week 4 | revenue recognition Flashcards
3 sections to analyze revenue
growth
- internal & external
quality
- Recurring vs Non-Recurring
- Customer concentration
- Seasonality vs volatility
- Gross vs Net Revenue
rev. rec. policy & changes
- consistency in rev rec
- new accounting standards (IFRS 15/ASC 606)
definition of internal & external growth
internal: growth achieved through the company’s existing operations
external: growth achieved through mergers, acquisitions, partnership or other external means
key drivers of internal & external growth
internal:
- Increased sales volume
- Price increases
- New product development
- New market w/ existing products
- Strong opportunities & huge potential CF
external: M&A
- Same industry:
- Vertical M&A: supplier, distributor
- Horizon. M&A: competitors
- When monopoly → stopped
- 70-80% of M&A result in failure → spent too much/cannot achieve synergy
- Cross-industry-diversification
- Managers want stable cash flow & reasonable benchmark for personal compensation
features/considerations of internal & external growth
internal:
- Low risk, sustainable, builds on existing strengths
- Relatively slow
external:
- Quick, immediate revenue increases
- High risk due to integration challenges, significant capital investment may increase leverage or dilute equity
difference between recurring & non-recurring revenue
recurring:
- Predictable, long term
- Link to Core Business
non-recurring:
- One time or irregular
- One time sales
- Asset sales
- Discontinued
- Need to analyze one by one to determine their impact on earnings
what happens with discontinued operations on IS?
Companies often divest of business segments
- Company reports the event at the bottom of the IS by segregating income from continuing vs discontinued operations
Companies are required to segregate the discontinued operation’s A&L on current & prior years’ BS
2 components on the discontinued operations line
- Net income/loss from segment’s business activities prior to the divestiture
- Any gain/loss on sale of business
Why Segregate Discontinued Operations?
Segregated in IS → represent a transitory item (not expected to continue)
- Transitory items won’t recur → largely irrelevant to predict future performance
Investors tend to focus on income from continuing operations → level of profitability likely to persist (continue) into the future
To be classified as a discontinued operation, the disposal of business unit must:
Represent a strategic shift for the company
Have a major effect on the company’s financial results
what is customer concentration & why is it crucial for assessing business risk?
The extent to which a company’s revenue is dependent on a small # of customers
- High customer concentration → revenue volatility if key customers reduce orders or leave
- Crucial for assessing business risk → highlights the potential vulnerability a company might face if it loses one or more major customers
describe Seasonality
- Predictable fluctuations w/ a yr, repeat consistently each year
- Interpret quarterly report carefully
- Retail, tourism, ski resorts
- Depends on economic condition (demand & supply)
- Ex. tension in middle east
describe Volatility
- Unpredictable revenue variation over time
- High volatility indicates underlying risks
- Could be one time event
- Oil & gas, commodities
types of sales allowance and what changes do they cause
Rights of return
Sales discounts (volume purchases)
Retailer promotions (point-of-sale price markdowns & other promotions)
These reduce the amount of cash the company receives
what should be done with sales allowance
Under GAAP company must report amount of cash expected to be received (NET sales)
Companies must deduct from GROSS sales the expected sales return & other allowances
- Use net but do adjustments
reporting sales allowance & the process
companies provide a reconciliation of sales allowance (sales returns & sales discounts & incentives)
process:
1. beginning balance
2. estimate sales return added
3. deduct to get actual sales return
4. ending balance
