How to Analyse Revenue Quality: A Six-Step Order

Test revenue quality in six steps: measure the growth against its comparative, compare receivables growth with revenue growth, read the days trend across at least three years, check how concentrated the revenue is, look at what happened to terms and provisions, then finish in the notes and the accounting policy. The output is a set of questions, never a verdict.

Here is why an order is needed at all. Revenue that will turn into money in the bank and revenue that will not look exactly alike on the income statement: one line, one amount, no marking on it to say which kind it is. Everything that separates the two sits somewhere else, on the balance sheet, in the ageing, in the customer list, in the notes at the back. So the test is not a formula. The test is a route through several documents, taken in a fixed order, writing down one note at each stop.

Order matters more here than anywhere else in reading accounts, and for one blunt reason. Each stop changes what the next stop is looking for. Run out of sequence, the steps arrive at the customer list without anyone knowing what they came to ask it. Stopped halfway, they leave half a finding. Half a finding still reads like an answer, so it is worse than none.

The order takes its terms as known. Revenue qualityA shorthand for how likely reported sales are to end up as money in the bank, and how repeatable they are. Revenue quality is a judgement about the character of the revenue, formed from several lines rather than read off one., receivables, days sales outstanding, provisions and the recognition policy are each set out in their own right, so the sequence adds only where to look, in what order, and what to write down. All six steps are worked on Anjani Stationers, an invented stationery business whose year two accounts run through all six, and a blank checklist card at the end carries to any other set of accounts.

Step one: how fast did revenue grow, and against what?

Step one opens the income statement. Revenue for the year and revenue for the year before give the change as a percentage. The year before that is taken as well, so there are two growth rates rather than one, and the pair is written down. Two growth rates, written down, is the whole of step one, and the second growth rate is the part people skip.

Step one produces a growth rate and a comparative, and a growth rate without its comparative is not yet evidence of anything. The same logic governs ordinary life. A shop that sold two hundred umbrellas last month says nothing until the four hundred it sold the month before is known, and even then it matters that it is now October. The same business one year earlier had the same customers, the same product and the same accounting policies, and no outside comparison can offer that. So the comparative is the business's own prior year.

Anjani Stationers, worked. Revenue was Rs 2,40,00,000 in year one and Rs 2,70,00,000 in year two. The change is Rs 30,00,000 on Rs 2,40,00,000, or 12.5 per cent. Go back one more: revenue in year zero was Rs 1,95,00,000, so year one grew 23.1 per cent. The note from step one is that growth roughly halved, from 23.1 per cent to 12.5 per cent, on a business that is still growing. Nothing about that is alarming on its own. The halving is written down and carried forward. The question it raises, why the pace fell, stays open until the later steps have had their turn.

Step two: did receivables grow faster than revenue?

Step two moves to the balance sheet and takes gross trade receivables for both years. The change is worked as a percentage, exactly as it was for revenue, and the two percentages are set next to each other. Then one further sum that takes ten seconds and is worth all of step two: last year's receivables multiplied by this year's revenue growth rate, and how far the actual balance sits above or below that.

Step two produces a comparison of two growth rates and the rupee gap between them, and it produces a question rather than a finding. The step does not say why the gap exists. The balance sheet does not carry reasons, so step two cannot. Step two only sizes the gap that steps three, four and five will go looking for, and a step two note that reads like a conclusion has been written too early.

Anjani Stationers, worked. Gross receivables went from Rs 78,00,000 to Rs 95,00,000, a rise of Rs 17,00,000, or 21.8 per cent. Revenue grew 12.5 per cent. So receivables grew about one and three-quarter times as fast as the sales they came from. Now the ten-second arithmetic: Rs 78,00,000 grown at 12.5 per cent would have been Rs 87,75,000, and the actual balance is Rs 95,00,000, so Rs 7,25,000 more is owed than growth alone accounts for. The note from step two is that Rs 7,25,000 of the closing receivables is not explained by the business simply being bigger, and the question is what it is sitting against.

Step three: which way is the days trend moving?

Now take three years, not two. Work days sales outstanding for each of the three, write the three numbers in a row, and read the row rather than the last entry. Two things get marked: the direction, and which year carried the largest single move. Step three is the only step in the order that refuses to work on a single year, and the refusal is deliberate.

Step three produces a shape, and the shape is the point: a level that stepped once and settled reads completely differently from a level that is climbing every year. A household that has slipped from paying its electricity bill on the due date to paying it three weeks late makes the difference concrete. If that happened in one particular month, when a wedding drained the account, and it has held steady at three weeks since, that is one story. If it slipped a week later every quarter, it is a different story with the same latest reading. Only the row of three tells the two apart.

Anjani Stationers, worked. Days sales outstanding was 56 days in year zero, 119 in year one and 128 in year two, carried to one decimal as 56.2, 118.6 and 128.4 when the moves are subtracted. Read the row. The direction is one way, worse in each successive year. But the size of the moves is lopsided: the jump from year zero to year one is 62.5 days, and the move from year one to year two is 9.8 days. The note from step three is that the wait more than doubled two years ago and has drifted a further ten days since, so the event to ask about sits in year one and the question for year two is whether it is still running. A reader who only had year two in front of them would have carried a nine-day drift into the rest of the order and missed the sixty-two-day step behind it.

Step four: how concentrated is the revenue?

Leave the totals and go to the customer disclosures and the receivables ageingA table splitting what customers owe by how long it has been outstanding, usually in bands such as under six months, six to twelve months, and beyond.. Two things get written down at step four. First, how much of the revenue comes from the largest customer or the largest few. Second, whether those same names also hold a disproportionate share of what is owed and of what is overdue. Step four is a matching exercise: the revenue list is laid over the receivables list, and the names that appear high on both are the finding.

Step four produces the names, and until the names are on the table the earlier steps are talking about an anonymous total that behaves as if every customer were the same. They never are. A food stall outside one office building and a food stall in a railway station can take identical daily cash, and the first one is a very different business on the day the office moves. ConcentrationThe extent to which sales or amounts owed depend on a small number of customers. High concentration means one customer's behaviour moves the whole business. is that difference, and step four is where a set of accounts stops being an average and starts being a list of actual counterparties.

Anjani Stationers, worked. The Sunrise Public School group took 30 per cent of year two revenue, so about Rs 81,00,000 of the Rs 2,70,00,000. On the receivables side it holds 40 per cent of the balance, Rs 38,00,000 of the Rs 95,00,000. Work its own wait and it comes to about 171 days, against about 110 days for every other customer on the book. The note from step four is that the largest source of revenue is also the slowest payer, and the two facts sit with a single counterparty rather than being spread across the customer list. That reframes what step two found: the Rs 7,25,000 the growth did not explain is now attached to a name.

Step five: what happened to terms and provisions?

Step five asks the accounts what the business itself expects. Two readings, in this order. First, the credit termsThe number of days a seller formally allows a customer to pay, agreed in the contract or stated on the invoice. Sixty days and ninety days are common.: are the stated terms the same as last year, or has the business started selling on longer credit? Second, the provision for doubtful debtsAn amount the business itself sets aside against receivables it does not expect to collect in full. The provision reduces the receivable balance shown on the balance sheet and is charged against profit.: what does it stand at, what did it stand at last year, and what is it as a share of the gross balance?

Step five produces the business's own opinion of its receivables. The people who raised the invoices are the ones who decided how much of them to write down, so that opinion carries a weight nothing computed from outside can match. Everything up to here has been an outsider's arithmetic on published totals. Step five is the first step where the accounts talk back.

Anjani Stationers, worked. On terms, the accounts show no change in the stated credit period. That half of the step yields nothing, and the nothing is written down rather than skipped. On the provision, the balance went from Rs 3,00,000 to Rs 9,00,000, three times what it was, with Rs 6,00,000 charged against year two profit to get it there. As a share of the gross book that is a move from 3.8 per cent to 9.5 per cent, so the proportion the business expects not to collect has risen roughly two and a half times over. The note from step five is that the business has tripled what it expects to lose. The tripling is management's own judgement rather than an outsider's inference, and the question is which balances the extra Rs 6,00,000 was raised against.

Step six: what do the notes and the accounting policy add?

Go to the back of the accounts. Read the revenue recognition policy in full, then read the notes that touch anything the earlier steps flagged. Step six is corroborationChecking a finding against a second, independent part of the same document. A number that survives corroboration is stronger than one that appeared only once., so no new material is being hunted for. The question is whether the back of the document agrees with what the front of it implied, and whether anything the earlier steps assumed is contradicted here.

Step six produces either a confirmation or a contradiction, and a policy that turns out to be entirely ordinary is a real result that gets written down as such. There is a temptation to treat an unremarkable finding as no finding. Resist it. Establishing that the recognition policy is conventional is exactly what allows the earlier notes to stand as questions about collection rather than questions about recognition, and those are very different conversations to have with a management team.

Anjani Stationers, worked. The policy states that revenue is recognised when notebooks are delivered to a school, not when an order is signed and not when the money arrives. Recognition on delivery is ordinary for this trade and nothing about it is stretched. Two timing items appear in the notes. A contract liabilityMoney a customer has already paid for goods or services the business has not yet delivered. The advance sits as a liability until delivery happens. of Rs 4,00,000, up from Rs 2,00,000, being schools that paid ahead of delivery. And accrued revenue of Rs 2,50,000 for a delivery made in the last week of the year and not yet invoiced. The accrued amount sits inside the Rs 95,00,000 rather than adding to it. The note from step six is that the policy is conventional and the two timing items are small and disclosed, so nothing in the notes contradicts the earlier five notes and nothing rescues them either.

What do the six notes say about Anjani Stationers' year two?

The pass is now complete, so lay the six notes out together. The six rows are the deliverable: not a paragraph of opinion, but six rows, each carrying what was found and the question it leaves open.

Read the right-hand column and notice what it is not. There is no sentence anywhere in it saying the revenue is real or the revenue is not real, and that absence is the procedure working correctly rather than the procedure being incomplete. Six passes over published documents can establish that Rs 7,25,000 of receivables is not explained by growth, that one counterparty holds 40 per cent of the book at 171 days, and that the business has tripled its own provision. None of those, alone or together, establishes what caused any of it. Only the contracts, the correspondence and the schools themselves can answer the six questions, and the order exists so that a reader arrives in that conversation with six specific questions instead of one vague suspicion.

Stopping after step two leaves four of the six questions unasked, and the two that do get asked are the two least able to explain each other. Step one gives a growth rate with no cause and step two gives a gap with no owner, so a reader who halts there has two facts that both point outward and nothing to point them at. Run the ledger to the end and the count is six questions against zero unasked, and the fourth of them, the one about a single counterparty, is the one every later conversation turns on.

Who runs this order in real work, and what do they do with the six notes?

Three people open the same accounts in the same week, run the same six steps, and stop at different rows because they are funding different risks.

A lender runs the order to size a limit and stops hardest at step four, an equity analyst runs it to decide what to ask on the results call and stops hardest at step three, and Anjani Kulkarni runs it on her own accounts to find out which conversation to have on Monday. Watch each of them. The lender is deciding how much short-term funding to extend against a book of receivables, and step four decides that almost by itself: a limit secured on Rs 38,00,000 owed by one group paying in 171 days is a different proposition from the same rupees spread over sixty schools paying in 110, even though steps one to three read identically in both worlds. So the lender takes the six notes and asks for the ageing split by customer before quoting anything.

The equity analyst has fifteen minutes on a call and one question that will be answered honestly. Step three is where that question comes from. The shape of the row decides what to ask: a level that stepped once and settled invites what happened in year one, while a level still climbing invites what is being done about it now. Getting that wrong wastes the only question. And Anjani Kulkarni, who runs the business, uses the order for something the other two cannot. She already knows why the pace halved and who is slow. The six notes give her the sequence in which an outsider will discover it. That sequence shows her what her own accounts will look like to a bank in March, and gives her until then to do something about the Rs 38,00,000.

One more use, and it is the least glamorous and the most common. The order is also how somebody else's finished note is checked. Given a paragraph asserting something about a company's revenue, ask which of the six steps produced each sentence in it. A note whose sentences all trace back to steps one and two is a note that stopped early, whatever confidence it is written with, and that test takes about a minute.

Anjani Stationers Private Limited, Anjani Kulkarni and the Sunrise Public School group are invented.
Educational material. Not advice on any investment, tax, budget or market position.