BankerCollege

Businesses see revenues as key to growing their companies, but for a business to grow, it must acquire the working capital and fixed assets needed to support the additional sales. Ideally, it generates the funds to finance these assets from its profitable operations.  However, sometimes, firms grow much more quickly than can be immediately supported by internal profits and must either borrow from creditors or seek more capital from investors.  

External sources can mean intrusion and interference from these outside funding sources, sometimes a painful choice for entrepreneurs who value their personal independence.  On the other hand, a business that grows too slowly may be overtaken by its competition and fall into decline.  Comedian George Carlin reminds us, “Some see the glass half full, and others see it half empty. I see a glass that’s twice as big as it needs to be.”  Filling its glass to its satisfaction requires the firm to know its limitations—how much does it have to sell to make a profit, how fast can it grow its sales given the company’s profitability, its productivity, and its earnings retention goals.

Description of Topic: Sometimes we take revenue for granted. First, did sales really grow at all, especially during periods of high inflation. How far apart are nominal sales and real sales? Second, below sky-high sales lie breakeven revenue, the "floor" for sales growth, the absolute minimum in sales needed to stay in business. Third, on the other hand, what factors construct a ceiling on sales—profitability, productivity, earnings retention, leverage—how much can sales grow without new, external debt financing or equity injection? Finally, how much profit bang does a company get from every dollar of revenue, i.e., how much operating leverage does a firm have, and how do ups and downs in revenue impact profit? 

Therefore, the purpose of this session is to show how we can employ breakeven and SGR to construct a revenue band with which to gauge the reasonableness of a client’s revenue projection.  Is the revenue projection inside this band?  Does the sales forecast show revenue growth large enough to earn a profit but not so large that it outstrips the client’s ability to support the projected growth?  Finally, since profit is really the point of sales, just how sensitive is a client’s profits to changes in revenues, especially negative changes?  

Learning Goals:

• Learn how to adjust nominal sales for inflation to determine if “real” revenues actually increased
• Learn how to calculate break-even sales to determine a firm’s minimum sales level
• Learn how to integrate profitability, productivity, earnings retention, and leverage into a sustainable growth rate that determines a “ceiling” on sales growth without additional outside debt and equity
• Gauge how sensitive a firm’s profit is to changes in revenues, especially declines in sales

Specific Areas Covered in Session:

1. Nominal sales vs. real sales

   1. Inflation rate and revenues
   2. Inflation rate and profits
2. Break-even sales (BES)
   • Gross profit margin and variable costs
   • Operating profit margin and fixed costs
   • Factors that change BES
3. Sustainable growth rate (SGR)
   • Why firms that grow faster than SGR need additional outside debt and/or equity
   • How to increase SGR
4. Operating leverage (OL)
   1. How to measure profitability’s sensitivity to changes in revenues
   2. How OL sensitivity impacts profitability over the business cycle
   3. Case Study to illustrate application of these measures in evaluating revenue projections

Who Will Benefit: Credit analysts and credit approvers, commercial bankers and their managers, chief credit officers, loan review officers, senior lender, commercial underwriters, loan committee members, bank directors, executive management