to ask why. For example, a company may induce revenue growth by offering favorable financing terms–like the ads you often see for consumer electronics that offer “0% financing for 18 months.” A new promotion such as this will create booked revenue in the current period, but cash won’t be collected until future periods. And of course, some of the customers will default, and their cash won’t be collected. So, the initial revenue growth may or may not be “good” growth–in which case, we should pay careful attention to the ‘allowance for doubtful accounts’.
Taken From : Advanced Financial Statements Analysis