How the Top Line Impacts Value

There are more than a few cult classics that glorify, or vilify, the role of the salesperson.  Movies and television shows can paint the picture of rock star salespeople living the dream despite dealing with high pressure situations and negative reinforcement from their bosses in order to push the company, or their own wallets, to new heights.  “Always be closing,” a quote by Alec Baldwin in Glengarry Glen Ross, is proof that sales should be at the forefront of everyone’s mind.  After all, sales are the lifeblood of an organization.  With so much emphasis on sales, it may seem as though the goal of a business owner should be to maximize revenue in order to drive value.  So, is a company with more sales always preferable to a company with less sales?  It may not always be that simple.  Of course net income and cash flow should always be considered alongside revenue, but taking a look at the composition of a company’s revenue stream can give us a great deal of insight into value.  We explore a few issues to be considered below.

  1. Revenue Growth

Revenue growth often drives value higher as growth in the top line is often mirrored by growth in net income or cash flows.  Companies with consistent revenue growth in previous years and continued projected revenue growth in the future will command a premium price in the marketplace.  The so-called “hockey stick” revenue growth can be very enticing for most, if not all, buyers.  Additionally, a growth trajectory drives down risk and often causes prospective buyers use a higher multiple when calculating the purchase price.  Reporting top line growth also speaks to the strength of the existing sales team and the company’s market position.  Revenue growth may seem like an obvious way to increase value, and the impact on value is seen not only in an increase in the future benefit stream (cash flow), but also a decrease in risk.  When an increase in future benefit is coupled with a decrease in risk, the effect is multiplicative on value.

  1. Diversification of Customer Base

Although sales growth can seem like a great plan to increase your company’s value, sales growth alone should not be the only plan.  High customer concentrations, even for a company that is experiencing top line growth, often increases risk and can hinder value.  As important as diversity is when allocating assets in your stock portfolio to control risk, diversity in customers is equally as important for the same reasons.  A plan to improve the diversity of the firm’s customer base should be coupled with a plan for sales growth.  If sales are grown from the already existing largest customers, potential buyers will discount the business due to a high proportion of its revenue coming from a few customers.  If one or two customers that make up a large percentage of sales decide to go in a different direction, the company’s future cash flows are likely to decline if those customers cannot be replaced.  Valuators can use a higher discount rate to calculate the present value of those future cash flows due to this uncertainty.  In the same vein as diversity in customers, the potential for the expansion into new revenue streams can be an avenue for improving value.  As more revenue streams are added to the company’s top line, the risk of one revenue source drying up is less damaging on the overall company’s value.  The composition of a company’s customer base and revenue streams can be significant levers to push and pull to grow value.

  1. Recurring Revenue

Revenue is good, but recurring revenue is great.  Recurring revenue tied to a contract is even better.  If that contract is transferable to a potential buyer, that may be the best case scenario if it can be achieved.  If a lot of a company’s revenue is recurring and contractual in nature, it is likely to warrant a premium price in the marketplace.  Recurring revenue dampens the risk associated with the revenue stream and in turn, the company’s cash flows.  As the cash flows into the future become more certain, the risk declines and valuation is likely to rise.

Sales are constantly on the top of mind for many, if not all, business owners.  While sales volumes are important, we also must consider other issues that appear in the top line of the income statement that will impact a business’ value.  Beyond sales volume, growth, customer concentrations, and recurring revenue need to be considered.  A plan to address these issues can prove to be extremely fruitful in growing and ultimately realizing value for business owners.