Why when a company sells receivables (say 400k with recourse, 300k uncollected) would we take the 300k away from EBITDA in the adjusted income statement? What has a how a company finances its recevibles got to do with its income statement? If they sell the receivables with recourse, surely we should be reversing a finance charge? David
where is this coming from?
Melinda McKay, CFA, an analyst at Integrity Equity, is considering an investment in Earthmovers Inc., whose most recent financial data is provided below. Earthmovers Inc. Income Statement Year ended Dec 31, 2006 ($U.S. thousands) Revenues 20,152 Gross profit 10,022 Operating income 4,819 Depreciation 823 Interest expense 1,040 Income before taxes 2,956 Taxes 887 Net Income 2,069 Earthmovers Inc. Balance Sheet Year ended Dec 31, 2006 ($U.S. thousands) Assets Liabilities & Owner’s Equity Cash 600 Accounts payable 5,500 Marketable Securities 200 Notes payable 3,500 Accounts Receivable 8,500 Total current liabilities 9,000 Inventories 3,500 Total current assets 12,800 Long-term debt 13,000 Net P,P&E 17,000 Preferred stock (100,000 shares) 1,000 Pension Asset 1,500 Common Stock (500,000 shares) 2,000 Intangible Assets 1,000 Retained earnings 8,300 Goodwill 1,000 Total stockholder’s equity 11,300 Total Assets 33,300 Total liabilities & Equity 33,300 The footnotes to Earthmovers Inc. include the following information: Inventories are valued at cost under the last in, first out (LIFO) method, the LIFO reserve is $1.2 million, up $120,000 from the previous year. Capitalized interest for 2006 is $550,000. Earthmovers recently sold $400,000 worth of accounts receivable with recourse. To date only $100,000 has been collected. The funded status of the pension fund is a pension liability of $1,000,000. Due to an increase in yields on corporate debt, the market value of the long-term debt is $12.35 million. The preferred stock is redeemable at the option of the preferred stockholder. The market value of the preferred stock is $9.50. Management viewed the potential liability of $5 million associated with a pending lawsuit as an improbable event. There is no insurance in place to cover any potential loss. Following the release of the financial statements, Earthmovers publicly acknowledged that the loss related to the lawsuit was a probable event and was working out a settlement for $3 million.
I believe the appropriate adjustment is to add an Asset and a Liability of $300k representing the uncollected A/R with recourse. Check that in the book, though. Not sure if there are income statement effects.
if you sell receivables with recourse that is really just unearned revenue. with recourse means the buyer has the right to sell the receivables back to the original seller if they don’t meet a certain set of criteria. so you have to look at a A/R sale with recourse as a liability. you are on the hook to buy them back if they don’t perform as expected. once collected, you can start earning that unearned revenue.
Since only 100,000 has been collected you need to deduct (400,000-100,000) from operating cash flow (since at the sale of 400,000 of receivables the entire 400,000 was added to OCF). Also, assets (accounts receivables will have to be increased by 300,000 and liabilities (current liabilities) by the same amount.
ok… this is the quick review… When you analyze sale of receivables check whether or not they have Recourse… if they are sold without recourse… that’s it… those receivables are never coming back to you… if they have recourse, then, that means that the people to whom you have sold the receivables actually can give them back to you if they can’t collect them (in lay man’s terms)… so as an analyst… what you do is increase receivables…and increase a liability to make the whole thing balance… hope this clears some doubt
Yes, but what has earning got to do with anything? Once we credit sales, it’s “earned”. Are you saying that it’s not “earned” until payment is received? That defeats the purpose of accurals accounting? Cheers! David
chad17 Wrote: ------------------------------------------------------- > Since only 100,000 has been collected you need to > deduct (400,000-100,000) from operating cash flow > (since at the sale of 400,000 of receivables the > entire 400,000 was added to OCF). > > Also, assets (accounts receivables will have to be > increased by 300,000 and liabilities (current > liabilities) by the same amount. Thanks for pointing out the OCF adjustment. Makes sense.
excuse me, what does recourse means??!?? I dont understand this.
Receivables are generally part of a SPE (bankruptcy remote) entity. The financial institution lends to the SPE at a lower rate. Recourse implies the the parent company of the SPE is still responsible for non collection of receivable…i.e. bank/financial institution can come back to them. On the EBITDA…generally the money the company gains from selling the receivables can be thought of as a loan therefore greater interest expense, though it should not affect EBITDA due to its definition.