First, from a high level, the income statement displays the ability of a company to generate value over a specific period of time. The balance sheet gives a snapshot picture of a company’s financial picture at the end of an accounting period. The statement of cash flows reflects the company’s ability to generate/raise cash from operating, investing and financial activities.
When you examine performance through KPIs/formulas, most of the data probably comes from an income statement. It is also the one read the most. Therefore, in this blog post (which is part of a series of related posts), I’ill start the tour and commentary there, in particular at the top-line; i.e., revenue!
Revenue defines a company’s operating size; thus, founders, their CFOs, and VCs focus on the growth in revenues, particularly as measured on a year-over-year basis. Though less visible, but as important, is the content of the revenues themselves.
The timing of revenue recognition is crucial, particularly so for company’s that sell a relatively small number of high ticket products, in a particular period.
Generally, it is acceptable to record revenue when the sale is irreversible. You may wait for delivery and acceptance of the product by a customer or for full installation to be complete, ensuring that the contract has been adequately fulfilled.
As an acquirer or investor, watch out for some companies that might be relatively aggressive regarding revenue recognition and book the majority of sales in the last month of a quarter, if not the last week of the quarter.
Look for big jumps in accounts receivable or days receivable outstanding. The most prevalent is the practice of stuffing the distribution channel.
Channel stuffing is done through offering special discounts, easy and extended payment terms, or even offering elaborate return privileges. Though, if demand for a product weakens enough, all the incentives in the world may prove ineffective.
If you are a potential investor or acquirer, you can determine wether or not a company that is pitching you is engaged in ‘channel…