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Vanity, Sanity & Reality

March 14, 2017 at 6:39 AM

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I’m asked to interpret accounts a lot by clients. Either their own or somebody else’s, perhaps a competitor, customer, acquisition target or supplier. It doesn’t matter what the reason or how big or small they are, I always look at three aspects;

 

  1. Are they growing revenue?
  2. Are they profitable?, and
  3. Do they generate cash?

 

Over the next 3 weeks I’m going to take a look at each of these in turn, starting this week with revenue, turnover or sales.

 

It’s important for a business to be growing, even if that growth is just to keep up with inflation, growth is healthy. So the first thing I look at is total sales and have they grown. If I’m lucky enough to have a few years of accounts I’ll look to work out the rate of growth. (Amount of growth divided by previous year’s sales x 100)

 

Take Qwerty Ltd, a small company with sales of £348,000 last year and £414,000 this year. The rate of growth is 18.97%. ({{£414,000 – £348,000} / £348,000} x 100)

 

Personally I like to see regular growth, but sometimes you see a significant increase in sales which can represent a step change in the business or may be a one off. It’s important to know which and so I start to ask questions. I also like to understand whether there is a cycle to sales. A time of the year where sales peak etc. Understanding this is vital as it helps plan activity and forecast cash flow and other resources that might be needed at either busy or quiet times.

 

Rapid uncontrolled growth can sometimes cause problems too as the cash needed to grow is more than the cash being generated. In this scenario “over trading” can eat through cash with disastrous consequences. As I always tell people, businesses ultimately fail because they run out of cash. That’s why “turnover is vanity and cash is reality”.

 

It’s also worth taking a look at the turnover note to see whether there is a geographical spread of sales. Turnover is usually split between the U.K., Europe and the rest of the world.

 

Analysing turnover is important, but it’s just the start. Next time I’ll be building on this and looking at profits (earnings).

 

RH

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