How to gauge and analyse revenues of a company

In the previous article, we took a brief look at the key financial statements that are found in a company's annual report. Today's article is more focused towards gauging and analysing revenues of a company from certain perspectives. The purpose for doing the same is only to understand companies and their long term fundamentals in a better manner. This would be helpful for especially for those wanting to do their own research on equities.

Core vs non-core: A handful of companies report the 'total income' earned by them within a year as 'sales'. We believe it would be more ideal for one to consider a company's integral earnings or income from core operations as sales and not the income that is generated from other operations (or non-core 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 for investors to follow to exclude these items from total income. This is in addition to them 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 of the annual report.

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. Change in terms of their contribution to the topline and profitability. All this is directed towards one understanding a business better.

 

 

 

 

 

 

 

 

 

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's entry into other businesses (hotels, agri, non-FMCG, papers, etc.) With this, its dependence on its slow and steady growing cigarettes business has reduced. The adjacent chart 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 industry, wherein there is a high correlation between the GDP growth and the growth in cement consumption.

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.

Equitymaster.com

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