More and More Revenue is NOT the Answer
Annual revenue growth likely commands way too much of your attention as a business owner. Yes, without revenues there would be no business, but focusing on revenues without considering price changes can set up your business for failure. That’s why The Business Ferret calculates 12 key financial metrics including Real Revenue Growth, which accounts for price changes and improvements in your cost of goods sold.
In “When Is Revenue Real?” we examined the belief that more revenue means more market share and more success, and we found that trying, like Wal-Mart, to compete on prices to get market share will drag down your profits. Now let’s imagine your business has gone the other direction and increased prices.
If your nominal revenues increased 10%, but you had raised prices 10%, you would have zero net Real Revenue Growth. You didn’t sell any more than last year; you just charged more for what you sold. Let’s say your revenue growth increased 10%, but at the same time you raised prices 15% across the board. Your real revenues declined 5%! Your nominal revenues increased, but you actually did less business.
Remember nominal revenue growth is simply measured by the change in revenue growth from one year to the next, positive or negative, as a percentage over the prior year. Measuring revenues this way does not account for any change in pricing or improvement in managing the cost of goods sold (or direct costs with a service business).
As demonstrated above, The Business Ferret subtracts price adjusted revenue growth from nominal revenue growth to determine Real Revenue Growth. Price adjusted revenue growth can be determined easily by dividing gross revenues by the cost of goods sold, producing the gross profit mark-up index. The change in the mark-up index represents the actual price increase or decrease overall within your firm.