Channel Stuffing

**blast_investor** Tue Feb 07, 2006 8:09 pm

Channel Stuffing
A deceptive business practice used by a company to inflate its sales and earnings figures by deliberately sending retailers along its distribution channel more products than they are able to sell to the public.

By channel stuffing, distributors temporarily beef up their accounts receivables. However, unable to sell the excess products, retailers will send the excess items instead of cash back to the distributor, who must readjust its accounts receivable and ultimately its bottom line. In other words, stuffing always catches up with the company, because it cannot maintain sales at the rate it is stuffing.

This is usually done fraudulently to raise the value of the stock. Channel stuffing is illegal.

**balaoko** Wed Feb 08, 2006 5:00 pm

3x, blast

Is there any way to find the stuffing? I guess we may check the receivable changes. if it changes too much, one should doubt it, right?

**blast_investor** Wed Feb 08, 2006 5:03 pm

Right, account receivables will show up bigger than normal, then revenue would be artificially higher, so does earning.

But the cash flow number would be pretty poor because the money does not come in from the "stuffed" sale.

Usually it is very difficult to tell from revenue or even account receivables. But cash flow number will tell.

balaoko wrote: 3x, blast

Is there any way to find the stuffing? I guess we may check the receivable changes. if it changes too much, one should doubt it, right?

**nodoodahs** Thu Feb 09, 2006 11:55 am

See my post on metrics here:
http://nodoodahs.blogspot.com/2006/02/metric-system.html

Specifically to detect channel stuffing, perform the following ratios for every quarter and year available:
(1) acct's rec'bl to revenue
(2) inventories to revenue
It'll show. Look at GM for 2000 to 2004, note the shortfall in earnings came in 2005. You could have seen it coming. Don't just look at those AR and INV alone, look at them in context of revenues. Note that some retailers will have high INV/REV in the quarter just before Christmas, this may be normal depending on the type of business (i.e. normal for jewelers not normal for grocery stores).

The Earnings Quality metric and the Cash Generating Power metric will find where a company is using "shenanigans" to boost Earnings.

**blast_investor** Thu Feb 09, 2006 12:11 pm

Agree. Inventory/revenue is main ratio to watch. Any serious value investor must do this due diligence before accepting the "officially" reported earning number.

The key point is to look for multi-year comparison. If investors only look at recent few quarters, it is not easy to find them.

By comparing year over year change, particularly going back several year back, the ratio will go out of whack and particularly the cash flow will go down hell.

nodoodahs wrote: See my post on metrics here:
Earnings.

**nodoodahs** Fri Feb 10, 2006 12:19 pm

blast_investor wrote: The key point is to look for multi-year comparison.

Yep. We're in perfect agreement there. I wrote nodoodahs wrote: Specifically to detect channel stuffing, perform the following ratios for every quarter and year available and in most cases you can get 5 years and 5 quarters out of MSN Money.

**blast_investor** Fri Feb 10, 2006 6:06 pm

MSN Money does provide better historical data than Yahoo finance.

Yahoo finance only provides 3 years of data.

nodoodahs wrote: and in most cases you can get 5 years and 5 quarters out of MSN Money.

**nodoodahs** Mon Feb 13, 2006 1:52 pm

Even better than that, the MSN is always in the same format, regardless of industry. Yahoo presents banks in different format than manufacturers, etc. Standardization of format makes checking several financial ratios a cut-and-paste operation into a spreadsheet. Very nice.