Just wondering if other Strawpeeps take much notice of receivables in company reports?
Its not something I have previous done but will pay much more attention to now I understand the implications a bit better; and honestly I’m a bit embarrassed I didn’t understand it prior to this late stage in my investing journey!
Having had a light bulb moment after reading an article on the subject, of which I’ve reproduced a section below, I asked Perplexity to identify ASX listed companies with rising receivables and got a bit of a fright when two of my holdings were in the worst five! Hitech and Genus Plus (my largest IRL holding). I’m going to exit Hitech but am reassured that GNP’s receivables as a percentage of revenue are essentially static.
It seems like a good thing to track as a potential red flag for dodgy accounting and a failing business model.
Rising receivables can disguise a business model under strain, however. Carillion, a building firm, collapsed in 2018, becoming Britain’s largest-ever liquidation. Hedge funds had short-sold its stock after noticing accounts receivable were climbing faster than revenues.
On other occasions, receivables are used for brazen fraud. Sunbeam, an American consumer-products firm, restated its results in 1998 after it was found to have inflated its revenue with sales it had not made yet, which were booked as accounts receivable. Satyam Computer Services, an Indian IT company, produced reams of fake invoices, designed to generate receivables and bolster tales of rapid expansion. When Enron, an energy-and-trading giant, crumbled in 2001, its receivables position proved to be illusory.
Receivables are difficult for auditors to scrutinise. Companies have lots of clients. Even when they are legitimate, it is hard to tell how much cash will eventually arrive from them. Shady practices such as “channel stuffing”, which involves sending customers more product than they have ordered and temporarily recognising the additional revenue, require a forensic eye to spot. Barry Minkow, a businessman jailed twice for fraud, was at least honest: “Accounts receivable are a wonderful thing. They are a tool that is used by a fraudster like me, to ask to borrow money mainly, and to show earnings.”
It looks as though receivables are normalising rather than deteriorating...
It's definitely something to keep an eye on, or rather when you see weak cashflow I try and work backwards to see where it went. Incremental ROIC is a big driver of valuation uplift (and downshift) and in a business like HIT, ROIC would be heavily influenced by working capital intensity.
That being said, I'm not sure Carillion or Sunbeam are the best analogues for what can go wrong in a business like HIT. When companies start to fudge the numbers there's usually some root reason why they are doing that. For a family owned company with no debt and no need to raise cash there's not an obvious reason, but HIT is not a company I follow too closely.