Allowance for Doubtful Accounts (2)
Let’s consider the two dimensions of revenue sources. The first dimension is cash versus accrual: we call this “cash” versus “maybe cash” (represented on the left side of the box below). “Maybe cash” refers to any booked revenue that is not collected as cash in the current period.
Office Depot’s receivables jumped more than its allowance. If we divide the allowance into the receivables (see bottom of exhibit above), you see that the allowance (as a percentage of receivables) decreased from 3.8% to 3.1%. Perhaps this is reasonable, but the decrease helped to increase the booked revenues.
Cash received did not increase as much as reported sales. This is not a bad thing by itself. It just means that we should take a closer look to determine whether we have a quality issue (upper left-hand quadrant of the box above) or a timing issue (upper right-hand quadrant of the box). A quality issue is a “red flag” and refers to the upper left-hand quadrant: temporary accruals. We want to look for any one-time revenue gains that are not cash.
When we read Office Depot’s footnotes, we will not find any glaring red flags, although we will see that same store sales (sales at stores open for at least a year) actually decreased in the United States. The difference between cash and accrual appears to be largely due to timing. Office Depot did appear to factor some of its receivables–that is, sell receivables to a third party in exchange for cash, but factoring by itself is not a red flag. In Office Depot’s case, the company converted receivables to cash and transferred some (or most) of the credit risk to a third party. Factoring affects cash flows (and we need to be careful with it, to the extent that it boosts cash from operations) but, in terms of revenue, factoring should raise a red flag only when (i) the company retains the entire risk of collections, and/or (ii) the company factors with an affiliated party that is not at arm’s length.
Taken From : Advanced Financial Statements Analysis