What does it mean when a company is said to be "stuffing the channel"? Well, it means that the company ships inventory ahead of schedule, filling its distribution channels with more product than is needed. Since companies often record sales as soon as they ship products, channel stuffing can make it appear that business is booming. In reality, the products not sold may well be returned eventually to the manufacturer. This means sales already claimed may never occur. In a sense, sales are made at the expense of sales in future quarters.

To determine whether a company is stuffing the channel, see if its accounts receivable growth is outpacing sales growth. If so, that's a red flag. Alternatively, you can calculate "days sales outstanding" (DSO). First, divide the last four quarters' revenues by 365. Then divide accounts receivable by that number. This reveals how many days' worth of sales the current accounts receivable represents. Between 30 and 45 days is typical. You can also follow the same process for the last quarter, dividing last quarter's revenues by 91.25 (days in a quarter, on average). A company with a low DSO is getting its cash back quicker and, ideally, putting it to use immediately, getting an edge on the competition. Rising numbers can signify channel stuffing. Remember that this isn't useful for all companies. Restaurants and cash-based businesses, for example, aren't going to have much, if any, receivables.

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