Financial Statements - Revenue Recognition Effects on Cash Flows and Financial Ratios

Both methods - the percentage-of-completion and completed-contract methods - produce the same net cash flow effect.

Cash Flow Effects

  • Percentage-of-completed contract method
    • Net income (NI) will be higher in the first years and lower in the last year.
    • Net Income will be less volatile.
    • Total assets will be greater.
    • Liabilities will be lower.
  • Completed contract method
    • Net income will be nonexistent in the first years and higher in the last year.
    • Net income will be very volatile.
    • Total assets will be smaller.
    • Liabilities will be higher (no recognition of retained earnings).
    • Stockholders equity will be lower.
    • Stockholders equity will be more volatile.

Impact on Financial Ratio

Ratio Formula % of Completion Method Reason Completed Method
Current Ratio

Current Assets
Current Liabilities

Higher Construction in progress includes portion of estimated profits Lower
Revenue
Turnover

Revenues
Average Receivables

Higher Revenues are reported Lower - Not measurable prior to completion
Assets to Equity

Total Assets
Equity

Higher Retained earnings are reported Lower - Not measurable prior to completion
Total Debt Ratio

Total Liabilities
Total Liabilities + Total Equity

Lower Liabilities are smaller and the denominator includes equity which is higher Higher
The Cash Flow Statement


Related Articles
  1. Investing

    Ratio Analysis

    Ratio analysis is the use of quantitative analysis of financial information in a company’s financial statements. The analysis is done by comparing line items in a company’s financial ...
  2. Trading Strategies

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  3. Economics

    Understanding Total Liabilities

    Total liabilities are the combined debts an individual or company owes.
  4. Active Trading Fundamentals

    Analyzing Oracle's Debt Ratios in 2016 (ORCL, SAP)

    Learn how the debt ratio, debt-to-equity ratio and debt-to-capital ratio are used to evaluate Oracle Corp.'s liabilities, equity and assets.
  5. Economics

    Understanding Revenue Recognition

    Revenue recognition is an accounting term describing how and when a company records revenue in its accounting records.
  6. Economics

    What is the Cash Ratio?

    The cash ratio is the ratio of a company's total cash and cash equivalents to its current liabilities.
  7. Investing Basics

    Understanding Leverage Ratios

    Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios - including the debt, ...
  8. Investing

    Asset Turnover Ratio

    Investopedia explains: The asset turnover ratio is a measure of a company's ability to use its assets to generate sales or revenue, and is a calculation of the amount of sales or revenue generated ...
  9. Technical Indicators

    Key Financial Ratios to Analyze Investment Banks

    Find out which financial ratios are most useful when analyzing an investment bank, and why tracking capital efficiency is especially important.
  10. Budgeting

    Evaluating Your Personal Financial Statement

    Determine your net worth by making your own cash flow statement and balance sheet.
RELATED TERMS
  1. Cash Asset Ratio

    The current value of marketable securities and cash, divided ...
  2. Shareholders' Equity

    A firm's total assets minus its total liabilities. Equivalently, ...
  3. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ...
  4. Operating Cash Flow Ratio

    A measure of how well current liabilities are covered by the ...
  5. Percentage Of Completion Method

    An accounting method in which the revenues and expenses of long-term ...
  6. Quick Liquidity Ratio

    The total amount of a company’s quick assets divided by the sum ...
RELATED FAQS
  1. What are some ratios I can use the operating cash flow ratio with?

    Understand the importance of a company's operating cash flow. Learn about some of the financial ratios that use the operating ... Read Answer >>
  2. What are the differences between percentage of completion and the completed contract ...

    Learn the advantages and disadvantages businesses face when using either the percentage-of-completion or completed contract ... Read Answer >>
  3. What does the operating cash flow ratio measure?

    Learn about the operating cash flow ratio, how the ratio is calculated and what it indicates about a company. Read Answer >>
  4. What are some alternative liquidity ratios to the cash ratio?

    Learn what the cash ratio measures, and understand what two other liquidity ratios can be used by a company to replace the ... Read Answer >>
  5. What does the cash ratio of a company measure, and how does it affect decision making?

    Learn what the cash ratio of a company measures, and understand why its an important liquidity ratio for a company to use ... Read Answer >>
  6. What is the difference between the cash ratio and the solvency ratio?

    Understand the difference between the cash ratio and the solvency ratio. Learn why a company should be focused on both ratios ... Read Answer >>
Hot Definitions
  1. Labor Market

    The labor market refers to the supply and demand for labor, in which employees provide the supply and employers the demand. ...
  2. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  3. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  4. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  5. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  6. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
Trading Center