The Incremental Information Content of

Receivables in Predicting Sales, Earnings,

and Profit Margins
THOMAS L . STOBER*

1. Introduction
Recently, Bernard and Noel (1991) [hereafter BN] studied what can be
learned from inventory disclosures. BN review alternative economic models
of the production-inventory cycle and discuss their implications for using
inventory disclosures to predict future sales and future earnings. They test
these implications on seven manufacturing industries where many firms
disclose details on the components of inventories. BN also study the retail
department store industry, where firms do not disclose detailed inventory
components.
BN's results for manufacturers suggest that inventory data convey in-
formation to investors in at least two different ways.
1. Unexpected inventory changes are positive leading indicators of fu-
ture sales, even after controlling for current sales. This relation is
driven primarily by unexpected changes in raw materials and work-
in-process inventories. It would be consistent with the "production
smoothing" and/or "lead time" models of inventory, where inven-
tory changes refiect managers' private information about demand.
2. Unexpected inventory changes appear to be weak negative leading
indicators of future earnings and profit margins, even after controlling
for current sales and earnings. This relation appears to be traceable
to unexpected changes in finished goods inventories. It would be
consistent with a "stockout" model of inventories, where current
demand is only partially reflected in current sales, the remainder
being reflected in the frequency of stockouts. That is, low (high)
ending inventories indicate a high (low) frequency of stockouts, and

*Associate Professor of Accounting, Indiana University

I am grateful to Victor Bernard and James Noel for allowing me to use data from Bernard and
Noel (1991). I also thank Tom Lys and participants in the 1992 JAAF-KPMG Peat Marwick Conference
for their helpful comments.

447
448 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

higher (lower) demand than would be predicted based solely on

current sales.
Interpreting retailers' inventories as analogous to the finished goods
component of manufacturers' inventories, BN report results for retailers that
complement those for manufacturers. In particular, consistent with a stock-
out model, retailers' inventories are negative leading indicators of future
eamings. They are also positively related to future sales, although the sales
effect is short-lived.
An earlier attempt to document the incremental usefulness of current
operating account balances is Bernard and Stober (1989). Like BN, Bernard
and Stober (1989) assumed that current and prior sales are already known;
however, they investigate the ability of both inventory and receivables bal-
ances to predict future sales. Unlike BN, Bernard and Stober (1989) did
not investigate the predictive ability of disclosures of inventory components
nor did they investigate predictions of future eamings and margins. Also,
the Bemard and Stober (1989) results on the incremental usefulness of
receivables in predicting future sales were sensitive to the deletion of outliers,
many of which appeared to be due to acquisitions and divestitures. BN
mitigated this problem by screening their data to remove the distorting
influence of such influential observations.
BN's study was motivated, in part, by a desire to better understand how
to interpret the results of some general studies of the information content
of accounting variables (Ou [1990]; Ou and Penman [1989a, 1989b]) as
well as several other studies focusing on the information in current ac-
counting accmals: Wilson (1986, 1987); Raybum (1986); Bowen, Burgs-
tahler, and Daley (1987); and Bemard and Stober (1989). With the possible
exception of Bemard and Stober (1989),' these studies fit BN's (pp. 145-
146) characterization of the prior literature as focused on "ad hoc statistical
relations with little regard for the underlying economic stmcture reflected
in these relations."
This study extends the results of BN to provide evidence on the incre-
mental information content of receivables in predicting future sales, eam-
ings, and profit margins. This is done by expanding the prediction equations
of BN to include unexpected receivables along with the unexpected portions
of inventory and its components.^ The potential usefulness of such evidence
1. Bemard and Stober (1989) did attempt to analyze some of the underlying economics behind
these relations; however, they did not find their predictive ability results on the components of working
capital useful in explaining Wilson's (1987) results on the information content of current accruals.
2. The key to understanding BN's results (and those of Bemard and Stober [1989]) is that the
predictive ability of inventories is assessed after controlling for the effect of sales reported for the current
quarter. This means that to the extent inventory buildups (drawdowns) result from unanticipated decreases
(increases) in current reported sales, such inventory changes should not contribute to the predictive
ability of unexpected inventories.
INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 449

is twofold. First, obtaining such evidence represents one more step toward
filling in the gaps necessary to understand and explain stock price reactions
to unexpected accruals.^ Second, and more generally, this type of evidence
is a logical building block in better understanding fundamental analysis.'*
The primary findings of this study are that, for manufacturers, receiv-
ables provide information useful for predicting future sales, eamings, and
margins that are incremental to that contained in total inventory balances.^
For predictions of future sales, in contrast to the ability of unexpected
inventory balances to predict sales several quarters ahead, the predictive
power of unexpected receivables is short-lived; it is evident only in one-
quarter-ahead predictions of sales. On the surface, this result is consistent
with a sales momentum explanation where receivables balances indicate the
level of sales for the last few weeks of a quarter. However, industry-level
evidence for the sales momentum explanation is weak, and more detailed
predictions of this explanation are not supported by the data.
For manufacturers, receivables appear to be most useful for predicting
future eamings and margins. Unexpected receivables balances are strong
negative leading indicators of eamings and margins for all prediction ho-
rizons, consistent with an "eamings quality" explanation. This is evident
in both pooled results for manufacturers and in industry-by-industry results
for five of seven manufacturing industries. In contrast, there is (at best)
only a weak negative relation between unexpected total inventories and next
quarter's eamings and margins that grows stronger in multiple-step-ahead
predictions. These effects are traceable primarily to predictions made at the
end of interim quarters; there is no reliable evidence that fourth-quarter
receivables balances (or fourth-quarter total inventory balances, for that
matter) are useful in predicting future eamings or margins.

3. Bemard and Stober were forced to conclude that

further progress in this line of research will require a better understanding of the
economic context in which the implications of detailed eamings components are inter-
preted. In addition, any research based on short-run association tests will require more
knowledge of the process by which information is transmitted from firms to the public.
In the meantime, we suggest that it is possible that the links between detailed eamings
components and valuation are so highly contextual that no parsimonious model would
ever capture more than a small portion of the story. (1989, p. 648)
4. Urging a retum to studying "the fundamentals," Penman observes that
If we are to estimate models, model parameters must be permitted to vary under varying
circumstances which is, of course, another way of saying that financial statement analysis
is situation specific. In this respect the type of work in Bemard and Noel 11991], where
predictions from inventories are modelled under different circumstances, is promising.
(1992, p. 481)
5. For retailers, receivables balances are not useful in predicting sales, inventories or margins.
This is not surprising given that receivables balances as a percentage of sales are only one-third to one-
fourth as large for retailers as they are for manufacturers.
450 JOURNAL OF ACCOUNTtNG, AUDITtNG & FINANCE

When eombined with data on inventory components (raw materials,

work-in-process, finished goods) fourth-quarter receivables balances still
have no incremental explanatory power, whereas some components of in-
ventories do. However, infomiation on receivables balances may be im-
portant in an expanded model including interaction terms representing cases
where unexpected receivables and unexpected inventory components have
opposite signs. This raises the possibility that more contextual explanations
are necessary to adequately explain the role of receivables in predicting
future sales, earnings, and margins.
The remaining sections are organized as follows. Section 2 outlines
alternative predictions about the incremental information content of receiv-
ables in predicting sales, earnings, and profit margins (the dependent var-
iables in the predictive ability tests), conditional on knowledge of
inventories. The sample and data are described in Section 3, which also
includes a description of bench mark prediction models for sales, earnings,
and margins, as well as the expectations model for receivables and its
estimation. Section 4 describes predictive ability results for unexpected
changes in inventories and receivables as leading indicators of sales, earn-
ings, and margins. Concluding remarks are provided in Section 5.

2. The Potential Information Content of Receivables

It is probably fair to say that the behavior of accounts receivable has
not received as much attention from economists as has the behavior of
inventories, likely due to the importance of the latter to macroeconomic
modelling. Thus it is not possible to appeal to formal economic models of
receivables balances that are on a par with the lead time, production smooth-
ing, and stockout models of inventories that guided the BN study. Two
alternative explanations of the information content of receivables, the earn-
ings quality explanation, and the sales momentum explanation, are discussed
here.

2.1 The Earnings Quality Explanation

Financial analysts often suggest that receivables provide important clues
about a firm's past and future performance. For example, O'glove (1987)
devotes an entire chapter to the analysis of accounts receivables and inven-
tories. He argues that
The analysis of sales and accounts receivable may provide a clue as to
whether a company is merely shifting inventory from the corporate level
INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 451

to its customers because of a "hard sell" sales campaign or costly

incentives. In such an instance, this type of sales may constitute "bor-
rowing from the future." (p, 107)

He later explains that

The difficulty comes when accounts receivable rise substantially over

what they had been in the same reporting period during previous years.
This can result from any of several factors. A spell of economic hard
times for the country, industry, or region will often cause stretchouts
in payments. A poor collection job might be another reason. Perhaps
the retailer, his back against the wall and eager to make sales, has
offered his customers liberal credit terms. . . . Whatever the cause, major
increases in accounts receivable is a danger sign. (p. 108)

Thus O'glove clearly views unexpected increases in receivables as "bad

news." However, the mechanism by which this bad news translates into
lower firm value—lower future sales, lower future margins, or both—is not
obvious.*
O'glove (1987) does not explain how he would interpret an unexpected
decrease in receivables. Unexpected decreases in receivables could indicate
a tightening of credit terms, or less need to offer generous credit terms to
generate a given amount of sales. If these are indicators of increased demand
for a firm's products, unexpected decreases in receivables could signal
' 'good news" in much the same way that unexpected decreases in inventories
imply the existence of stockouts and unfilled demand. Again, it is not clear
whether increased demand for a firm's products would translate into greater
future sales, greater margins, or some combination of the two. However,
these predictions are symmetric to O'glove's predictions for receivables
increases—unexpected receivables balances should be negatively related to
the future prospects of the firm. Because of this, it is convenient to group
them both under the general heading of the earnings quality explanation.

6, Bernard and Stober argue that

If UREC [unexpected receivables, conditional on current period sales] is negative
(because collections were unexpectedly low, and/or receivables unexpectedly high), it
could imply either of the following. First, it may reveal that management was able to
generate the previously announced sales volume only by relaxing credit policy and/or
"borrowing from the future" (as argued by O'glove [1987, p, 107]), Second, it may
reveal that customers have become less willing or able to pay quickly. We would view
both of these as negative signals about the value of the firm; however, these implications
for firm value may or may not operate in terms of changes in expected future sales
(1989, p, 642) 6 /- y •
452 JOURNAL OF ACCOUNTING, AUDITING & HNANCE

2.2 The Sales Momentum Explanation

An alternative to the earnings quality explanation, at least as it applies
to future sales levels, relies on the concept of sales momentum. The key to
the sales momentum explanation is recognizing that although firms report
only aggregate sales for a quarter consisting of approximately 13 weeks,
sales made during the last several weeks of the quarter should have the
greatest impact on ending receivables balances. If sales increase toward the
end of a quarter, accounts receivable will probably tend to look high in
relation to sales made during the entire quarter. The opposite is true if sales
decrease at the end of a quarter. Thus, receivables balances could act as a
positive leading indicator of future sales., by providing information on recent
sales levels (assuming there is persistence in sales). An example illustrates
the mechanisms involved.
Assume there is a firm that normally carries 60 days' sales in receivables.
The implied receivables turnover (assuming a 360-day year), is

360 / 60 = 6 times per year,

or
9 0 / 6 0 = 1.5 times per quarter

Given knowledge of only aggregate sales for the quarter (5,), the
conditional expectation for the firm's end-of-quarter receivables balance
is
E{R,\S) = 2/3 5,.

Unexpected receivables at the end of period t (UR,) would then be

UR, = R, - 2/3 5,.

Three situations are of interest: a base case with level monthly sales
and scenarios A and B where sales increase and decrease, respectively,
from the original level, during the third month of the quarter. In each
situation, actual receivables balances are assumed to consist of the last
60 days' (two months') sales, but unexpected receivables for quarter t
(UR,) are based on the conditional expectation for receivables given sales
for the quarter t (5,).
In the base case, sales are $1,000 per month in each of the three months
of the quarter. The actual receivables balance would be $2,000, derived as
follows:
INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 453

2.2,1 Base Case: Level Monthly Sales

Actual Receivables
Month Sales Balance
1 $1,000
2 1,000 X 1.0 $1,000
3 1,000 X 1.0 1,000
$3,000 $2,000

Here, the receivables expectations model "explains" the actual receivables

balance (expected and actual receivables balances are equal), so unexpected
receivables are zero:
UR, = $2,000 - 2/3($3,000) = 0.
In scenario A, sales in months 1 and 2 are $1,000, but in month 3,
sales increase to $1,300, producing an actual receivables balance of $2,300,
as follows:

2,2,2 Scenario A: Sales Increasing in Month 3

Actual Receivables
Month Sales Balance
1 $1,000
2 1.000 X 1.0 $1,000
3 1.300 X 1.0 1,300
$3,300 $2,300

Since the new, higher level of sales in month 3 is aggregated with the
original level of sales occurring in months 1 and 2 in the receivables ex-
pectations model, unexpected receivables are positive:^
UR, = $2,300 - 2/3($3,300) = $100.
Scenario B illustrates the mirror image of scenario A—sales are again
$1,000 in months 1 and 2, but decrease to $700 in month 3, producing an
actual receivables balance of $1,700.

7. Alternatively, if sales had steadily increased by $100 per month, from $1,000 in month 1 to
$1,100 in month 2, and to $1,200 in month 3. all essential quantities (sales for the quarter, the actual
receivables balance, and expected accounts receivable) would be the same. Thus, unexpected receivables
would still equal $100.
454 JOURNAL OF ACCOUNTING, AUDITING & HNANCE

2.2,3 Scenario B: Sales Decreasing in Month 3

Actual Receivables
Month Sales Balance
1 $1,000
2 1,000 X 1.0 $1,000
3 700 X 1.0 700
$2,700 $1,700

Here, unexpected receivables are negative:*

UR, = $1,700 - 2/3($2,700) = -$100.
Comparing scenarios A and B with the base case shows that unexpected
receivables are sensitive to recent trends in sales. Thus, ending receivables
balances can reveal information about future sales that is not captured by
the contemporaneous sales figure. If there is persistence in sales (that is, if
the most recent sales levels are representative of future sales levels), then
unexpected receivables will be positively related to future sales, although
the resulting effects on earnings and margins are not clear-cut. However,
at least with respect to future sales, under the sales momentum explanation
unexpected increases in receivables (conditional on current sales) would be
"good news," and unexpected receivables decreases would be "bad news."
This simple example, of course, ignores some realistic complications:
seasonality in sales, for example.' However, this same basic logic carries
over to even more complex situations. So, under the sales momentum ex-
planation, one would always predict that unexpected receivables are posi-
tively related to future sales. The essential element necessary for the sales
momentum explanation to operate is that end-of-quarter receivables balances
comprise less than the last three months' sales. Receivables balances should
be stronger indicators of sales momentum, however, the shorter the time
lag to collection. Therefore, an additional test of the descriptive validity of
the sales momentum explanation is whether the relation between receivables
balances and future sales is stronger for firms with shorter average collection
periods.

2.3 The Joint Infornfiation Content of Inventories and Receivables

The lead time and production smoothing models of inventory imply that
unexpected inventories should be positive leading indicators of future sales.

8. Parallel to the alternative scenario described in note 7, assuming sales were steadily decreasing
by $100 per month would again produce the same essential results.
9. The actual expectations models for receivables in the empirical work control for seasonality.
INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 455

Therefore, unexpected inventories and unexpected receivables may convey

similar information about future sales. However, there are reasons to believe
that the information about future sales in unexpected receivables will not
merely duplicate that of unexpected inventory balances. Under the sales
momentum explanation, ending receivables balances respond to the level
of sales during the last few weeks of the quarter just ended, where this level
of sales is expected to persist into the future. In contrast, under the lead
time and production smoothing models of inventories, managers adjust in-
ventories based on their own private information about future demand—
information that includes, but is not limited to, recent sales levels. Depending
on the lead times involved and/or the desirability of engaging in production
smoothing, inventory balances may reveal management's information about
future sales more than one quarter ahead. To the extent that it is costly to
adjust production and inventory levels, or that there are substantial lead
times involved in doing so, receivables will react more quickly than inven-
tories to recent changes in sales levels that were not previously anticipated
by management. Thus, by revealing information about recent sales levels
that is not incorporated into ending inventory balances, the information about
future sales in receivables would complement the information about future
sales in inventories.
The results of BN (Table 6, p. 173) indicate that inventories are leading
indicators of sales in one-, two-, three-, and four-quarter-ahead predictions.
Because the sales momentum explanation posits the same directional pre-
dictions for receivables balances, it is important to determine whether the
information about future sales provided by receivables balances differs from
that provided by future sales. The sales prediction tests here are structured
as tests of incremental information content by adding additional regressors
representing unexpected receivables to BN's prediction equations involving
unexpected inventories.
Similarly, prediction tests for eamings and margins here are structured
as tests of incremental information content. BN (Table 6, p. 172) report
that, for manufacturers, there is (at best) a weak negative relation between
unexpected inventories and next period's eamings and margins that becomes
stronger when multiple step predictions are considered. (For retailers, this
negative relation is evident in BN's results at all prediction horizons.) Be-
cause the eamings quality explanation yields similar directional predictions
for unexpected receivables, the goal is to determine whether receivables
balances are incrementally useful in predicting future eamings and margins.

3. Sample and Data

The sample is the same as that in BN. This sample consists of all firms
on the 1988 Compustat files in seven manufacturing industries plus an eighth
456 JOURNAL OF ACCOUNTING, AUDITING & RNANCE

industry, retail department stores. Each industry contains 15 or more firms

meeting the following criteria:
1. 40 continuous quarters of nonmissing quarterly Compustat data on
sales, income before extraordinary items, and total inventory for
fiscal years 1978-1987, and
2. 10 continuous years of nonmissing annual data on the components
of total inventory (raw materials, work-in-process, finished goods)
for fiscal years 1978-1987.
A total of 168 firms meet these criteria (152 firms in the seven manufacturing
industries and 16 retail department store firms).
Because of concern that extreme observations reflect "data distortions"
such as the effects of acquisitions and divestitures (discontinued operations),
BN screen the data to remove the distorting infiuence of such influential
observations. Their additional data screens eliminate
1. sales observations if sales more than doubled or fell by more than
half from their level in the comparable quarter of the prior
year;
2. observations of inventory and its components if either (a) production
more than doubled or fell by more than half from its level in the
comparable quarter of the prior year or (b) the year-to-year change
in the quarterly inventory-to-sales ratio was not between — .5 and
-I- .5, inclusive; and
3. observations of profit margins not between - .25 and -I- .25, inclu-
sive, '° or earnings observations if the year-to-year change in quarterly
earnings scaled by sales of the base quarter was not between those
same limits.
In addition to these data screens, a condition parallel to 2(b) above is imposed
on receivables here, eliminating
4. observations of receivables if the year-to-year change in the quar-
terly receivables-to-sales ratio was not between - .5 and -I- .5,
inclusive.
Missing observations from these screens are propagated throughout the data
set. Thus, the absence of any variable needed in a particular regression
results in the loss of an entire observation."
10. BN indicate that this screen was to have eliminated "earnings observations" if the year-to-
year change in the quarterly eamings-to-sales ratio was not between — .25 and -I- .25, inclusive; however,
their programs actually eliminated observations of scaled earnings (profit margins) where (the levels of)
profit margins fell between these limits.
11. BN delete sales observations only when they appear in the numerators of variables appearing
in their prediction equations and expectations models; sales observations used to scale other variables
are not deleted if they do not meet these criteria. Also, BN delete both current and lagged observations
of scaled variables not meeting these screens except for lagged observations involving seasonal differ-
ences of variables.
INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 457

BN estimate bench mark prediction models for quarterly sales, eamings,

and margins (the dependent variables in the predictive ability tests). These
models include AR(1) models in seasonal differences for sales and eamings
as in Foster (1977), and a model for profit margins identified by BN allowing
profit margins to follow a stationary process, that includes the Foster (1977)
model as a special case. Denoting sales as 5 and eamings as E, these models
are summarized next.
Sales Predictions:
c _ o c _ c
— = 85 + <^s ^^ + e,.

Earnings Predictions:
Et — •£'(-4
8^ + (t)£ V,.
0,-4 'Jt-5

Margin Predictions:

8M + ^ M l + ^ M 4 + ^

As in BN, these bench mark prediction models are estimated with pooled
cross-sectional, time-series data on an industry-by-industry basis.
BN's expectations models for total inventory (/) and its components—
raw materials (RM), work-in-process (WP), and finished goods (FG)—are
summarized below. These models include past values of both sales and
inventory as regressors. Because data on inventory components are available
only annually, values of total inventory are used in place of component data
at the nonseasonal lags.
Expectations Model for Total Inventory (/):

, S, — 5,_4 S,-i — 5,-5

+ 05—^ + be z + e,.
0,-4 -Jr-S

Expectations Models for Components of Inventory:

Expectations Model for Raw Materials {RM):

T bo + TT - + ^4 ^ - ^

i3 ijj_4 tjj_| ij^_<

"i—:: + b
St-,
458 JOURNAL OF ACCOUNTING, AUDITING & HNANCE

Expectations Model for Work-in-Process (WP):

+ *5—^ + be + e,.
»J(-4 ^1-5

Expectations Model for Finished Goods (FG)\

/ ^/-l ^f-4 \'-'/-l "^1-5

S, - 5,_
^ + be + e,.

As in BN, the models are estimated industry-by-industry with pooled cross-

section, time-series data.
Expectations for receivables (R) are based on the accounting identity
involving sales (5) and cash collections (C):
R, = R,-i -\- S, — C,.
Given knowledge of sales for period t, the conditional expectation for re-
ceivables is
E(R,\S,, i?,_,) =/?,_, + 5, - E(C,).
Simplifying this expression requires an expression specifying the be-
havior of expected cash collections. A simple economic assumption for cash
collections is that 100 percent of last periods' receivables (net of allowances
for bad debts) will be collected in the current period, along with IOO7 percent
of the current period's sales:
E(C,) =/?,_, + yS,.
This means that the conditional expectation for receivables is
E(R,\S,, /?,_,) = R,_, + S, - (/?,_, + 75,) = (1 - 7)5,.
In other words, under this assumption, the expected ending receivables
balance, conditional on sales for the period, depends only on sales.
BN scale all variables by current sales to control for size. Dividing the
conditional expectation for receivables through by current period sales re-
moves sales from the equation altogether. However, in their inventory ex-
pectations models, BN also include lagged values of the dependent variable
to control for seasonality. Variables so added to the right-hand sides of their
expectations models are the value of the dependent variable at the seasonal
INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 459
TABLE 1
Expectations Models for Receivables
Expectations Models for Receivables (R,) scaled by Sales (S,):

Jr'" ^ "'s "• '^jz *

Coefficient Estimates
No. of No. of
Industry' bo b, b. b. MSE R' Obs.'' Firms

1: Drugs ,25** ,44** ,67* ,41** ,18 ,41 558 17

2: Metals ,20* » -,21** ,74* ,42** ,15 ,60 1,120 32
3: Machinery ,20* * ,19** ,75* ,38** ,18 ,60 908 26
4: Electronics ,21* I- -,04 ,72* ,37** ,11 ,55 657 19
5: Computing ,40* !• -,50** ,56* ,51** ,16 ,55 505 15
6: Transport ,09* t 12** ,86* ,55** ,12 ,75 875 25
7: Instruments ,08* * ,06 ,91* ,46** ,14 ,75 630 18
8: Retail ,01** -,20 ,98* ,63** ,07 ,94 495 16
"SIC codes for industries are 2830-2839 Pharmaceuticals (DRUGS), 3400-3499 Metal products
and fabrication (METALS), 3500-3599 Nonelectrical machinery (MACHINERY), 3670-3679 Elec-
tronic products (ELECTRONICS), 3680-3689 Computing equipment (COMPUTING), 3700-3799
Transportation equipment (TRANSPORT), 3800-3899 Instrumentation & controls (INSTRUMENTS),
and 5300-5399 Retail department stores (RETAIL),
'No, of obs, represents number of firm-quarter observations with useable data,
**Coefficient significant at ,05 level, two-tailed test,

lag and the first lag of the seasonal difference of the dependent variable,
each scaled by the contemporaneous value of sales. Making similar ad-
justments to the equation for receivables gives the following receivables
expectations model:
Expectations Model for Receivables:

l - + e,.
Jr-

Table 1 contains estimation results for the receivables expectations models.

As elsewhere, these models are estimated industry by industry with pooled
cross-sectional, time-series data. Nearly all the estimated parameters in these
models are significantly different from zero, indicating that the controlling
for seasonality is indeed necessary. However, the Rh of these models are
not as high as in some of BN's inventory expectations models, raising the
possibility of omitted variables. At a minimum, the lower Rh for the ex-
pectations models for receivables indicate that there is substantial noise in
the relation between receivables and sales.'^

12, Some of the noise in the relation between receivables and current sales levels may be due to
the relative ease with which firms can sell receivables to a factor and remove them from their balance
sheets, as compared with sales of most items of inventory.
460 JOURNAL OF ACCOUNTING, AUDITING & HNANCE

TABLE 2
Distribution of Receivables Scaled by Sales for the Same Quarter
(RJS,)
Selected Fractiles
Industry' Mean Median .10 .25 .75 .90

1: Drugs ,78 ,74 ,59 ,65 ,84 ,97

2: Metals ,71 ,65 ,50 ,57 ,77 1,00
3: Machinery ,79 ,76 ,50 ,63 ,89 1,09
4: Electronics ,74 ,71 ,55 ,62 ,83 ,93
5: Computing ,86 ,85 ,58 ,71 ,99 1,12
6: Transport ,65 ,62 ,36 ,54 ,72 ,93
7: Instruments ,84 ,79 ,62 ,69 ,89 L05
8: Retail ,22 ,09 ,00 ,03 ,36 ,64

"SIC codes for industries are 2830-2839 Pharmaceuticals (DRUGS), 3400-3499 Metal products
and fabrication (METALS), 3500-3599 Nonelectrical machinery (MACHINERY), 3670-3679 Elec-
tronic products (ELECTRONICS), 3680-3689 Computing equipment (COMPUTING), 3700-3799
Transportation equipment (TRANSPORT), 3800-3899 Instrumentation & controls (INSTRUMENTS),
5300-5399 Retail department stores (RETAIL),

Table 2 contains descriptive information on end-of-quarter receivables,

scaled by sales for the same quarter (RJS,). The median receivables-to-sales
ratios within the seven manufacturing industries range from a low of .62
(industry 6: transportation equipment) to .85 (industry 5: computing equip-
ment). In contrast, for retail department stores (industry 8), the median
receivables-to-sales ratio is only .09, and receivables are less than 3 percent
of sales in one-fourth of all cases.
The median receivables-to-sales ratios for manufacturers imply that the
average number of days sales in ending receivables balances differ from
sales reported for the quarter by 34.2 days of sales (.38 x 90) for trans-
portation equipment (industry 6) but only by 13.5 days of sales (.15 x 90)
for computing equipment (industry 5). Taken at face value, these ratios do
not appear to leave a lot of room for the sales momentum explanation to
operate. Indeed, the .9 fractiles of these ratios show that receivables are
equal to or greater than 100 percent of the prior quarter's sales in 10 percent
of all firm-quarters for four out of the seven manufacturing industries in the
sample. However, such comparisons probably overstate the degree of over-
lap between ending receivables and the prior quarter's sales. Total receiv-
ables on Compustat (the only receivables data item available on a quarterly
basis) includes such nontrade receivables as interest and dividends receiv-
able, recoverable income taxes, and amounts due from unconsolidated
subsidiaries.'^
13, This data item excludes receivables from captive finance subsidiaries because the sample time
INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 461

4. Predictive Ability Results

BN assess whether inventory disclosures predict sales, earnings, and
margins by adding the residuals from the inventory expectations models as
additional regressors in their bench mark prediction equations. Here, ad-
ditional regressors representing both unexpected inventories and unexpected
receivables are added to these bench mark equations. The coefficients of
these additional regressors measure the incremental predictive power of
receivables or inventories, given knowledge of the other independent var-
iables. Results on the incremental information content of receivables given
total inventory balances are described first, followed by consideration of
whether receivables have incremental explanatory power over data on in-
ventory components.

4.1 Results for Receivables Combined witb Total Inventories

Table 3 shows results for firms in the seven manufacturing industries
pooled together. Tbe coefficients of regressors representing unexpected total
inventories (UI) and unexpected receivables (UR), added to the bench mark
equations for sales, earnings, and margins, are shown in panels A, B, and
C, respectively. Results are presented for one-, two-, three-, and four-
quarter-ahead predictions as well as for one-year-ahead predictions."* The
first three columns of each panel show the results for all four quarters of
firms' fiscal years ("all quarters"). However, since data on inventory com-
ponents are not available for interim quarters, later regressions involving
inventory components use only data from fourth quarters. To control for
potential differences between fourth quarters and interim quarters. Table 3
also shows results broken out separately for fourth quarters and for interim
(first, second, and third) quarters.
In Table 3, the coefficients on unexpected inventories for all quarters
are similar to those reported by BN. Unexpected inventory balances are
positive leading indicators of future sales for all prediction horizons. Al-

period (1978-1987) ends before consolidation of all majority owned subsidiaries was mandatory. (Fi-
nancial Accounting Standards Board [FASB] Statement No. 94, Consolidation of all Majority Owned
Subsidiaries, issued in October 1987. was effective for financial statements for fiscal years ending after
December 15, 1988.) Thus, receivables from captive finance subsidiaries are included in receivables
here only for firms that voluntarily consolidated such subsidiaries before the effective date of FASB
94. To tiie extent that some nontrade receivables are included in prior periods receivables balances, the
terms involving lagged receivables balances should remove somefirm-specificand even seasonal variation
in such items. The remaining variation will show up as noise in unexpected receivables.
14. The benchmark prediction equations for sales, earnings, and margins are modified for multiple-
quarter-ahead predictions as described in BN (p. 171). Also, following their convention, values of the
dependent variables for the one-year-ahead predictions are averages of the next four quarters' sales,
earnings, and margins figures.
 S — go
I ~ I I I I

I
7' i
I
O O O\ O\

s s s
s I I I ' I '

<s Ol
s •2
I I I
00
00

BQ
0
00 r^
z •§ .—I o 00

.a
in)

a: S PS
I I I I

I
I o»
7 ' I ' I ' I '

pT) — o^ o^^
-^' Tf ^f rn

III

— cs ro

462
 Or<^0<NO

8 §;

7171

1 i ' 7 '7
CN
I
8I
s

I
01*

02*

02*

02*
29)

25)

SF;
1 cs 1 CN

1
1 17 1
1
1
1 _i3 d
u > c
S 2 ?

* * 3
^cant i
:ant at

tories;
02*
45)
.35)

vo
8 8 CN

o
.—

o s
I I B
c op U
00 c

|1|
"^ f*^ f^ m
1! I
~ c S
C <U c
.a 'o §

L e i» j» a

o*3
—
*3
o
CN
oZ3
C1
oS >•u
Tf —

463
464 JOURNAL OF ACCOUNTING, AUDITING & HNANCE

though unexpected inventories are, at best, weak negative leading indicators

of future earnings and margins in one-quarter-ahead predictions, this neg-
ative relation becomes stronger in multiple step-ahead predictions, beginning
two quarters ahead for earnings and three quarters ahead for margins. Thus,
adding unexpected receivables to the prediction equations does not diminish
the explanatory power of unexpected total inventories as documented by
BN. However, BN do not report separate results on the explanatory power
of interim and fourth-quarter total inventory balances. Table 3 shows that
only the positive relation between unexpected inventories and future sales
in panel A is consistent across interim quarters and fourth quarters. In
contrast, although the negative relation between unexpected inventories and
future eamings and margins in panels B and C shows up in the results for
interim quarters, it is largely absent from the results on fourth-quarter total
inventories.
Focusing on the results for unexpected receivables balances, panel A
shows that, given total inventories, receivables provide information useful
for predicting future sales. Consistent with the sales momentum explanation,
unexpected receivables balances are positive leading indicators of next quart-
er's sales. The coefficients of unexpected receivables in the one-quarter-
ahead predictions are significantly positive for all quarters (f = 2.73) and
for interim quarters (f = 2.30). Although it is not significant at conventional
levels, the coefficient of fourth-quarter unexpected receivables exceeds the
corresponding coefficient for interim quarters and is more than one and one-
half standard errors above zero, based on approximately one-third the num-
ber of observations as the interim quarter results. However, in contrast to
the results for unexpected inventories, the incremental explanatory power
of unexpected receivables for predicting future sales is short-lived. In the
results for all quarters and those for interim quarters, the coefficients on
unexpected receivables in panel A drop off when moving from one- to two-
quarter-ahead predictions, then alternate signs in the three- and four-quarter-
ahead predictions, but none of these coefficients is significant.
For predictions of eamings and margins in panels B and C of Table 3,
the situation is somewhat different. In the results for all quarters, unexpected
receivables are strong negative leading indicators of eamings and margins
in the one-step-ahead predictions, where unexpected inventories had little
or no predictive power. Even in the multiple-step-ahead predictions, where
the coefficients of unexpected inventories are significantly negative, unex-
pected receivables continue to exhibit significant incremental explanatory
power. This negative relation is driven by the results for interim quarters,
however. The coefficients of fourth-quarter unexpected receivables fre-
quently switch signs and none is significant.
INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 465

The exact reasons the fourth-quarter results differ from those of interim
quarters are unknown. To be sure, the predictive ability tests for a single
quarter are less powerful than tests for the three interim quarters or tests for
all four quarters combined. However, there could be reasons why the pre-
dictive ability of fourth-quarter receivables balances would systematically
differ from that of interim receivables balances. For example, managers
may engage in end-of-year balance sheet window dressing by factoring
receivables, or by altering credit terms to speed up collections (e.g., offering
larger discounts). Similarly, managers might exert more effort at year-end
to manage nontrade receivables, such as amounts due from unconsolidated
affiliates. Such activities would add noise to unexpected receivables at year-
end that might not be present at interim dates.
Tests like those in Table 3 were also conducted on an industry-by-
industry basis. Although the industry-level results are not separately tabu-
lated here, the following is a summary of cases where the coefficients for
unexpected receivables were significant (at the .05 level in two-tailed tests)
in regressions including data from all quarters. For predictions of sales,
receivables are significant positive leading indicators of sales (as in the
pooled results in panel A of Table 3) only in industry 1 (drugs), there for
both one- and two-quarter-ahead predictions. However, receivables are sig-
nificant negative leading indicators of sales (opposite the pooled results) in
two-quarter-ahead predictions in industry 3 (machinery) and in three- and
four-quarter-ahead predictions for industry 7 (instruments). Therefore, there
is little evidence supporting the sales momentum explanation at the industry
level.
In contrast, for predictions of eamings and margins, there is more con-
sistency between the pooled results (in panels B and C of Table 3) and
industry-level results. For industry 1 (dmgs), receivables are significant
negative leading indicators of both eamings and margins at all horizons
except the one-quarter-ahead predictions. For industry 2 (metals), receiv-
ables are significant negative leading indicators only of eamings and there
only in one-quarter-ahead predictions. For industry 3 (machinery), receiv-
ables are significant negative leading indicators of both eamings and margins
in one-quarter- and one-year-ahead predictions, and of margins alone in
two-quarter-ahead predictions. For industry 4 (electronics), receivables are
significant negative leading indicators f both eamings and margins at all
horizons except for two-quarter-ahead predictions of margins. For industry
6 (transportation), receivables are significant negative leading indicators of
both eamings and margins in one-quarter- and one-year-ahead predictions.
The only industry-level result on eamings and margins that is opposite the
pooled results and significant at even the .10 level (in a two-tailed test) is
466 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

for industry 7 (instruments), where receivables are significant positive lead-

ing indicators of margins in one-quarter-ahead predictions. Thus, there is
at least some evidence of a significant negative relation between future
eamings and margins in the industry-level results for five of seven manu-
facturing industries and little contrary evidence. Interestingly enough, how-
ever, there is no evidence that receivables (or inventories) are useful in
predicting future eamings and margins in industry 5 (computers). This in-
dustry supplies much of the anecdotal evidence consistent with the "eamings
quality explanation" in O'glove's (1987) chapter on the analysis of receiv-
ables and inventories.
Although unexpected receivables have incremental explanatory power
for the pooled sample of manufacturers, there is no similar evidence of
incremental explanatory power for retailers. In regressions similar to those
in Table 3 for the retail department store industry (not shown here), un-
expected receivables do not exhibit any incremental explanatory power in
any of the prediction equations, or at any prediction horizon. In retrospect,
this is not too surprising, given the low receivables-to-sales ratios for
retailers.
Table 4 summarizes the results of testing the proposition that the de-
scriptive validity of the sales momentum explanation should vary inversely
with the average collection period. The ratio of receivables to quarterly sales
(RJS,) is linearly related to the average collection period. '^ The tests in Table
4 involve stratifying the sample based on firm-specific average receivables-
to-sales ratios. These average receivables-to-sales ratios are calculated as
the time-series mean of quarterly receivables-to-sales ratios (RJS,) for each
firm over the entire sample period. Firms designated as having high (low)
average receivables-to-sales ratios are firms whose ratios are above (below)
the median such ratio for their industry. Since the receivables expectations
models are estimated on a pooled industry-by-industry basis, these models
were reestimated for this test to allow differential intercepts (within each
industry) for designated as having high (low) average receivables to sales
ratios.'*
Since the sales momentum explanation does not apply to eamings and
margins. Table 4 shows the results of estimating only the sales prediction
equation separately for firms with high and low average receivables-to-sales
ratios. If the sales momentum explanation is driving the positive relation
between unexpected receivables and future sales, this relation should be

15. Assuming a 360-day year, the average collection period = 90 days x R/S,.
16. The purpose of this modification is to eliminate any tendency for unexpected receivables for
firms classified ex post as having high (low) average receivables-to-sales ratios to be systematically
positive or negative.
 tS 00 S •*. ' ^
a;
§

72)
14 ( 51)
59)
Ol
Tt

25** (
20** (
3
5
30**
23**
a
o m ON (N —' IT) (N — — 00
Z Q O O^ O O
IT ^ »n >o

59)
CM
00 3 <N
essor

IRect

1 1
o;
;:3 g
38 3SO
Sales Rat

o o o
nventiory,

"§ g 1 1 1 1 1
'

1
08)
98)
s vo ? s 96)
10
38

CM
Ol
-a m
(3
(6

(6
(4
(8
Sales
ibles-
terim

§
s
**
**
**
**

**

s.
statis

s:: bo
CN 00
^1 3 ON
^nts

••»*
z 0 'J:
•^ 00 -^
vo m >n
iC (Q ..5

!^ ON — (N ^
:ant at .10 1 vel, •o-ta
l-o«
iinex cted

a
a: ? 8.
Z
evel

3 B s o1 8
N
1
o
'^ ' 9
T
uart

ones;

s ovo I
tio

O( Sg;
vo
5 1 *
* Tt
#* 'c

f ) tN (N 9 9 r -:

>n
3^ ON O in •III
111
CM ^ Tt "^
z Tt 00 r^
o O
rn ON

r i (S^ cM*^ '^ —T

S S§ ^
c:
N < < < <:
'i 3l is
2 i2 e =3 u 22 d 2 ^
a: is Q t2 u ^ «3 S S u

467
468 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

Stronger for finns with low average receivables-to-sales ratios. However,

this prediction is not supported by the data. In fact, for the one-quarter-
ahead predictions, the opposite is true—the coefficients on unexpected re-
ceivables are significantly positive only for firms with high average receiv-
ables-to-sales ratios.'^

4.2 Results for Receivables Combined with Inventory Components

Table 5 reports the results of using data on inventory components in
place of total inventory balances to predict sales, eamings, and margins.
Since retailers report only data on total inventories, these results are for the
pooled sample of manufacturers. Also, because data on inventory compo-
nents are available only at year-end, these results correspond to the fourth-
quarter results in Table 3, where fourth-quarter receivables were weak pos-
itive leading indicators of next quarter's sales but unrelated to future earnings
and margins. Therefore, prior expectations on receivables adding significant
explanatory power in Table 5 are not high.
Similar to the results reported by BN, panel A of Table 5 shows that
unexpected raw materials and unexpected work-in-process inventories are
positive leading indicators of future sales. Thus the positive relation between
fourth-quarter unexpected total inventories and future sales appears to be
driven by these components, consistent with production smoothing or lead
time models of inventory. As in Table 3, there is weak evidence that un-
expected receivables are positive leading indicators of future sales one
quarter ahead. The coefficients of unexpected receivables for the multiple-
step predictions of future sales are all positive and similar in magnitude to
those reported for the fourth-quarter regressions in Table 3, but none is
significant.
In panels B and C of Table 5, the performance of unexpected receivables
is again very similar to the fourth quarter results reported in Table 3. The
coefficients of unexpected receivables switch signs and none is significant.
As in the results reported by BN, only the coefficients of finished goods
inventories are significant in the one-year-ahead predictions, consistent with
stockout model for finished goods. However, given the lack of predictive
power for fourth-quarter total inventories in Table 3, it is not clear that
fourth-quarter finished goods inventory balances are what is driving the

17. Some of the estimated coefficients are larger for firms with low average receivables-to-sales
ratios. However, this is not evidence in favor of the sales momentum explanation. The reasoning is that
in such firms, receivables balances support a greater amount of sales activity, thus greater estimated
coefficients would naturally be expected. Here, the appropriate comparison involves only the significance
levels of the coefficients.
INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 469

TABLE 5
Predictability of Sales, Earnings, and Margins for Manufacturers
Based on Inventory Components and Receivables Data
Sample Size (N) and Coefficients (t-statistics) on Designated Regressors***

Horizon N URM UWP UFG UR

Panel A:
Predictions of (Changesin) Sales, Based on Lagged Sales, Inventory, and Receivables Data

1 Qtr. Ahead 1,018 .37** .39** .13* .07*

(4.99) (5.50) (1.67) (1.86)
2 Qtrs. Ahead 1,011 .28** .42** -.02 .07
(2.98) (4.69) (-.23) (1.38)
3 Qtrs. Ahead 1,013 .24** .31** .07* .01
(2.27) (3.08) (1.67) (.12)
4 Qtrs. Ahead 1,012 .24** .35** .16 .07
(2.27) (3.38) (1.41) (1.26)
1 Year Ahead 1,004 .26** .35** .16 .07
(3.23) (4.58) (101) (1.32)

Panel B:
Predictions of (Changes in) Earnings, Based on Lagged Eamings, Inventory, and Receivables Data

1 Qtr. Ahead 993 -.00 .00 -.02 .00

(-.16) (.12) (-1.05) (.37)
2 Qtrs. Ahead 993 .03 .04 -.02 .02
(1.21) (1.67) (-.99) (1.75)
3 Qtrs. Ahead 991 -.02 -.06 -.06 -.01
(-.89) (-2.60) (-2.24) (-1.09)
4 Qtrs. Ahead 977 -.03 -.03 -.03 -.01
(-1.00) (-.85) (-.86) (-.83)
1 Year Ahead 964 -.01 -.01 -.04 -.01
(-.27) (-.68) (-2.00) (-.55)

Panel C:
Predictions of (Levels of)Margins, Based on Lagged Margins, Inventory, and Receivables Data

1 Qtr. Ahead 1,003 -.00 .00 -.02 .00

(-.78) (-.06) (-1.39) (.78)
2 Qtrs. Ahead 1,000 .02 .00 -.01 .00
(1.17) (.28) (-.79) (.39)
3 Qtrs. Ahead 1,002 -.00 -.03 -.05 -.02
(-.15) (-1.36) (-2.08) (-1.73)
4 Qtrs. Ahead 989 -.03 .03 -.04 -.01
(-1.12) (-1.17) (-1.49) (-.43)
1 Year Ahead 964 -.01 -.01 -.03 -.00
(-.77) (-.54) (-1.94) (-.24)

*Coefficient statistically significant at .10 level, two-tailed test.

**Coefficient statistically significant at .05 level, two-tailed test.
***UI—unexpected total inventories; URM—unexpected raw materials; UWP—unexpected work
in process; UFG—unexpected finished goods; UR—unexpected accounts receivable.
470 JOURNAL OF ACCOUNTING, AUDITING & HNANCE

Strong negative relation between unexpected total inventories and future

earnings and margins observed across all quarters in Table 4.

4.3 Other Tests

The predictive models considered here may not capture the full range
of signals that could be conveyed by unexpected receivables and unexpected
inventories. For example, receivables being abnormally high may mean one
thing if inventories are abnormally high as well and something else if in-
ventories are abnormally low. Attempts to capture these more contextual
relations include estimating models that incorporate interaction terms whose
coefficients isolate the effects of cases where unexpected receivables and
unexpected inventory components have opposite signs.'* When models in-
volving total inventories (such as those in Table 3) are modified to include
such interaction terms, none of the coefficients of the added terms is sig-
nificant. However, results (not separately reported here) for models involv-
ing unexpected inventory components provide evidence of some significant
interactions, particularly interactions between unexpected receivables and
unexpected work-in-process inventories. Unfortunately, these models could
be especially susceptible to biases resulting from the inability to purge the
effects of acquisitions and divestitures from the data." Subject to this caveat,
the pattern of interactions observed suggests that in cases where work-in-
process inventories are abnormally high and receivables are abnormally low,
future sales, earnings, and margins will be higher than would otherwise be
expected, conditional on the other variables in the model.
One possible scenario consistent with such a pattern of interactions is
that if recent sales levels and receivables balances are low because of an
impending model changeover or the inability to produce enough inventory
to keep up with demand, a bulge in work-in-process inventories may be a
transitory phenomenon that works itself out in future periods with positive
consequences for sales, earnings, and margins. Although this explanation
fits this aspect of the data, it is admittedly ex post. However, it illustrates
that the relations between unexpected receivables, unexpected inventory

18. See Stot)er (1993) for some examples of models that include such interaction terms.
19. If large acquisitions and divestitures are distorting the data, the unexpected components of all
current operating assets (receivables and inventories) would be expected to move together. Although
the data screens are intended to remove such distorted observations, it is possible that some remain in
the sample. BN (n. 17, p. 170) generally recognize that data distortions from acquisitions and divestitures
could bias their coefficients on all of the inventory components upward. (They argue that this econometric
problem would be most severe in the sales and earnings equations, but the equation for profit margins
should be relatively unaffected.) If such effects are present here, then the interaction terms may simply
pick up the effects of removing the upward bias in other coefficients.
 INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 471

components, and future sales, earnings, and margins are complex and may
be context dependent. It is likely, then, that parsimonious explanations such
as sales momentum and earnings quality capture only a part of the story.
Further work is necessary to sort out such interactions and better understand
the economic logic underlying them.^"

5. Concluding Remarks
This study provides evidence on the incremental information content of
receivables in predicting future sales, earnings, and profit margins. It extends
the results of Bernard and Noel (1991) (BN) by adding unexpected receiv-
ables, along with the variables they investigate—total inventory and its
components—to their prediction models for sales, earnings, and margins.
The tests are conducted on the BN sample. Although this permits direct
comparisons with the results of BN, it also represents a limitation of this
study. The sample is a nonrandom one; BN selected their industries to have
sufficient data to estimate expectations models for inventories, receivables,
sales, earnings, and margins on an industry-by-industry basis. Therefore,
caution should be exercised in generalizing the results beyond the eight
industries represented in this sample.
Two simple explanations for the potential information content of re-
ceivables guide the investigation: the earnings quality explanation and the
sales momentum explanation. The major findings are that, for manufactur-
ers, receivables provide information useful for predicting future sales, earn-
ings, and margins that is incremental to that contained in total inventory
balances. Like unexpected inventory balances, unexpected receivables are
positive lead indicators of future sales. Relative to evidence on unexpected
inventory balances predicting future sales multiple quarters ahead, however,
the predictive power of unexpected receivables is short-lived; it is evident
only in one-quarter-ahead predictions of sales. On the surface, these results
are consistent with a sales momentum explanation, where receivables bal-
ances indicate the level of sales for the last few weeks of a quarter. The

20. A potential way around the data problems caused by the effects of acquisitions and divestitures
is to use statement of cash flows data on changes in total inventories and receivables >om operations,
which exclude these effects. Future work in this area might profitably exploit statement of cash flows
data by estimating the prediction equations within these years based on " a s - i f inventory and receivables
balances that ignore changes in total inventory and receivables due to acquisitions and divestitures. The
resulting estimates would not be contaminated by the effects of acquisitions and divestitures and thus
represent tests of the predictive ability of pure changes in inventories and receivables from firms' operating
activities. Quarterly data from the statement of cash flows are available on Compustat beginning with
the first quarter of 1987. However, there are trade-offs involved, as receivables data from 1988 on will
also include receivables from captive finance subsidiaries that were not consolidated during the sample
time period examined here (see note 13).
472 JOURNAL OF ACCOUNTING, AUDITING & HNANCE

data do not support more detailed predictions of the sales momentum ex-
planation, however.
The pattern is different for predictions of manufacturers' future earnings
and margins. Although unexpected total inventories are strong negative
leading indicators of future earnings and margins in multiple-step-ahead
predictions, the relation between unexpected total inventories and next quart-
er's earnings and margins is weak. In contrast, pooled results for manufac-
turers indicate that unexpected receivables balances are strong negative
leading indicators of earnings and margins for all prediction horizons. This
effect is traceable primarily to predictions made at the end of interim quarters;
there is no evidence that fourth-quarter receivables balances (or fourth-
quarter total inventory balances, for that matter) are useful in predicting
future sales, earnings, or margins. For all four quarters combined, at least
some evidence of a significant negative relation between future earnings and
margins is also observed in industry-level results for five of seven manu-
facturing industries.
When combined with data on inventory components, available only at
year-end, fourth-quarter unexpected receivables still do not predict sales,
earnings, or margins. However, information on unexpected receivables may
be important in expanded models that include interaction terms representing
cases where unexpected receivables and unexpected inventory components
have opposite signs. Such interactions suggest that the links between un-
expected receivables, unexpected inventories, and future sales, earnings,
and margins may be more complex than contemplated by the simple ex-
planations guiding this study.

REFERENCES
Bernard, V. and J. Noel. 1991. "Do Inventory Disclosures Predict Sales and Earnings?" Journal of
Accounting, Auditing, and Finance (Spring): 145-181.
Bernard, V. and T. Stober. 1989. "The Nature and Amount of Information Reflected in Cash Flows
and Accruals." The Accounting Review (October): 624-652.
Bowen, R., D. Burgstahler, and L. Daley. 1987. "The Incremental Information Content of Accrual
Versus Cash Flows." The Accounting Review (October): 123,-1AT.
Foster, G. 1977. "Quarterly Accounting Data: Time-Series Properties and Predictive-Ability Results."
The Accounting Review (January): 1-21.
O'glove, T. 1987. Quality of Earnings: The Investor's Guide to How Much Money A Company is Really
Making. New York: The Free Press.
Ou, J. 1990. "The Information Content of Noneamings Accounting Numbers as Earnings Predictors."
Journal of Accounting Research (Spring): 144-163.
Ou, J. and S. Penman. 1989a. "Accounting Measurement, Price-Earnings Ratios and the Information
Content of Security Prices." Journal of Accounting Research (Supplement): 111-144.
Ou, J. and S. Penman. 1989b. "Financial Statement Analysis and the Prediction of Stock Returns."
Journal of Accounting and Economics (November): 295-329.
Penman, S. H. 1992. "Return to Fundamentals." Journal of Accounting, Auditing, and Finance (Fall):
465-483.
Raybum, J. 1986. "The Association of Operating Cash Flows and Accruals with Security Returns."
Journal of Accounting Research (Supplement): 112-133.
Stober, T. 1993. "Positive and Negative Inventory Divergence: Testing Thornton O'glove's Analysis
INCREMENTAL INFORMATION CONTENT OF RECEIVABLES 473
of the Components of Manufacturing Inventories." In Stephen E. Butler, Ed. Earnings Quality.
Norman: The University of Oklahoma, Center for Economic and Management Research.
Wilson, G. 1986. "The Relative Information Content of Accruals and Cash Hows: Evidence at the
Earnings Announcement and Annual Report Release Date." Journal of Accounting Research (Sup-
plement): 165-200.
Wilson, G. 1987. "The Incremental Information Content of the Accrual and Funds Components of
Earnings After Controlling for Earnings." The Accounting Review (April): 273-322.