Today's big blowup was Friedman's (NYSE:FRM), a jewelry retailer based in lovely Savannah, Ga. The stock plunged some 40% at last check on heavy volume following last night's triple-whammy announcement.
The company is boosting its allowance for doubtful accounts (resulting in a sizable charge), placing its CFO on a leave of absence, and facing a formal SEC investigation. In this article we'll focus on the first item, since it seems reasonable that the other two are in some way connected.
Companies keep an allowance for doubtful accounts on the balance sheet to plan for receivables they might not be able to collect. (It's clearly marked on Friedman's balance sheet as part of the accounts receivable line item under "Assets" -- receivables are listed with the allowance removed. If a company determines that certain bills won't be paid, it writes them off.)
Friedman's credit losses were higher than its reserves. (The resultant charge -- as much as $0.43 per share -- is the company trying to reconcile its financial statements.) You can see why a company might do this: In Friedman's case, credit sales make up more than half of all revenues and if customers aren't paying up then those revenues are, well, tarnished.
It's difficult to see this sort of thing coming before a company takes a step like Friedman's did today. The company has kept its allowance as a percentage of receivables steady at about 10% for years now -- only today admitting that its figure should be higher and, perhaps, as high as 17%.
There were, however, warning signs that might have triggered further investigation or, at the very least, caused you to ask some tough questions. Two ugly trends turn up after some quick calculations: For the last five fully reported fiscal years, receivables turnover crept lower while days sales outstanding hit a high to end last year.
(We'd prefer them to be moving in the opposite direction: Visit our " How to Read a Balance Sheet" area for more.)
The final warning sign -- though it surfaced too late for many -- came in late-October. We didn't use the latest full-year data in the above calculations because the company said last month it would delay the release of its updated financials, which were to be distributed yesterday, in order to comply with investigations by the SEC, the Justice Department, and its own auditors.
No matter how you cut this gem, it looks pretty flawed.
Discuss what happened at Friedman's, and how to spot this kind of trouble in the future on our Reading Financial Statements discussion board. Dave Marino-Nachison can be reached at [email protected].
