Everyone with an interest in the firm regards growth metrics as indicators of the company's financial health and prospects for the future performance.
Most profit-making companies are expected to grow over time— increasing sales, raising profits, and increasing 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 static market, a company with stagnant sales and profits is a company not 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 measures 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 and illustrate business growth metrics in context with related terms and concepts, emphasizing four themes:
- First, reasons that owners and analysts turn to business growth metrics to assess business perfromance, business health, and business prospects for the future.
- Second, seven Business Growth factors that serve as business performance indicators, and the differences between single-period and multi-period growth rates.
- Third, the meaning of exponential growth, and how to measure exponential growth rates, and how to mis-interpret exponential growth rates.
- Fourth, exponential growth modeling examples with historical sales revnue figures from Apple Computer.
- What are business growth metrics?
- Defining business growth metrics in concrete terms that measure business performance. Seven Frequently Used Growth Metrics:
- Which metrics measure single-period business growth?
- Single-period growth compared to a multi-period increase
- What is exponential growth? How do you calculate exponential growth?
- What is the 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 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 the 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 successful 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 particular profit metrics such as Operating Income or Earnings Before Interest and Taxes EBIT. These firms believe that "selective" metrics such as these paint a more authentic picture of earning performance in the firm's core line of business, than "bottom line" Net Profit.
Several performance factors related to stock 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 primarily 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 show the company is not increasing owner value as it should.
Firms usually expect that costs will increase over time, in all cost categories of the firm's core line of business. "Costs" should rise 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 particular attention to tracking cost growth in several specific cost categories when they suspect the following:
- Gross margins are falling.
Falling gross margins are likely when gross profits are growing less than 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 decline may be indicated, for instance, when there is growth in "cost per sale" or "length of the sales cycle." Declining sales effectiveness may also be underway when there are decreases in average order size, market share, or competitive win rate.
Business firms must enough maintain liquidityto meet short-term financial obligations. Business firms define liquidity with 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 keen 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 be alerted 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 warning signs 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 kinds 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 observe 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 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 complicated 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 lifecycle. 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 for "profits" merely to remain constant. Such is the case when the firm is reducing prices, or with increasing "cost of sales" or overhead.
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.
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.
- The firm may set targets for 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 for 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, growing 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 mean, 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 particular 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 five 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 single year 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 adverse changes for both Revenues, profits, and EPS.
- Positive revenue and profit growth returned for 2017, but at relatively low annual rates (6.7% for revenue growth and 5.8% for 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 usually makes new product announcements.
- Revenues for 2017, overall, show growth over 2016. However, two 2017 quarters (Q2 and Q3) still show sizeable shrinkagerelative 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 is uncertain in 2017.
New companies in their first years of business measure growth with 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 annually 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 even faster.
- 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 ten consecutive years. With sales revenues for Year 0 at $1.0 million and a 10% annual growth rate for ten 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 over ten years and the upper curve shows revenues resulting from 20% yearly growth over the same ten years.
Starting with sales revenues of $1.0 million in Year 0, the lower curve reaches $2.6 million after ten years of 10% annual growth. The upper curve shows that a 20% yearly 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. These curves show the nature of exponential growth.
The exponential growth of the same kind results, incidentally, from investing funds with interest compounding across multiple periods. $1.0 million invested at 10% per annum for ten years would result in 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 something like this:
Aerofirma company reported sales revenues of $1,000,000 for Fiscal Year 2007. Ten years later, the company has sales of $2,593,743 for FY 2017. This result 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 ten periods when the starting and ending revenue figures are both known. The exponential growth formula provides the answer when solved for "i" instead of FV, as shown below in Exhibit 3.
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:
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 exceptionally 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 with 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 keen 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—for significant changes in factors 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:
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, shows 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.
Calculating Cumulative Average Growth Rate to Model Revenue Growth
Remember that the CAGR metric is, in fact, an average (the geometric mean) of some 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 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 ten years.
Because Apple's sales figures approximate an accurate 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 (2018) it is not clear whether the 2016 decrease is merely 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 excellent. 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 blind to any numbers between the first and the last. To emphasize this point, consider one final chart. Exhibit 9 shows three data series with different growth profiles but equal CAGR measures.
Exhibit 8. Plotting data for three 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 three years, and then "explosive" growth during the final year. Series 3 shows just the opposite: Massive increase in the first year, and then nearly stagnant growth for the last 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 precisely 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:
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 pattern, 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 yearly 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.