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How to check for channel-stuffing

Sun., Dec. 12, 2004, midnight

Q: What does it mean when a company is said to be “stuffing the channel”? — S.B., Aspen, Colo.

A: When a company stuffs the channel, it 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 to the manufacturer. This means sales already claimed may never occur.

To sniff out channel-stuffing, see if a company’s accounts receivable growth is outpacing sales growth. If so, that’s a red flag. Alternatively, calculate “days sales outstanding” (DSO). First, divide the last four quarters’ revenues by 365. Then divide accounts receivable by the number you got. This reveals how many days’ worth of sales is represented by the current accounts receivable. 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 immediately to use, 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.

Q: What does “shrinkage” mean in the business world? — P.B., Greensboro, N.C.

A: It refers to the routine loss of inventory, such as through accidental breakage or theft.

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