Sales and Earnings Acceleration

Most companies would be thrilled to see their sales accelerating. However, it needs to be accompanied by acceleration of earnings. The reality is that for growth to be healthy sales and earnings acceleration go hand-in-hand.

A Simple Example

Take a look at selected data for the hypothetical company below.

sales and earnings trends

As you can see both sales and earnings are increasing. However, the chart also reveals something of concern. The top line is a trend line for sales that show sales are increasing steadily. Unfortunately, the earnings are not keeping pace as demonstrated by the lower trend line. Also note that sales and earnings acceleration are diverging. That is, they are moving further apart relationally.

The Issue

In order for increasing sales to make the most contribution, it is important that the earnings on the additional sales keep pace. When this falls short it can be for a number of reasons. One, the sales increase could be as a result of lower margin products. In that case a company needs to see if there is a way to reduce the cost of the products they are selling, sell them at higher prices, or decide if they really want to continue selling them. Perhaps there are other products that would have much better gross margins. Secondly, if we are looking at decelerating net earnings in relation to sales, then we also need to consider if operating expenses are growing disproportionately. If the sales and/or customer service effort to support new products is excessive, then this erodes earnings as well. The same thing goes for other operating expenses as well. Do the additional sales require administrative costs that are too high to justify the additional sales?

The point I’m making is that just because sales are increasing, perhaps exponentially even, that does not always mean good things are in store, Remember that sales and earnings acceleration do not necessarily go hand in hand. Because of that it is important to monitor the earnings impact of additional sales.

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As always, your comments are welcomed.


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