The release of financial results by public quoted companies come with a lot of expectations from shareholders as they look out for a return on their investment especially dividend to be paid by such companies. Most shareholders are usually not happy when a company fails to declare dividend and more saddened when such companies declare losses.
However, instead of fighting the directors, shareholders need to take a deeper look at financial results beyond the surface to determine the value of such a company because there are times in business when it is actually more important to look at revenues and not profit.
Whilst profitability is important in determining the value of the company, revenues also play a key and sometimes even a more important role in determining the value of a company.
This is why when a company’s revenue dips, its share price sometimes tank despite also reporting profit growth. So, when is revenue actually more important than profit and what are the implications?
A loss making business can sometimes be looked at as one with an intrinsic value provided revenue is growing. This is because growth in revenue indicates the current losses may be temporary due to high operating cost or interest expenses or taxes or a combination of both.
In this situation, shareholders should view the company as one that requires major restructuring of operations rather than one that needs to shut down.
Companies invest in new products line, acquire more assets however, some products or assets take time to break-even and during this “gestation period,” companies could run into losses.
Also, the company may be spending so much on research and development; marketing and promotional cost all in a bid to ensure its product is noticeable and garnering market share.
In such cases, shareholders should focus more on revenues and not necessarily profits. An increase in revenue shows that consumers like the products resulting in higher demand which sooner rather than later turns to profit.
Businesses that operate on low margins often walk on the thin line as they trade on huge volumes, high operating cost, and low-profit margins. As such, a sudden rise in operating cost or drop in revenue can lead to a huge loss.
However, a hike in operating cost is often bearable when compared to a drop in revenue. If revenue growth persists despite low profits, management sees an opportunity to widen margins by cutting wastes.
If the company focuses on profits alone and disregard revenue, then in no time it will continue to rake in losses eventually losing to your competition and probably shut down. Oil and Gas companies and small retail supermarkets fall in this category.
Some companies face huge losses due to misfortune or circumstances beyond their control. This is called Exceptional and/or Extraordinary Items in accounting because it is not expected to occur again. It could be that a fire or a lawsuit or a write-down of a loss-making division affected the company’s business so much it made a loss.
It is often advisable to absorb those losses to clear the way for a brighter future. Focusing on revenue during this “trying period” help stakeholders determine if the company is able to reverse its fortunes quickly enough.
A profitable business may not necessarily mean the business is a solvent one. You can sell a product, which cost you N2000 for N4000 and make a 100% gain. However, if you do not collect the N4000 cash your profit it’s as good as gone. The business must generate enough cash flows. Profit is realized when the company receives cash from the revenue. So whilst cash is dependent on revenue, profit is dependent on cash and also on revenue. As such, companies that show ability to generate huge cash flows are typically valued higher even though they report low profits.
Companies with an economic moat typically report an increase in revenues in spite of the competition around it and even in economic downturns. If it consistently grows revenues despite competition then investors believe even when it suffers losses it is temporary and profitability will resume once the problems are identified and resolved. Economic moat describes a company’s competitive advantage derived as a result of various business tactics that allow it to earn above-average profits for a sustainable period of time
