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Cash received did not increase as much as reported sales. This is not a bad thing by itself. It just means that we should take a closer look to determine whether we have a quality issue (upper left-hand quadrant of the box above) or a timing issue (upper right-hand quadrant of the box). A quality issue is a "red flag" and refers to the upper left-hand quadrant: temporary accruals. We want to look for any one-time revenue gains that are not cash.
When we read Office Depot's footnotes, we will not find any glaring red flags, although we will see that same store sales (sales at stores open for at least a year) actually decreased in the United States. The difference between cash and accrual appears to be largely due to timing. Office Depot did appear to factor some of its receivables--that is, sell receivables to a third party in exchange for cash, but factoring by itself is not a red flag. In Office Depot's case, the company converted receivables to cash and transferred some (or most) of the credit risk to a third party. Factoring affects cash flows (and we need to be careful with it, to the extent that it boosts cash from operations) but, in terms of revenue, factoring should raise a red flag only when (i) the company retains the entire risk of collections, and/or (ii) the company factors with an affiliated party that is not at arm's length.
Cash-Based but Temporary Revenue
When it comes to analyzing the sources of sustainable revenues, it helps to parse the "technical" factors (lower left-hand quadrant). These are often strangely neglected by investors.
The first technical factor is acquisitions. Take a look at this excerpt from a footnote in Office Depot's annual report:
...impacting sales in our International Division during 2003 was our acquisition of Guilbert in June which contributed additional sales of $808.8 million. (Item 7)
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