Most profit-making companies are expected to grow over time—growing sales, growing profits, and growing shareholder value.
When the industry and markets are growing, a company that does not grow may be at risk of losing out to competition, losing customer confidence, and losing investor confidence.
Even with a constant market, a company with stagnant sales and profits is a company not even keeping up with inflation. As a result, senior management, shareholders, and potential investors, have a keen interest in tracking business growth metrics for the company.
Growth metrics in business fall into two classes:
- Single-period metrics. These measure progress towards specific short-term business objectives. Single-period metrics represent either growth magnitudes or growth rates.
- Multi-period growth metrics. These represent long term growth rates in financial performance, business volume, company size, and other business performance measures.
The multi-period growth metric cumulative average growth rate CAGR, for instance, often appears in the financial sections of company Annual Reports. Companies often use CAGR to summarize 5- or 10-year growth rates of sales revenues and profits.
Explaining Growth Metrics in Context
Sections below further define, explain, and illustrate business growth metrics. Note especially that the term appears in context with related terms and concepts, including the following:
Discussion below show, for instance, how the popular multi-period growth metric Cumulative Average Growth Rate (CAGR) derives from historical data.
- What are business growth metrics?
- Defining business Growth in Concrete Terms.. Business growth metrics measure business performance. Seven Frequently Used Growth Metrics:
- Which metrics measure single-period business growth?
- Single-period growth vs. multi-period growth.
- What is exponential growth? How do you calculate exponential growth?
- What is cumulative average growth rate CAGR? How do you calculate CAGR?
- Apple multi-period growth example: Interpreting and misinterpreting CAGR multi-period growth metrics.
- Example: What CAGR shows and what CAGR hides.
- Financial Metrics provides a complete introduction to metrics for analyzing cash flow and financial statements.
- Income Statement and Balance Sheet represent the primary business data sources for growth analysis.
- The Excel-based ebook Financial Metrics Pro is a comprehensive metrics handbook, teaching tutorial, and template library.
Business growth metrics reveal that some firms are failing, some are barely surviving, and still others are thriving with excellent prospects for the future. In most cases, everyone involved with the firm takes a keen interest in tracking business growth metrics—owners, investors, directors, officers, managers, and employees. Growth metrics derive from historical data but they command attention because they predict the future.
In competitive industries, moreover, industry analysts and competitors also have good reason to watch growth metrics closely. Companies compete when they contend for the same customers in the same market. One firm's growth performance, therefore, is likely to impact another firm's growth performance. And, in cases where markets are expanding or shrinking, individual firm growth metrics help explain why overall market size is changing.
Seven Ways to Ask: Is the Business Growing as it Should?
Businesspeople address such questions with single-period and multi-period growth metrics. For firms in private industry, growth analysis focuses on ...
- Firstly, factors that represent earnings performance, such as profits, margins, cash flow and working capital, and earnings per share EPS.
- Secondly, factors that impact or contribute to earnings performance, such as sales revenues, operational efficiencies, competitive success rates, and market share.
Following are seven frequently used and carefully watched factors at the heart of business growth analysis.
Sales revenues, in fact, are the most popular measure of company "size." The question "How large is that company" typically brings answers such as this:
That's a $12 billion company!
Everyone understands that such figures refer to sales revenues.
The highest level objective for profit making companies is, in principle, "increasing owner value." In practical terms, however, firms approach this objective by earning profits. After a profitable period, owner value increases when the Board of Directors turns the period's profits into shareholder dividends and Balance Sheet retained earnings. The analyst can rightly say that the firm's future depends, above all, on its ability to earn and grow profits.
Not surprisingly, Annual Report growth metrics usually focus first on recent earnings performance and prospects for future earnings. For many, this means highlighting Income Statement "bottom-line" profits—known more formally as Net Income, Net Earnings, or Net Profit after taxes.
Other companies, however, choose instead to highlight selective profit metrics such as Operating Income or Earnings Before Interest and Taxes EBIT. These firms believe that selective metrics such as these paint a truer picture of earning performance in the firm's core line of business, than do bottom line Net Profits.
Several performance factors related to share ownership are also center stage when analysts and investors ask whether the firm is meeting its highest level business objective—increasing owner value. Questions regarding ownership value focus especially on the firm's Earnings per share EPS performance, stock share prices, and changes in the firm's Owner's Equity account.
Positive growth on these factors affirms that the company is meeting the highest level business objective, while negative growth rates on these factors indicates the company is not increasing owner value as it should.
Firms normally expect that costs will grow over time, in all cost categories of the firm's core line of business. Costs should grow, that is, when the company grows by any of the other performance measures in this section. Exceptions, of course, are costs in areas that are already known for inefficiency, which management targets for reduction.
In any case, the firm's officers and managers may give special attention to tracking cost growth in several specific cost categories when they suspect the following:
- Gross margins are falling.
This may be the analyst's conclusion when gross profit growth is less than growth for product direct costs or manufacturing overhead.
- Operating efficiency is degrading.
Indicators include specific operating costs that are increasing faster than sales or operating profits.
- Sales effectiveness is declining.
This may be indicated, for instance, when there is positive growth in cost per sale or length of the sales cycle. Decline may also be signaled by negative growth in average order size, market share, or competitive win rate.
Business firms must enough maintain liquidity to meet short immediate financial obligations. Business firms define liquidity in terms of metrics that measure the firm's access to working capital or, in some cases, available cash. For that reason, officers and senior managers have a strong interest in tracking the firm's working capital and cash balances. Negative growth rates in these metrics are warnings that normal operations are at risk.
The firm may receive alerts that liquidity growth is negative, when it discovers it cannot pay for infrastructure maintenance or equipment upgrades. Negative liquidity growth can also mean the firm will soon be unable to fund marketing programs or develop new products. In extreme cases, the firm may even be unable to meet payroll. Understandably, management looks to liquidity metrics growth rates for advance warning that such problems are imminent.
The Working Capital metric derives from figures in two Balance Sheet categories:
Working capital = Current assets – Current liabilities.
- Current assets are assets of several kind that could—in principle—transform into cash soon. Cash is a Current asset, of course, but also assets such as Inventories, Accounts Receivable, Short Term Investments, Marketable Securities, and Prepaid Expenses.
- Current Liabilities are debts the firm must pay in the near term, usually within a year or less.
Some firms do not regard all Current Assets as being especially liquid. Firms with this view also watch carefully the growth rates in the firm's access to cash and its ability to generate positive net cash flow.
One cash metric for this purpose is the Net Cash Flow result the firm reports each period. Net CF for the reporting period is taken as the difference between two totals on the firm's Statement of Changes in Financial Position (or Cash Flow Statement): Sources of Cash, and Uses of Cash.
Net Cash Flow = Sources of Cash -- Uses of Cash
Dividing the firm's annual sales revenues by the average size of the employee population provides a simple but informative measure of the firm's ability to generate revenues from its workforce. Dividing the firm's Net Profits by the same headcount figure also gives a rough but useful measure of the firm's ability to use employees productively.
Total employee headcounts are also useful for estimating and planning certain costs—costs for meeting floor space needs, for providing IT support resources, or for paying employee wages and salaries.
The interpretation of employee population growth rates can be a complex subject, however. The optimal intercorrelations among growth rates for employee headcounts, sales revenues, and profits, for instance, change as firms move through phases of the business life cycle. And, preferred growth rates for these factors also depend on the firm's industry, business model, cost structure, and competitive situation.
As a result, some financial officers and other senior managers spend quite a few years with a firm and its industry, before they are confident they know the optimal target size for the employee population. This understanding develops from long experience tracking growth rates for employee headcount, as well as other business performance metrics in this section.
These measures will usually correlate positively with sales revenues, profits, and market share. There are a few conditions, however, when units sold must grow in order for profits simply to remain constant. This is the case when the firm is reducing prices, or when its cost of sales or overhead are increasing.
Changes in the growth rates for units sales and size of the customer base, however, are direct indicators that the company's business model is changing, or that the company's market is changing, or that the firm's success against competitors is changing.
A company's strategic objectives may include reaching growth targets for the next year.
- Targets may be set for positive growth in areas such as sales revenues, profits, profitability, working capital, cash flow, market share, unit sales, and stock prices.
- Firms may express growth targets as growth limits they should not exceed. For example, "Salaries will grow no more than 4% on average this year."
- They may also express targets in terms of negative growth. For example," We intend to reduce expenses for office supplies by 10% this year."
Most single period targets and metrics are easy to understand when firms express them both in absolute numbers and percentages. For Example,
- "Our objective is to grow sales revenues from $1.6 million to $2 million this year, that is grow sales revenues by 25%."
- "We intend to limit employee population growth this year to no more than 1,000 new employees beyond our current employee base of 10,000. We intend, that is, to allow no more than a 10% increase in the employee headcount.
Short term growth targets for new business start-ups usually make sense only when the firm expresses them absolute numbers. Percentage growth figures are meaningless when starting from 0 or a near-0 base. E.g.,
- Our first year target is $500,000 in sales.
- To reach profitability, we have to sell and ship 100,000 units in our first year.
|Apple Net Income
|Apple Earnings per Share EPS
Exhibit 1. Selected single-period growth metrics for Apple Computer, for fiscal years 2015, 2016, and 2017.
Single-period growth metrics for Apple Computer, Inc. are under special scrutiny for fiscal years 2015, 2016, and 2017.
For the fiscal year ending September 2017, Apple reported net profits of $48.351 billion on Sales Revenues of $ 228.570 billion. These figures are impressive, but Apple's Corporate officers know well that analysts and investors are keenly aware that 2017 follows several years of slowing growth and uncertainty about future growth for the company. This concern no doubt accounts for the focus on growth metrics in the headline for the company's Q4 2017 announcement::
Revenue Up 12 Percent and EPS Up 24 Percent to New September Quarter Records!
Apple sales revenues grew spectacularly during the 9-year period 2003 - 2012, averaging 43.1% growth per year. Rapid growth ended in 2012, however. For the 5 year period 2012- 1017, Apple sales revenues grew at an average rate of 7.9% per year. Investors and analysts now watch Apple's yearly and quarterly growth rates carefully, looking for indicators on the company's future growth prospects.
Annual and Quarterly Growth Results
The annual single period growth rates in Exhibit 1 tables lead to several conclusions:
- 2015 produced relatively high growth (26.2% revenue growth, 35.1% profit growth, and 9.28% EPS growth).
- 2016, however, saw negative growth for both Revenues, profits, and EPS.
- Positive revenue and profit growth returned for 2017, but at relatively low annual rates (6.7% for revenue and 5.8% profit growth).
Quarterly growth rates for sales revenues in 2017 (bottom table, above right) reveal still other aspects of the Apple growth dynamics.
- Apple business volume is highly seasonal. Very high sales volume occurs in Q1 (October-December), the holiday season, and Q4 (July-September), when the company normally makes new product announcements.
- Revenues for 2017, overall, show growth over 2016. However, two 2017 quarters (Q2 and Q3) still show relatively large negative growth relative to the corresponding quarters in 2016.
These single period results lead to the overall conclusion that Apple's return to the high growth rates of 2003-2012 are not yet assured in 2017.
New companies in their first years of business measure growth in terms of absolute numbers for business indicators such as sales revenues, profits, or units sold. These numbers can be input into the company's business model to estimate when the company will first "break even" and when there will be enough working capital to allow further investment in hiring, developing products, acquiring assets, and other actions necessary for survival and growth.
After several years in business, however, (perhaps after an initial period of rapid expansion) it is more useful to evaluate company growth across multi-year periods. For companies established in business for several years or more, multi-year growth rates are the better indicators of healthy financial performance and prospects for the future.
- A company that grows sales revenues by $100,000 per year for ten consecutive years, is showing stable sales growth figures. The same company, however, has a shrinking growth rate for sales. Will this company soon become unprofitable? That depends on management's ability to shrink cost growth at an even greater rate, every year.
- A company that grows sales revenues by 10% per year for ten consecutive years has a positive and stable growth rate. Long term profitability for this company requires "only" that costs grow no more than 10% per year.
When interest shifts to growth rates over multiple years, the analyst will very likely be dealing with the phenomenon of exponential growth.
Consider, for instance the company mentioned above, with sales revenues growing 10% per year for 10 consecutive years. With sales revenues for Year 0 at $1.0 million, and an annual growth of 10% for 10 years, the result would be the lower (darker) sales revenue curve in Exhibit 2 below.
Exhibit 2. Sales revenue curves illustrate exponential growth. The lower curve shows revenues resulting from 10% annual growth across 10 years and the upper curve shows revenues resulting from 20% annual growth across the same 10 years.
Starting with sales revenues at $1.0 million in Year 0, the lower curve reaches $2.6 million after 10 years of 10% annual growth. The upper curve shows that a 20% annual growth rate brings revenues from $1.0 million in Year 0 to $6.2 million in Year 10.The growth rates for each curve are constant from year to year, but note that the revenue lines are curved. This is the nature of exponential growth.
Exponential growth of exactly the same kind is, incidentally, the result of investing funds with interest compounding across multiple periods. $1.0 million invested at 10% per annum for 10 years would result in exactly the same curve and final total value of $2.6 million. In either case—sales revenue growth or investment growth—exponential growth follows the formula: FV = PV (1+ i ) n where:
- FV = Future Value, or Final Value.
- PV = Starting value, or initial Principle deposit
- i = Annual interest rate or growth rate
- n = number of compounding or growth periods.
The number of periods, n, serves as the exponent making growth an exponential function.
The most frequently asked business growth question is phrased something like this:
Aerofirma company reported sales revenues of $1,000,000 for Fiscal Year 2007. Ten years later, the company reported sales of $2,593,743 for FY 2017. This is a ten-year increase of more than 259%. The question is this:
What was the average annual growth rate across these years?
The section above shows how to find the final period revenue FV, given a starting revenue PV, a growth rate i, and the number of growth periods n.
The question in this section, however, asks for the value of i across 10 periods when the starting and ending revenue figures are both known. The answer is given by the exponential growth formula solved for i instead of FV, as shown at below in Exhibit 3.
|Cumulative Average Growth Rate CAGR|
| CAGR = (FV/PV)1/n – 1.0
CAGR = Cumulative Average Growth Rate
PV = Starting (Present) Value
FV = Final (Future) value
n = Number of periods
Exhibit 3. The CAGR formula answers the question: What was the average annual growth rate across n years?
Using the data above for FV, PV, and n, CAGR calculates as follows in Exhibit 4:
|Cumulative Average Growth Rate CAGR|
CAGR = (2,593,743/1,000,0000)1/10 – 1.0
Exhibit 4. Cumulative average growth rate, or CAGR is the average growth rate, i, in exponential growth. CAGR is the ratio of final value over starting value, raised to a fractional exponent, less 1.0.
In an MS Excel spreadsheet, the same CAGR formula is as follows:
Conclusion: Aerofirma's sales revenues grew at an average rate of 10.0% per annum for the ten-year period 2007-2017.
CAGR can be computed the same way, of course, given starting and ending figures for profits, employee headcount, units sold, or any of the other business measures discussed above.
|Apple Sales Revenues 2002 - 2017 |
Fiscal Year October - September
Exhibit 5. Apple Sales Revenues figures and annual growth rates for fiscal years 2002 - 2017.
Over the 40 years of its corporate history, business performance for Apple Computer, Inc., has seen periods of spectacular growth in revenues and profits. During the same timespan, however, Apple has also seen a few periods of slow or negative growth.
The Section above, Apple Periodic Growth, shows how single-period growth metrics for apple have been especially volatile for the fiscal years 2015 - 2016. The present section and the following section take a longer term, multi-period view of Apple growth covering fiscal years 2002 through 2017.
Sales Revenue Focus for Growth
Apple growth could be analyzed usefully in terms of any of the growth performance factors from the section above—revenues, profits, or Earnings per Share (EPS), for instance. For simplicity, however, examples below focus on just one of these: Net Sales Revenues.
Those with a strong interest in predicting Apple's prospects for future growth will begin by trying to explain multi-period growth performance--and changes in multi period performance--n terms of events such as the following:
- Changes in Apple corporate management.
- Changes in competitive strategy and product strategy.
- New product introductions
- Advances in technologies
- Competitors successes and failures
- Market growth and other market dynamics.
Corporate Management and Investor Analysts alike have two reasons for carefully examining multi-period growth metrics.
- Firstly, multi period analysis helps evaluate the impacts of management actions, such as changes to the company's business strategies, the impacts of market changes, and the consequences of competitors actions.
- Secondly, multi period analyses of historical growth metrics serve as a basis for predicting or forecasting future business performance.
With these purposes in mind, consider the history of Apple's year-to-year growth rates for sales revenues. Exhibit 6, for instance, presents the single-year growth rates, for the period 2003-2017:
Exhibit 6. Apple Inc. single period revenue growth rates, for fiscal years 2002 - 2017. Notice that the series of extremely high growth rates seems to end with year 2012.
One conclusion stands out in Exhibit 6: The years 2004 - 2012 saw very high revenue growth rates (annual growth exceeding 10% per year). The years 2013 - 2017, however, showed generally lower growth rates and less predictability. Exhibit 7, below, will further show that revenue growth from 2004 to 2013 was highly predictable because revenues in that period grew in close conformance with an exponential growth model.
Predicting Revenue Growth With Exponential Modeling
Exhibit 7, below, plots Apple sales revenues themselves. Note that the graph line in black, with data markers, represents sales the revenue figures from Exhibit 6. Some will notice immediately that a portion of the revenue curve looks very much like the exponential growth curves in Exhibit 2 above.
Consider, for instance, Apple sales revenues for 2003-2013, from the Exhibit 5 table above. Revenues clearly show strong growth for this ten-year period: 2013 revenues of $170.9 billion are more than 27 times the 2003 revenues of $6.2 billion. Simply quoting the 27-fold figure, however, does not communicate a "feel" for year-to-year growth rates that Apple sustains across these years. For this, analysts will calculate the cumulative average (annual) growth rate, CAGR.
Exhibit 7.Net sales figures for Apple for 2002-2017 (solid black line) plotted alongside mathematical exponential curve (solid green line). For the period 2003 - 2013, both curves grow at an average annual rate of 39.3% for ten years. For this period, the actual sales curve conforms closely to the exponential curve. For this period, therefore, CAGR fairly represents year-to-year sales growth. Modeling and predicting sales growth for the years after 2013 present different challenges.
Calculating Cumulative Average Growth Rate to Model Revenue Growth
Remember that the CAGR metric is really an average (the geometric mean) of a number of individual growth rate figures. CAGR—like all averages—is meant to stand as the typical, or representative, value for the data set. Like all averages, CAGR says nothing about differences among individual values within the data set. Put another way, CAGR—like all financial metrics—reveals data set characteristics that might not easy to see in a simple review of the numbers, but at the same time is "blind" to other aspects of the data.
Using the Excel version of the CAGR formula, and the revenue figures for 2003 and 2013, Apple's average annual revenue growth rate is calculates as:
CAGR = (170910/6207)^0.10 - 1.0
CAGR = 39.3 % (More precisely, 39.3120147%)
Exhibit 8 above plots Apple sales revenues, but note especially that Exhibit 8 also shows a mathematical exponential growth curve (solid green line), starting at $6.2 billion for 2003, and growing exponentially at 39.3120147% per year for 10 years.
Because Apple's sales figures approximate a true exponential curve, it is appropriate to use the CAGR (39.3%) to represent all year-to-year growth rates for this ten-year period. For this period, in other words, the exponential model made apple revenue growth highly predictable.
For forecasting revenues and revenue growth after 2013, however, the business analyst faces a different challenge. Note especially that that revenues for 2016 are less than revenues for 2015.
At present (early FY 2018) it is not clear whether the 2016 decrease is simply an anomaly in the midst of a new exponential growth curve, or whether Apple revenue growth rates are entering a period of high variability.
The cumulative average growth rate CAGR is widely used in business today, especially in Annual Reports. In these reports, firms always present multi year performance histories, and at the same time, build a case that prospects for future growth are good. As a result, Investors and analysts are well-advised to keep in mind both the strengths and weaknesses of the CAGR metric. CAGR uniquely reveals some growth information, and at the same time CAGR can be blind to important aspects of growth histories.
CAGR values are based entirely on two figures from the data series: a starting value (PV) and the ending value (FV). CAGR is completely blind to figures between the first and the last. To emphasize this point, consider one final example showing three data series with different growth profiles but identical CAGR measures.
Exhibit 8. Plotting data for 3 growth series graphed in Exhibit graph.
Data for these series could represent sales revenues, profits, units sold, or any of the business measures discussed above. Exhibit 8 covers four years of growth for the three series.
Notice that all three data series have the same starting point (PV) and same ending point (FV). Series 1, however, shows little growth for 3 years, and then "explosive" growth during the final year. Series 3 shows just the opposite: Massive growth in the first year, and then nearly stagnant growth for the final three years. And, Series 2 sits midway between Series 1 and Series 3, with steady growth from Years 0 to Year 4. Nevertheless, all three series have exactly the same CAGR. Differences between growth profiles are not visible in the CAGRs, but they are shown very clearly when graphed in Exhibit 9, below:
Exhibit 9.Three data series from Exhibit 6 graphical form. CAGR is determined entirely from starting and ending values, but is completely blind to data between the first and last.
Not all growth curves have anything close to the exponential profiles shown in Exhibits 2 and 7 above. Here, Series 2 and 3 depart from the exponential profile, and are thus poorly represented by a calculated CAGR The Series 1 curve is closer to the exponential curve, but this series, too—like the Apple sales revenues in Exhibit 5—is probably better characterized by two CAGRs rather than a single CAGR for the entire curve.
Conclusion: CAGR best represents annual growth across multiple periods when the growth curve approximates an exponential function. CAGR represents annual growth performance poorly when the overall growth curve departs substantially from the exponential curve.
For cumulative average growth rate working examples, templates, and spreadsheet implementation, please see Financial Metrics Pro.