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Gauging a company's revenues

Mar 27, 2009

In the previous article, we had taken a brief look at the key financial statements that are found in a company's annual report. In today's article, we will take a look how one should view and analyse the key revenue constituents of a profit and loss account (P&L).

Core vs non-core
A handful of companies report the 'total income' earned by them within a year as 'sales'. We believe one should always take into consideration a company's integral earnings (core operations) as sales and not the income that is generated from other operations. The latter could include items such income from sale of scrap, income from interest and dividends, forex gains, profit on sale of assets, export incentives, job charges, and miscellaneous receipts, amongst others.

While these items may not be a significant part of the total income, we believe it is a good practice to follow, apart from knowing the precise figures. In fact, it would be even better if one could further bifurcate such earnings under two heads - other operating income and other income. Details regarding total income are found in respective schedules.

Segment and region wise
Revenues are generated from sales of goods or services. However, for companies which have presence in various businesses, a good practice would be to study the change in segment wise/ product wise / businesswise revenues on a year on year basis. One can also take a look how the income from each business segment (as a percentage of net sales) has changed over the years. This gives a good judgment in knowing how a company's segments or businesses have been performing over a particular time frame.

Source: Company
Companies enter new businesses for two main reasons -to diversify their revenue streams and de-risk their business from a presence in a single segment. Further it also helps to capitalise on the opportunities in fast growing segments. A classic example would be ITC Limited's entrance into other business (hotels, agri, non-FMCG, papers, etc.) Over time, this move has helped it reduce dependence on its cigarettes business. The adjacent chart shows gives an idea as to how the scenario has changed for the company over the past few years.

Another way a company can diversify itself is by having presence across geographies. An investor can study a company's revenue pattern (from each zone, region or country) over the years. Companies having transnational presence have the option of focusing on the high growth areas or areas that are relatively resilient to an economic slowdown. In addition, if its operations in a certain country/region are witnessing a problem, it could curb the fall in revenue by focusing on operations in other countries/regions.

Seasonal and cyclical businesses
The revenue volatility would remain high for companies that are present in seasonal or cyclical businesses, especially if viewed on a quarterly basis. A seasonal business is a business for which certain seasons of the year are far more profitable than others. These include businesses such as seeds and fertilizers (harvest season), hotels (vacation), air conditioners (summer season), rain coats and umbrellas (monsoon season), amongst others. On the other hand, a cyclical business is largely dependent on economic cycles. A classic example for the same would be the cement business, wherein there is a high correlation between the GDP growth and the growth in cement consumption.

As such, we would recommend investors to look at performance of such companies over the long run.

In the next article, we shall take a look at the key expenditure constituents of a P&L. It would be advisable for investors to not look at the P&L revenue constituents on a standalone basis but to review the same in relation with the expenditure constituents to gauge the overall impact.

Investing: Back to Basics Article Series - Previous article | Investing: Back to Basics Article Series | Next article

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