Lesson 3 of 8
Sold, not paid
Receivables are revenue already counted and money not yet held. Verizon carried $24,742 million gross and an allowance of $896 million against it.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A receivable is revenue that has already been counted in profit and money the company does not have.
- It is carried net of an allowance for the part the company expects never to collect, and that allowance is an estimate.
- Receivables growing faster than revenue is the single most common shape behind a profit that produced no cash.
The first of the four timing cases is the most common. Work is done, an invoice goes out, revenue is recognised, and the money arrives sixty days later or not at all.
Between those two moments the company holds an asset called a receivable. It is a promise, and the accounts have to decide how much of it to believe.
What a receivables balance is made of
- Gross accounts receivable$24,742m
- Allowance for credit losses−$896m
- Carried on the balance sheet= $23,846m
The entry, and what it commits
A credit sale debits accounts receivable and credits revenue. Profit rises at that moment, before any money exists, and the asset stands as the claim.
When the customer pays, cash is debited and the receivable is credited. Profit does not move at all, because it was recognised at the sale. That second entry is invisible in the income statement and appears only in the cash flow statement, as a fall in receivables.
The allowance is a forecast
No company collects every invoice. US rules require a company to estimate the losses it expects over the life of the receivable and carry the asset net of that estimate.
Verizon's FY2021 10-K, filed on 11 February 2022, shows $24,742 million (Verizon Communications Inc. FY2021 10-K, accession 0000732712-22-000008) of gross accounts receivable at 31 December 2021, an allowance for credit losses of $896 million (Verizon Communications Inc. FY2021 10-K, accession 0000732712-22-000008) and a net figure of $23,846 million (Verizon Communications Inc. FY2021 10-K, accession 0000732712-22-000008). The allowance is 3.6 percent of the gross balance.
A year earlier the same filing shows an allowance of $1,252 million on gross receivables of $25,169 million, which is 5.0 percent. The balance sheet asset moved partly because customers paid and partly because the company changed its view of what would be collected.
Why the growth rate matters more than the level
The second pattern has three ordinary explanations and one that is not. The company may have moved into a market that pays slowly, may have offered longer terms to win business, or may have had a large sale land in the final week. Or revenue was recognised that will not be collected.
Nothing in the balance is evidence by itself. What the number does is tell you which question to ask, and the answer is usually in the revenue recognition policy and the receivables note rather than in the ratio.
Where it shows in the cash flow statement
An increase in receivables appears as a negative adjustment in the operating section, because profit included revenue that brought no money. It is the first line most readers skip and the one that most often explains a gap.
Fen Street Bindery's version was $40,000 of the $25,400 gap between its profit and its operating cash. The other accruals partly offset it, which is why the gap is smaller than the receivable.
Check yourself
A customer pays an invoice recognised as revenue last year. What happens to profit?
- It rises by the amount collected
- Nothing. Profit was recognised at the sale; the payment only moves the asset into cash
- It falls, because the receivable is written off
Show the answer
Answer: B.
Collection is a balance sheet event. It appears in the cash flow statement as a fall in receivables and never touches the income statement.Verizon carried gross receivables of $24,742 million and an allowance of $896 million at the end of 2021. What is the allowance?
- Cash set aside to cover bad debts
- An estimate of the amount the company expects never to collect, deducted from the asset
- A liability owed to customers
Show the answer
Answer: B.
It is a contra asset holding a forecast. Changing the estimate changes both the asset and the year's profit, with no cash moving.Revenue grows 20 percent and receivables double. What does that tell you?
- The company is overstating revenue
- Collection slowed sharply, which has several ordinary explanations and one that is not, so it is a question rather than a finding
- Nothing, since both figures rose
Show the answer
Answer: B.
Longer terms, a new market, a late-quarter sale and uncollectable revenue all produce this shape. The balance identifies where to look, not what is there.Sources
- Verizon Communications Inc., FY2021 Form 10-K, filed 11 February 2022, accession 0000732712-22-000008, for gross accounts receivable, the allowance for credit losses and the net balance at 31 December 2021 and 31 December 2020.
- ASC 606, Revenue from Contracts with Customers, on recognising revenue when control transfers.
- ASC 326, Financial Instruments, Credit Losses, on the current expected credit loss model that sets the allowance.
What this leaves out
- The Verizon figures are history, read from the balance sheet filed for those fiscal years. They are not a statement about the company today and not a view on any security.
- The two-company table uses invented round numbers so the days calculation can be checked by hand.
- Days of revenue in receivables is computed here on year-end balances against the full year's revenue. Using average balances or quarterly revenue gives different figures from the same accounts.
- Nothing here is advice about any security.