Is There A Problem Brewing Within This Company?

Vegetable canner and fruit juice manufacturer Sino Grandness Food Industry Group Ltd (SGX: T4B) has been hitting some headlines lately after falling hard in price since Tuesday.

Apparently, a report criticising the China-based company’s financials and business appeared on the internet a couple of days ago. I’ve seen the report, but I’ve no wish to wade into any debate about the validity of the author’s findings.

What I’d like to do though, is to share an interesting facet of Sino Grandness’ financials which I wanted to find out for myself after reading through the report. But first, let’s run through the important financial figures in question.

The numbers that matter

Author and investor Thornton O’glove published a book in 1987 called Quality of Earnings which provided analytical tools that can help investors sift out companies which might face possible problems in the future.

In the book, O’glove suggested two important financial ratios to watch. One of it involves inventory analysis, which my colleague Chin Hui Leong had previously discussed. The other one deals with a company’s accounts receivables. In particular, it looks at the relationship between a firm’s accounts receivable and revenue – and that’s what I wanted to find out with Sino Grandness.

As a brief introduction, the accounts receivable line item is found in a company’s balance sheet and it is simply sales that have been recorded but not yet collected. According to O’glove, a sharp rise in receivables can be dangerous:

“Whatever the cause, major increases in accounts receivables is a danger sign.”

O’glove would further compare the growth of a company’s accounts receivables with its revenue – if the former grew much faster than the latter, then investors might want to sit up and pay some attention.

According to my fellow Fool Rex Moore, accounts receivables which grow disproportionately in relation to sales can be a sign of the following serious business issues a company might be facing:

“It’s a problem if a company is forced to extend more generous payment terms to its customers (from 30 days to 60 days, for example) in order to keep their business. And it’s a problem when customers are dragging their feet and not paying on time — or never pay. And it’s definitely a problem when unscrupulous management forces more product through the distribution channel than its customers are able to sell. (This is known as “channel stuffing.”)”

How does Sino Grandness fare?

With the above in mind, let’s look at how Sino Grandness’ revenue and accounts receivables have grown over the past few years stretching back to the second quarter of 2011.

Sino Grandness

Source: S&P Capital IQ

As you can see from the chart above, Sino Grandness’ quarterly accounts receivables had largely grown at a faster pace (sometimes significantly so) than its quarterly revenues going back to the fourth quarter of 2012.

I’m not suggesting any malfeasance on the part of Sino Grandness’ management here or that the company’s business is in any imminent danger of collapse. But, investors might still want to keep an eye on how the situation of the divergent growth in accounts receivable and revenue eventually plays out.

In any case, the bottom-line for investors is this: Watch your accounts receivables.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.