Deferred revenue, which is also referred to as unearned revenue, is listed as a liability on the balance sheet, because under accrual accounting, the revenue recognition process has not been completed, and the company’s product or service is still due to the buyer. When a company uses the accrual accounting method, revenue is only recognized as earned when money is received from a buyer and the goods or services are delivered to the buyer. When a company accrues deferred revenue, it is because a buyer or customer paid in advance for a good or service that is to be delivered at some future date.

Cash received in this manner is considered a liability because there is still a chance the good or service will not be delivered, or the buyer may cancel his order. If either case occurs, a company has to repay the customer, unless other payment terms were explicitly stated in a signed contract.

An example of deferred revenue is when a magazine company accepts payments in the form of yearly subscription services, which are paid annually. If the magazine company delivers a monthly magazine, only one-twelfth of the collected money can be recognized per month, because the full 12 magazines have not yet been delivered.

If a customer decides to cancel his subscription, or the magazine company decides to discontinue the subscribed magazine, the company is obligated to return the unearned money to the customer unless previously stated otherwise. This is exactly why it is considered a liability until earned.

Earnings before interest, taxes, depreciation and amortization, or EBITDA, is a popular equity evaluation metric for analyzing companies in the telecommunications sector mainly because of what the metric excludes, such as depreciation.

The Nature of the Telecommunications Sector

To understand the usefulness of EBITDA as an evaluation metric, an investor must understand the nature of the telecommunications sector. The sector is, overall, characterized by being high-growth, capital-intensive, with high fixed costs and relatively high levels of debt financing. Many companies have a large base of fixed assets, leading to correspondingly high levels of depreciation expenses. An additional factor to consider is telecom firms sometimes receive tax incentives from the government. These tax incentives can result in rather volatile swings in free cash flow, and, therefore, cash flow metrics may not be the most well-suited evaluation points for telecom firms. By excluding capital expenditures, depreciation and financing costs, EBITDA provides a cleaner evaluation of a company’s earnings.

Advantages of the EBITDA Metric

One advantage of using EBITDA for evaluations is that by excluding the impact of accounting and financing decisions related to capital expenditures, it allows for more accurate comparisons between similar firms, especially if one firm is in the midst of extensive capital projects while the other is not. EBITDA is considered a more reliable indicator of a company’s operational efficiency and financial soundness because it enables investors to focus on a company’s baseline profitability without capital expenses factored into the assessment.

Also, from a purely practical standpoint, using EBITDA is helpful because it is also used in other valuation measures commonly applied to telecommunications companies, including EV/EBITDA and debt/EBITDA.

EBITDA Drawbacks

One of the major strengths of EBITDA, its exclusion of capital expenditures, can also be viewed as a weakness. Some analysts argue that precisely because capital expenditures are very important to telecom companies, they should be included and, in fact, carefully scrutinized. EBITDA provides an assessment of profitability, but not of operating cash flow, a metric that provides very good tracking of a company’s working capital management.

Inventory turnover is an important metric for evaluating how efficiently a firm turns its inventory into sales. For a couple of key reasons, average inventory can be a better and more accurate measure when calculating the inventory turnover ratio.

Inventory Turnover

Inventory turnover details how much inventory is sold over a period of time. One way to calculate it is as:

Cost of Goods Sold ÷ Average Inventory

Notice the need to calculate average inventory in the denominator. Average inventory is simply the average between the reported inventory level during the beginning of the measurement period and during the end of the measurement period.

Why Average Inventory?

When thinking about the differences between the income statement and balance sheet, one starts to understand why average inventory is used. Income statements cover a period of time, such as a quarter or single year. Using an annual 12-month period as an example, the stated cost of goods sold (COGS) figure will be recorded and accumulated throughout the year and then the average is determined from these numbers. In other words, average inventory is the COGS level that builds from January through December for a firm that uses a calendar year as its fiscal full year period.

In contrast, a balance sheet represents the state of a firm’s assets and liabilities at a certain point in time. For the calendar year example above, this same firm’s annual inventory level will be the snapshot on December 31. For this reason, it is certainly arguable that taking the average of the inventory level at the beginning and ending of the year is more accurate.

An Example

The need for average inventory is even more justifiable for a firm that experiences seasonality. For many retailers, inventory levels build during the end of the year to prepare for sales during the all-important holiday season that starts with Black Friday (to indicate that a retailer operates in the red all year, until it starts earning profits and operates in the black)

Assuming a quarterly inventory turnover estimate for retailer Target Corp (TGT), its fiscal 2013 inventory level stood at $8.4 billion in July but jumped nearly 30% to $10.4 billion in October, just as it was preparing for the holiday season. Using average inventory helps smooth these two disparate periods.

The Bottom Line

Managing inventory levels is important for most businesses and this is especially true for retailers and any company that sells physical goods. Average inventory is needed for a more accurate picture in a couple of key cases.

At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

Buying on margin involves borrowing money from a broker to purchase stock. A margin account increases your purchasing power and allows you to use someone else’s money to increase financial leverage. Margin trading confers a higher profit potential than traditional trading but also greater risks. Purchasing stocks on margin amplifies the effects of losses. Additionally, the broker may issue a margin call, which requires you to liquidate your position in a stock or front more capital to keep your investment.

Suppose you have $10,000 in your margin account, but you want to buy stock that costs more than that. The Federal Reserve has a 50% initial margin requirement, meaning you must front at least half the cash for a stock purchase. This requirement gives you the ability to purchase up to $20,000 worth of stock, effectively doubling your purchasing power.

After you make the purchase, you own $20,000 in stock and you owe your broker $10,000. The value of the stock serves as collateral for the loan he has given you. If the stock price increases to $30,000 and you sell it, you keep what remains after paying back your broker (plus interest). Your proceeds equal $20,000 (minus interest charges) for a 100% gain on your initial investment of $10,000. Had you initially paid for the entire $20,000 yourself and sold at $30,000, your gain is only 50%. This scenario illustrates how the leverage conferred by purchasing on margin amplifies gains.

Leverage amplifies losses in the same way. Suppose the stock price decreases to $15,000 and you sell it to prevent further losses. After paying your broker the $10,000 you owe him, your proceeds come to $5,000. You lost half your original investment. With traditional investing, however, a price drop from $20,000 to $15,000 only represents a 25% loss.

Another risk of purchasing stocks on margin is the dreaded margin call. In addition to the 50% initial margin requirement, the Federal Reserve also requires a maintenance margin of 25%. You must have 25% equity in your margin stocks at all times. Your margin agreement with your broker may call for a higher maintenance margin than the Fed’s minimum. If the value of your stock decreases and causes your equity to fall below the level required by the Fed or your broker, you may receive a margin call, which requires you to increase equity by liquidating stock or contributing more cash to your account.

Returning to the example above, assume your broker’s maintenance margin requirement is 40%. Because you owe your broker $10,000, a drop in the stock price from $20,000 to $15,000 decreases your equity to $5,000. That is only 33% of the stock price – you have fallen below the 40% minimum. If you cannot or choose not to contribute more capital to cover the margin call, your broker is entitled to sell your stock, and he does not need your consent.

Social responsibility in marketing is important because the practice involves focusing efforts on attracting consumers who want to make a positive difference with their purchases. Recyclable packaging, promotions that spread social awareness and portions of profits that benefit charitable groups are examples of social responsibility strategies.

Many companies have adopted social responsibility strategies in marketing as a means to help the community or produce services and products that benefit society. For example, marketing departments may launch a campaign that encourages consumers to buy a bundle of socks versus one pair and the company in turn donates a bundle of socks to military personnel overseas or to homeless shelters in the community. As a result of such generous donations the company brands itself as socially responsible and ethical, which ultimately attracts customers who are engaged in socially responsible commitments and who want to support the welfare of the community.

Corporate responsibility goes hand in hand with social responsibility practices. For example, administrators, executives, and shareholders and stakeholders must practice ethical behaviors and join the community in promoting responsible marketing efforts. Putting on appearances or greenwashing, the practice of deceptively promoting environmentally friendly processes or products, indicates to customers that the company is not committed to social responsibility and can ultimately hurt the brand and the company’s success. Consumers often do their research and can see through gimmicks and slogans that are not genuine.

Although an initial investment may be involved to split portions of profits or donate to those in need, social responsibility in marketing promotes a positive company image, which can significantly impact productivity and profitability favorably.

The capital adequacy ratio (CAR) measures the amount of capital a bank retains compared to its risk. National regulators must track the CAR of banks to determine how effectively it can sustain a reasonable amount of loss. National regulators must also determine if a bank’s current CAR is compliant with statutory capital regulations. The CAR is important to shareholders because it is an important measure of the financial soundness of a bank.

Two types of capital are measured with the CAR. The first, tier 1 capital, can absorb a reasonable amount of loss without forcing the bank to cease its trading. The second type, tier 2 capital, can sustain loss in the event of liquidation. Tier 2 capital provides less protection to its depositors.

In relation to the amount of funds borrowed and deposits made, the amount of shareholders’ equity within a bank is comparatively small. Because of this, banks are typically highly leveraged, which requires banks to operate on a higher plane of borrowing than would be seen in most other businesses.

In general, a business borrows funds that are approximately equal to its net worth. A bank, by contrast, has liabilities that are typically in excess of 10 times its equity capital. The greatest part of those liabilities are representative of smaller sums of money that depositors have entrusted to the bank.

Because of the nature of risk under which banks operate, capital regulations require banks to maintain a minimum level of equity per loans and other assets. This required minimum is designed for protection, allowing banks to sustain unanticipated losses. The minimum is also designed to offer depositors confidence in the security of their deposits given the asymmetric information.

An individual depositor cannot know if a bank has taken risks beyond what it can absorb. Thus, depositors receive a level of assurance from shareholders’ equity, along with regulations, audits and credit ratings.

The amount of equity a bank receives from shareholders sets the limit on the value of deposits it can attract. This also limits the extent to which the bank can lend money. If a bank sustains large losses through credit or trading, eroding the bank’s net worth, this causes a decreased fund base through which a bank can offer loans.

The CAR provides shareholders with a better understanding of the risks a bank is taking with the equity they provide. A bank that continually takes more risks than it can reasonably sustain leaves potential shareholders with a sense that their equity investments are more at risk. A bank must maintain a professional level of risk management and sound lending practice to attract the capital that acts as its first line of defense against loss, both expected and unforeseen.

Using trailing 12-month (TTM) figures is an effective way to analyze the most recent financial data in an annualized format. Annualized data is important because it helps neutralize the effects of seasonality and dilutes the impact of non-recurring abnormalities in financial results, such as temporary changes in demand, expenses or cash flow. By using TTM, analysts can evaluate the most recent monthly or quarterly data rather than looking at older information that contains full fiscal or calendar year information. TTM charts are less useful for identifying short-term changes and more useful for forecasting.

Companies conducting internal corporate financial planning and analysis have access to detailed and very recent financial data. They use the TTM format to evaluate key performance indicators (KPI), revenue growth, margins, working capital management and other metrics that may vary seasonally or show temporary volatility.

In the context of equity research and valuation, financial results for publicly traded companies are only released on a quarterly basis in securities filings in accordance with generally accepted accounting principles (GAAP). Less frequently, firms provide monthly statements with sales volumes or key performance indicators. Securities and Exchange Commission (SEC) filings generally display financial results on a quarterly or year-to-date basis rather than TTM. To get a clear picture of the last year of performance, analysts and investors often must calculate their own TTM figures from current and prior financial statements. Consider General Electric (GE)’s recent financial results. In Q1 2015, GE generated $29.4 billion in revenue versus $34.2 billion in Q1 2014. GE logged $148.6 billion of sales for the full year of 2014. By subtracting the Q1 2014 figure from the full-year 2014 figure and adding Q1 2015 revenues, you arrive at $143.8 billion in TTM revenue.

Accountants consider work in progress (WIP) to be a current asset because it is a type of inventory asset. Accountants consider inventory assets to be current, because they are reasonably expected to be converted into cash within one year’s time.

Some accountants distinguish between WIP with work in process. Work in process represents the intermediary stage between raw materials and finished goods, while WIP includes the development of long-term (noncurrent) assets. This is atypical, however, and most references to work in progress allude to a stage of inventory asset.

Understanding Current Assets

In financial accounting, current assets include any balance sheet accounts with assets that the company can convert into cash within one year. This conversion needs to be during normal operations; liquidation due to bankruptcy wouldn’t count, for instance.

Common types of current assets on the balance sheet are cash, short-term notes receivable, prepaid expenses and marketable securities. Almost all inventories are considered current assets.

Current assets are contrasted with noncurrent assets, such as long-term notes receivable. Intangible assets are also noncurrent; a business cannot liquidate patents or goodwill.

Work in Progress

It’s easiest to explain work in progress within the context of a manufacturing process. Imagine a warehouse where lumber is used to create tables and chairs. The lumber arrives as raw material, unchanged by the production process inside the warehouse. Over time, pieces of lumber are sized, cut, polished and joined together. These materials are considered WIPs. Once a good is considered ready for sale, it becomes a finished good.

Most production processes take less than one year to complete. A complete finished good can be sold for cash or an account receivable. Consequently, accountants can consider WIP to be a current asset on the balance sheet.

A sunk cost is a cost that cannot be recovered or changed and is independent of any future costs a business may incur. Since decision-making only affects the future course of business, sunk costs should be irrelevant in the decision-making process. Instead, a decision maker should base her strategy on how to proceed with business or investment activities on future costs.

For example, suppose a business executive of a finance consulting company is hired to build a financial analytics application and will receive $10 million at the end of the project. The business executive determines it will cost $7 million in total to finish the project and take one year. The company will profit $3 million for completing this project.

However, in the ninth month of operation, her team runs into problems with the main framework of the application. The firm already spent $5.25 million on this project, and the business executive must decide whether to continue with the project or cancel it. She estimates that this major setback will cost an extra $1 million. However, the company can still profit $2 million from the project.

Whether the business executive decides to continue with the project or cancel it, the costs spent for the nine months of operation cannot be retrieved. This should be irrelevant to her decision because only future costs and potential revenues should be considered. If she cancels the project, the company would incur a $5.25 million loss and have revenues of $0. If she continues with the project, the future revenue for the company is $10 million, and future costs are only $2.75 million.

She decides to continue with the project because it is a 3.64 return on investment, ignoring sunk costs. The consulting company delivers its application to the hirer and receives revenues of $10 million and has a profit of $2 million.

A company performs a reverse stock split to boost its stock price by decreasing the number of shares outstanding, which typically leads to an increase in the price per share.

How a Reverse Split Works

When a company does a reverse split, it cancels its current outstanding stock and distributes new shares to its shareholders in proportion to how many shares they owned before the reverse split. For example, in a one-for-10 reverse split, shareholders would receive 1 share of the company’s new stock for every 10 shares that they owned. If a shareholder owned 1,000 shares before the split, the shareholder would own 100 shares after the reverse stock split.

Why Would A Company Perform A Reverse Split

A reverse split would most likely be performed to prevent a company’s stock from being delisted from an exchange. If a stock price falls below $1, the stock is at risk of being delisted from stock exchanges that have minimum share price rules. Reverse stock splits can increase share prices to avoid delisting, and being listed on a major exchange is important for attracting equity investors.

A split might also be done to boost the company’s image if the stock has fallen dramatically. If the stock is trading in the single digits, it’ll likely be seen as a risky investment particularly if the price is near $1 or considered a penny stock by investors. A reverse split might be engineered by a company to protect it’s brand’s image by trying to prevent the penny stock label. There is a negative stigma typically attached to penny stocks traded only over the counter.

A reverse split sending the stock higher might draw more attention from analysts. Higher-priced stocks attract more attention from market analysts, and if analysts have a favorable view of a company and its stock, it’s great marketing for the company. 

The Effect of a Reverse Stock Split

A reverse stock split has no inherent effect on the company’s value, so the company’s total market capitalization is the same after the reverse split. The company has fewer outstanding shares, but the share price increases in direct proportion to the reverse stock split. The total value of the shares an investor holds remains the same as well. If an investor owned 1,000 shares worth $1 each prior to a one-for-10 reverse stock split, after the split the investor would own 100 shares worth $10 each. The total value of the shares is still $1,000 for the investor. 

Implications of a Reverse Split

Reverse stock splits can carry a negative connotation. As stated earlier, a company is more likely to undergo a reverse stock split because its share price has fallen so low that it’s in danger of being delisted. As a result, investors might believe the company is struggling and that the reverse split is nothing more than an accounting gimmick.

However, a reverse split can be beneficial to a company by boosting its stock price to a level that enables it to transition from being a penny stock traded over the counter to being listed on a major exchange, thereby attracting the interest of more investors.