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Why do people get nervous when a company's earnings fluctuate? And why is it a given that companies need some flexibility in when they book revenue, to make people less nervous?

Fluctuating revenue is a genuine risk of being in the stock market, shouldn't the participants face up to that risk instead of it being hidden by the companies' accounting tricks?
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Fluctuating revenue is a genuine risk of being in the stock market, shouldn't the participants face up to that risk instead of it being hidden by the companies' accounting tricks?

I wish they would. :)

In my time in accounting and finance there was nothing worse than having an unexpected spike in either direction when it came to revenue - you'd think the world was coming to an end, even though at the end of the year, we always came reasonably close to what had been forecast anyway.

Life has fluctuations, but apparently, revenue shouldn't...

Cindy
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Why do people get nervous when a company's earnings fluctuate?

People tend to believe that those in charge of a company have some degree of control. The company needs to set its budget and plans according to the revenues that will be taken in. If a company can not predict its revenues with some degree of accuracy how can it possibly plan for its future? If the management of a company can not make an accurate forecast of its earnings how can investors? When their are unexpected spikes (in either direction) in revenues it shows that managements planning is not as good as it could be.

Why is it a given that companies need some flexibility in when they book revenue, to make people less nervous?

Companies are given a little bit of flexibility as to when they book revenues because the way businesses earn revenues are different. It's easy to see that a retailer such as Walmart should book revenues at the point of the sale, when the payment is made and the sale is complete. Now, a road construction company that is working on a three year project with payment dispursed throught the time period is a different story.

The Realization Principle (A.K.A. Recognition Principle) requires that revenue be recognized at the time, but not before, it is earned. This can get pretty fuzzy sometimes. Just because someone pays you doesn't mean you've earned it yet (unearned revenue/deposits/retainers). Also, just because you haven't been paid yet doesn't mean you haven't earned it (sale/services on credit).

Typically a sale/service is booked as revenue when the company has earned the right to payment, whether they receive payment or not.
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When their are unexpected spikes (in either direction) in revenues it shows that managements planning is not as good as it could be.

As someone who has been more involved in the budgeting/planning process than I ever care to repeat, we were directed to flat line everything. Takes all the spikes out. When we would try and put the spikes in, upper management rejected it.

Cindy
we tried...
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we were directed to flat line everything. Takes all the spikes out.

Normally this is what has to be done. However, if a spike can accurately be predicted it should be prepared for. For instance, if you are a manufacturer and your largest competitor is going out of business you should assume that your sales will go up. If you own a donut shop and Krispy Kremes and Dunkin-Donuts are opening within a block of you within the next month you should factor in a negative spike.

Unexpected spikes scare investors because they show that management either didn't consider, or didn't expect a change in their business environment.
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