Good is not enough.
Neither is great.
In today’s world, the one quality that makes investors open up their wallets is growth.
People aren’t concerned with the kind of product you’re making. Instead, they’re concerned with how well you can bring that product to market, and how many people will buy into it.
In order to fully understand what people expect of your company, and in order to know what you yourself can reasonably expect from your company, you need to know the basics of corporate finance.
Today’s article, fittingly enough, is about revenue growth. That’s a figure we all see all the time, but what does it really mean? And if you have a certain amount of revenue growth, is that good or bad?
Revenue growth is the amount of change in cash flow, positive or negative, from one time period to the next in a company’s sales.
Yes, it’s called “negative revenue growth” instead of something like “revenue shrinkage.”
You’ll note that that definition above was pretty vague. Why is it just “one period?”
Because you can measure it with any period you like. Most people talk about quarterly or annual revenue growth, but if you have the data to back it up you can discuss monthly, weekly, or even daily revenue growth instead. And in some tumultuous economic times, those may be valuable metrics!
Change from point A to point B is illustrated as follows:
(Current Amount – Previous Amount) / Previous Amount
That’s hard to visualize, so let’s conjure up an example.
A Sample Company
We’ll start out with an imaginary company that practically couldn’t do better – call it StratoSphere.
StratoSphere makes wonderfully addictive phone apps, and thanks to a couple of viral social media posts, they’ve had a fantastic first quarter of 2020.
In the fourth quarter of 2019, people bought StratoSphere’s killer app 500,000 times. In the first quarter of 2020, all of those customers told their friends how great it was and they went out and bought it too. Therefore the app had 950,000 sales in Q1 2020.
To calculate the company’s revenue growth, we use the information from two different income statements to calculate the difference between Q1 2020 and Q4 2019.
950,000 – 500,000 = 450,000.
That was StratoSphere’s increase in revenue in dollars. To find the growth, we have to figure out what percentage that growth dollar amount was of the previous quarter’s sales amount. Again, this information could be found on the company’s financial statements.
450,000 / 500,000 = 0.9 = 90%.
Therefore, we can say that StratoSphere had 90% revenue growth from Q4 2019 to Q1 2020.
Always Get More Data
The thing you’ve got to remember is that just one quarter’s growth doesn’t mean a whole lot. You’ve got to look at the growth over multiple quarters to really understand how the business is doing.
That might have been an excellent quarter for growth, but it could just as easily have been a single fluke. Apps in particular are very vulnerable to the fickle attention of the market – how many games on your phone have been there for more than a year?
It’s much better to have consistent growth over a long period of time than to have a quick flash in the pan and then disappear.
Furthermore, you can show “revenue growth” and not really be telling the whole story.
Remember, those are the pure sales numbers – we assumed that StratoSphere was selling its app for a dollar apiece, and therefore calculated 90% quarterly growth.
How about the advertising or operating costs? With phone games, you’re not running into a lot of danger with development because they rarely have large dev teams. However, you might be pumping lots of money into a YouTube or Facebook ad surge.
Moving away from apps, you can imagine how the operating costs of a software company might be relatively high. Those costs could come from salaries, health benefits, bonuses, and even something as simple as rent in a metropolitan area.
And those costs could totally wipe out extra money gained from a boost in revenue.
Revenue growth does indicate that your product is selling well, but it definitely doesn’t tell the full story about your business.
Growth Is No Good Without A Good Starting Point
Lastly, you’ve got to look at both growth and absolute figures.
What if I told you I had a company that grew its total revenue 100% every day? Would you be begging me for a seat on the board of directors?
Hopefully not – because that company might have started out with just $1 in revenue and only have been operating for three days, leaving me with a tidy net revenue of $7.
That’s an extreme example, of course, but that kind of number-fudging happens every single day with companies around the world who want to seem more impressive to investors than they really are.
Normal Industry Revenue Growth Rate
If you’re considering entering the market with SaaS, you’ll want to know what kind of revenue growths is typical for the industry. Is 90% what you should be striving for?
Well, probably not – only because it’s not good to get your hopes too high.
According to a 2017 survey, the median growth rate for companies with annual recurring revenue (ARR) less than one million dollars was roughly 60 percent, and for companies with $50 million in ARR, that figure was 27 percent.
In general, smaller companies tend to grow faster than larger companies because the big fish customers just aren’t coming out in the droves they need to be to drive constant high revenue growth.
Also, you should know that it tends to take six years or so for a company to reach a million dollars in annual bookings.
But would relatively small growth after that be such a bad thing? It’s easy to read articles like this one with exaggerated numbers and want only that kind of result for your own company, but it’s also important to look at the overall picture.
Is the growth you’re expecting achievable given previous performance? Are you running your business in a way that will support high growth without sacrificing net profits?
Those are the questions you’ve got to ask for yourself – because those questions are going to determine your success.