What it means
Revenue growth is calculated by comparing sales in the current period with sales in the previous one. A positive result means the business is selling more, and a negative result means sales are shrinking.
Both results should prompt questions about why. Growth matters because it signals demand for what the business offers.
It also affects valuations, as investors often pay more for companies that are growing quickly, provided the growth is profitable. Growth that needs ever more spending can destroy value.
The choice of period changes the story. Year-on-year growth removes seasonal swings, such as a retailer's busy December, whereas quarter-on-quarter growth shows momentumwhereas quarter-on-quarter growth shows momentum but can mislead if the business is seasonal.
Comparing like periods avoids this trap. When looking over several years, analysts often use the compound annual growth rate (CAGR), which smooths the path into a single average annual figure.
It shows the steady rate that would take revenue from its starting point to its ending point. It is useful for comparing businesses over the same number of years.
Growth should be read with care. Revenue can rise because of price increases, acquisitions or one-off sales, so analysts also look at organic growth, which strips out acquisitions, and at real growth, which removes inflation.
Fast growth is not always healthy. A business can grow revenue by cutting prices or by offering generous credit, which may damage margins and cash flow, so growth should be compared with profit and cash generation.
A healthy business grows revenue and profit together.
In practice
Real-world examples
Example 1
A software start-up grows monthly revenue from $80,000 to $88,000 in a month. Growth is 8,000 / 80,000 = 10%. The founders compare this with their target of 8% and decide to hire two more salespeople. They review the hires after three months.
Example 2
A restaurant group reports sales of $9,000,000, up from $8,100,000 the year before. Growth is 900,000 / 8,100,000 = about 11.1%. However, two new restaurants opened, so like-for-like growth on existing sites is only 3%. The board prefers to look at the second figure.
Example 3
A manufacturer sees revenue fall from $5,000,000 to $4,500,000 after losing a large customer. The growth rate is -500,000 / 5,000,000 = -10%. The board sets up a plan to replace the lost sales over the next two years. Finance models the effect on costs.
Think of it
Think of revenue growth like the speedometer on a car. It tells you how fast you are moving forward, but you still need to check your fuel gauge to know if you can sustain the journey.
Formula
Calculation
Revenue growth rate = (Current period revenue - Previous period revenue) / Previous period revenue x 100%
Suppose a company's revenue rose from $2,500,000 last year to $3,000,000 this year. The increase is 3,000,000 - 2,500,000 = $500,000. The growth rate is 500,000 / 2,500,000 = 0.20, or 20%. If revenue was $2,000,000 two years ago, the compound annual growth rate over the two years is the square root of (3,000,000 / 2,000,000) minus 1, which is the square root of 1.5 minus 1, or about 22.5%.Case study
Seen in the real world
Willowbrook Home Goods is an illustrative, fictional online retailer that reported revenue growth of 35% and celebrated at its annual meeting. Sales had risen from $4,000,000 to $5,400,000.
The finance manager broke the figure down. She presented it in a one-page chart for the board. Price rises accounted for 8 percentage points, an acquisition for 12, and organic volume growth for only 15.
The company also found that the growth had come partly from heavy discounts, which cut gross margin from 42% to 36%. In this illustrative story, the board changed its targets to focus on organic growth and gross profit, which gave a truer view of how the business was performing. Bonuses were linked to the new measures.
Watch out
Common mistakes
- Comparing a seasonal quarter with the previous quarter, when the same quarter last year is the fairer comparison. This removes the effect of busy and quiet seasons.
- Treating revenue growth as proof of success, when profit and cash flow may be falling.
- Using a percentage change from a tiny base, which can make a small increase look very large. A business that grows from $10,000 to $20,000 has doubled, but it remains tiny.
Questions
People also ask
What is a good revenue growth rate?
It depends on the industry and size of the business, as small start-ups may grow at 50% or more while mature companies may be happy with growth of 3% to 5%.
What is the difference between revenue growth and CAGR?
Revenue growth compares two periods, while CAGR gives the steady yearly rate that would produce the same result over several years.
How do I calculate growth when revenue falls?
Use the same formula, and the answer will be a negative percentage, such as -10%. It tells the reader that sales shrank. Boards usually ask for the causes and a recovery plan.