Revenue Fluctuations and Accounting Standards

Volatility

• Predictable fluctuations in revenue that occur consistently each year are referred to as seasonality.
• Unpredictable revenue variation over time is known as volatility.
• High volatility indicates underlying risks, which could be due to one-time events.
• Businesses like retail, tourism, and ski resorts experience predictable seasonal fluctuations in revenue.
• The oil and gas industry is known for its unpredictable revenue variations and high volatility.

Gross Revenue vs Net Revenue: Allowance

• Companies often offer customers various sales allowances, such as rights of return, volume purchase discounts, and retailer promotions (point-of-sale price markdowns).
• These allowances reduce the cash a company receives, meaning reported revenue should reflect the net sales figure.
• Generally Accepted Accounting Principles (GAAP) require reporting the cash expected to be received (net sales).
• Companies must deduct expected sales returns and other allowances from gross sales.

Sales Allowances: Example

• If Levi Strauss sells jeans for 130(costing130 (costing 130(costing80) and anticipates a 3% return rate, its income statement would reflect this adjustment.

Reporting Sales Allowances

• Companies are required to provide a reconciliation of sales allowances, including sales returns, discounts, and incentives.

Analysis of Sales Allowances

• There are three key metrics to analyze sales allowances:
  • Additions charged to Gross Sales: measures the income statement amount, revealing the impact of pricing pressure on net sales.
  • Sales Allowances as a Percentage of Gross Sales: measures the balance sheet amount, highlighting the dollar value of allowances.
  • Adequacy of the allowance amount: compares estimated future returns to actual realized returns.

Discontinued Operations

• Discontinued operations are segregated in the income statement because they represent a transitory item, unlikely to recur.
• Investors focus on income from continuing operations as it reflects the profitability likely to persist in the future.
• A disposal of a business unit qualifies as a discontinued operation if it represents a strategic shift for the company and has a major effect on its financial results.

Analyst Adjustments

• When analyzing a company's return on equity (ROE) and return on assets (ROA), analysts use "Income from continuing operations" as the appropriate earnings number.

Customer Concentration

• Customer concentration refers to the degree to which a company's revenue depends on a small number of customers.
• High customer concentration can lead to revenue volatility if key customers reduce orders or leave.
• Understanding customer concentration is crucial for assessing business risk.

Analyst Adjustments 5.1

• Analysts adjust numbers to account for deliberate variations in sales allowances across years, as managers may inflate or deflate estimates to meet net sales or earnings targets.
• Analysts estimate an "average" rate of additions charged to gross sales and apply that average to adjust related balance sheet and income statement accounts.

Analyst Adjustments 5.1: Levi Strauss

• An average rate is estimated based on historic data.
• This average rate is used to adjust both balance sheet and income statement numbers for accuracy.

Unearned (Deferred) Revenue

• Some industries commonly receive cash before recording revenue.
• Deposits or advance payments are not recorded as revenue until the company performs its obligations.
• Companies record a liability (unearned revenue) to reflect the obligation to deliver products or services.
• When the good is provided or service rendered, the unearned revenue liability is reduced, and revenue is recognized.

Analysis of Unearned Revenue

• A decrease in deferred revenue liabilities suggests current reported revenue was collected from customers in a prior period.
• Growth in deferred revenue can predict future increases in revenue and profit.
• Analysts carefully track the rate of change in deferred revenue to understand potential revenue trends.

Accounts Receivable

• Selling goods on account presents the risk of customers being unable to pay.
• Companies must estimate the amount of receivables likely to be uncollectible and only report the collectible amount.
• An aging analysis groups accounts receivable by the number of days past due to estimate uncollectible accounts.

Write-Off of Uncollectible Accounts

• When a customer declares bankruptcy and a receivable is deemed uncollectible, a write-off is recorded, adjusting the allowance.

Analysis of A/R - Magnitude

• The magnitude of accounts receivable is measured using two ratios:
  • Accounts Receivable Turnover
  • Days Sales Outstanding (DSO)
• DSO reveals the average number of days it takes to collect outstanding accounts receivable.

This quiz covers key concepts related to revenue fluctuations, including seasonality and volatility in various industries. It also addresses the differences between gross and net revenue, emphasizing sales allowances and GAAP principles. Test your understanding of how these financial concepts impact businesses.