Wednesday, October 22, 2003

Useful Metric: Accounts Receivable

As you sift through the financials of investment prospects, keep an eye on accounts receivable. This item, found just below "cash and equivalents" on the balance sheet, indicates the money owed a company by its customers.

Looked at in the context of sales performance, accounts receivable can suggest how quickly customers are paying their bills. Naturally, the sooner they cough up, the better. The company can then plough that cash back into the business, pay its expenses, reward stockholders with dividend payments, eliminate debt, or do any of the other good things that cash flow enables. Also, it's a sad truth of business that the older a receivable is, the less likely it will be paid off at all.

A good way to see whether a company is staying on top of its accounts receivable is to measure "accounts receivable turnover," defined as total credit sales for a particular accounting period divided by the average value of the accounts receivable during that period.

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