Are You

Are You

One of the biggest mistakes a company can make is to focus exclusively on its sales and not so much on the gross margin. It's what's called "Top Line Fixation". You know that your company has fallen prey to it, if your top management can easily cite all kinds of sales statistics, but not the gross profit margins or if your sales force gets commissions based on revenue growth and nothing else.

If growing your top line is your top priority, chances are that your bottom line will not be adequate. Examples in the world of big business abound.

From 1985 to 1993 Apple's revenues increased from $1.9 billion to $7.9 billion, and yet due to lower margins, its stock price remained exactly the same. On the other hand, during Jack Welch's first 19 years at the helm of GE, revenue increased barely fourfold yet the stock price grew fortyfold. And even though sales were up 400%, total employment was down 25%.

Even more striking is an example of Pepsi and Coke from the 1980s. Pepsi wanted to boost its revenues so it went into an expansion mode and became larger than Coke. Its revenues exceeded Coke's revenues by $12 billion! So far so good, right? You'd think they had a reason to celebrate. Not so fast... Coke's profits at the time were twice as high as theirs and their market value nearly three times as high.

Roger Enrico, who was running Pepsi at the time, had Pepsi stock valued at $19 million, while his counterpart at Coke had stock valued at $850 million.

Roberto Crispulo Goizueta was the chairman, Director and CEO of Coke from August 1980 until his death in October 1997. He is known for having created more wealth for shareholders than any other CEO in history and he had this to say about it all:

The curse of all curses is in the revenue line.

People get mesmerized by the revenue line and they forget that there is a whole lot going on between the sales line and the net profit line on their profit and loss statements. Some people have the erroneous belief that every dollar of sales drops straight to the bottom line and makes them richer. That is simply not the case. That is why I keep stressing to all my clients just how important knowing all of their numbers is.

That is why the income statement and not the sales statement (or a sales report) is one of the four basic financial reports. And that is why the income statement needs to be more than just glanced at, but analyzed. The numbers as such don't tell you everything you need to know. It is the relationships between the numbers that hold the key - the ratios.

Even if your sales are growing, but if your margins are declining, your business might be headed for trouble.

In my many positions as a Controller, we never looked at any actual results, budgets or strategic plans without the CAGR calculation (Cumulative Average Growth Rate). And in the profitable companies I worked for, the profit growth rate always needed to match or exceed the sales growth rate.

It all starts with knowing what your expectations should be and then setting that as your goal.

Here is another quote of Roberto Goizueta:

State expectations. Meet expectations. Repeat.

So, let your 2010 be all about ratios and profitability!

Lucy Rudnicka is a former Corporate Controller. She now owns her own Accounting Services firm and specializes in small business bookkeeping as well as part-time Controller services.

She believes that every business, no matter how large, needs accurate and timely financial statements. Get professionally designed income statement templates today and start managing your business with profitability ratios.

And sign up for your FREE Small Business tips at http://www.financialsforyou.com.

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