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Assess Accounts Receivables Like a Factor

November 15, 2012 | About:
Accounts receivables are an important item on the balance sheet, as they are a critical component of many under-valuation scenarios and financial ratios. Accounts receivables could make up a significant part of the net current asset valuation used in determining if a stock is a net-net case. Also, accounts receivables are used in the calculation of the current ratio and quick ratios, indicators of short-term liquidity. Furthermore, accounts receivables are important clues to future revenue and cash levels.

However, investors typically take the value of accounts receivables as given, without any adjustments. A factor, a third party which buys accounts receivables at a discount from small-medium enterprises to improve their cash flow, is probably the most well-qualified person to assess accounts receivables.

A factor will assess the quality of accounts receivables in a step-by-step manner.

First, the debtor concentration needs to be evaluated. If a large percentage of accounts receivables is concentrated with a few customers, the risk of non-payment on the receivables is higher. In addition, if the customers themselves have weak balance sheets and poor profitability, the accounts receivables should be discounted further.

Second, investors should examine the aging of accounts receivables. Receivables overdue for a period exceeding the average receivable days of a company is at high risk of write-down. A trend analysis could be done to examine the trend of receivable days and the proportion of receivables overdue for more than 90 days.

Last, receivables from related parties should be ignored, as the transactions between related parties might not be done on a arm's length basis. The likelihood of fraudulent invoices is also greater with receivables from related parties.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He publishes value investing case studies, investment checklists, and potential stock ideas on the Cheapskate Investing blog. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website

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