Financial Education

The “top line” revenue number is of particular significance in financial statement analysis. For one thing, overstating the revenue line will generally have a direct impact on profits. A relatively easy way to assess the earnings quality of revenue is to convert it into cash collections from customers, as would be done when creating a direct-method statement of cash flows.

Under normal circumstances, revenue and cash collections from customers should follow a similar pattern. By analyzing the ratio of revenue to cash collection over time, investors may be able to detect changes in the quality of sales. The conversion itself is fairly simple: Cash collections from customers = Revenue - the change in accounts receivable + any change in deferred revenue.

It is useful to check the footnotes to the financial statements, as deferred revenue and certain receivables are frequently lumped into “other” liabilities and assets, respectively. It would also be prudent to adjust receivables for any changes in the amount of securitized, or “factored” receivables.

For more information, see all articles on: Accounting, Adjusting Reported Financial Statements, Financial Statement Analysis, Fundamental Analysis, Investing in Stocks, Ratio Analysis

See also:

Accounts Receivable

Cash Collected from Customers

How Lessors Report Operating Leases

What is a Balance Sheet?

The Statement of Cash Flows