What it means
Total revenue growth mixes together several very different things. A company can post a 16% increase while its existing operations barely move, simply because it bought a competitor halfway through the year and a weaker home currency inflated overseas sales when translated back.
Organic growth removes those effects so that like is compared with like. The usual adjustments are to exclude revenue from businesses acquired within the last twelve months, remove revenue from anything sold or closed, and restate foreign revenue at last year's exchange rates.
It matters because acquisitions are bought with cash or shares while organic growth is largely self funded, so the two say very different things about the quality of a business. A group growing at 15% purely by acquisition is buying its growth, and the market will price it accordingly.
The calculation is not standardised in law, which means management has some discretion over what counts as organic. A common area of debate is whether extra sales won by cross selling an acquired product through the existing sales force are organic or acquired, and companies should explain their choice clearly.
Most listed groups report the figure quarterly alongside total growth, often labelling it like for like, underlying or constant currency growth. Comparing the two side by side is the quickest way to see how much of a headline growth number came from the chequebook rather than from customers.
In practice
Real-world examples.
Example
A veterinary group tells investors it grew 22%, then discloses organic growth of 4% after excluding eleven practices acquired during the year. The share price falls because analysts had assumed most of the growth was coming from existing sites.
Example
A UK based engineering firm reports 9% revenue growth, but a weaker pound flattered its US sales. On a constant currency basis the organic figure is 3%, which is what the board uses when setting the following year's bonus targets.
Example
A software company deliberately reports organic growth excluding a small acquisition, then continues to report it separately for a full twelve months so that the comparison stays clean when the acquisition becomes part of the base.
Think of it
“Organic growth is growth you create yourself-not growth you buy by acquiring other companies.
Formula
Calculation
Organic growth rate = ((current year revenue - acquired revenue - currency effect - prior year revenue) / prior year revenue) x 100
A distribution group reports revenue of $58,000,000 this year against $50,000,000 last year, which is headline growth of $8,000,000 / $50,000,000 = 16%. Within that, $4,000,000 came from a business acquired in March and $1,000,000 came from favourable exchange rates on European sales.
Organic revenue is therefore $58,000,000 - $4,000,000 - $1,000,000 = $53,000,000. The organic growth rate is ($53,000,000 - $50,000,000) / $50,000,000 = $3,000,000 / $50,000,000 = 0.06, or 6%. Ten of the sixteen percentage points of headline growth were bought or delivered by the currency markets rather than earned from customers.Case study
Seen in the real world.
The following is a fictional, illustrative example. Kestrel Care Group, an invented operator of childcare nurseries, grew revenue from $50,000,000 to $72,000,000 across three years and management celebrated a compound growth story in every board pack. The pattern only became clear when a prospective lender asked for the organic figure.
Once the eleven nurseries bought during the period were excluded, organic growth in the illustrative accounts averaged just 1% a year, and in the most recent year existing sites had actually shrunk slightly as local competitors opened nearby. The acquisitions had been funded by debt, so interest costs were climbing while the core business stood still.
Kestrel's fictional board paused the acquisition programme for a year and redirected the money into refurbishing sixteen underperforming sites. Organic growth recovered to 5%, and the group returned to buying nurseries from a much more comfortable position.
Watch out
Common mistakes.
- Comparing organic growth from one company with total growth from another, which makes the second business look far stronger than it is.
- Forgetting to strip out disposals as well as acquisitions, which understates organic growth when a loss making division has been sold.
- Treating an acquisition as organic from the moment it is integrated, rather than keeping it out of the calculation for a full twelve months.
Questions
People also ask.
Is organic growth always better than acquired growth?
Not always, but it is usually cheaper and more repeatable, so investors pay a higher multiple for it.
How does it relate to like for like sales in retail?
They are close cousins, with like for like typically comparing only stores open for a full year in both periods.
Can organic growth be negative while total growth is positive?
Yes, and that combination is a warning sign that acquisitions are masking decline in the existing business.
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