This week’s reading covers the breakdown of “bill-and-hold,” profitability ratios, and leverage ratios.
“Bill-and-hold” is an accounting method that allows a company to recognize revenue from a sale before the exchange happens. In other words, it is a way of accommodating retailers who want to buy large quantities of products for sale in the future but put off paying for them until the products are actually sold. “Chainsaw Al,” who was CEO of Dunlap, would use this accounting method to sell Dunlap appliances to stores. It was effective for both parties, as retailers did not have the space to store these appliances in the winter but would be able to store them next season. However, Dunlap’s A/R was unusually high in one of its quarter earnings. Eventually, consumer products analyst Andrew Shore calculated a ratio called days sales outstanding (DSO), which prompted him and other analysts to downgrade Dunlap’s stock.
Out of all the profitability ratios, I believe the return on assets (ROA) is the most essential ratio for investors and analysts to consider when evaluating companies. Since every company relies on its assets to generate money (software, vehicles, machinery, etc.), ROA reflects the efficacy of this. Maintaining a balanced ROA is essential for these two reasons: (1) if an ROA is too low, that means the company’s assets are not generating enough revenue to fund its operations. (2) If an ROA is too high, that usually means executives are using accounting tricks to reduce its asset base.
Out of all the leverage ratios, I believe operating leverage is the most essential ratio for investors and analysts to consider when evaluating companies. This ratio is calculated as fixed costs/variable costs. For example, if Apple moves into a bigger, more efficient store, Apple is increasing its fixed costs. However, their goal is to reduce variable costs since fixed costs remain constant while variable costs fluctuate with production. By achieving this, companies can achieve cost stability, which makes it easier for them to manage their expenses.
Works Cited
Berman, Karen. “Financial Intelligence, Revised Edition: A Manager’s Guide to Knowing What the Numbers Really Mean.” Google Play, Google, Jan. 2013, https://play.google.com/books/reader?id=7TfCiz1LkMMC&pg=GBS.PR1&hl=en_US
Written by Mikael La Ferla
Mikael La Ferla 