Earnings Growth Versus Revenue Growth

For many entrepreneurs, launching a new business often means walking a fine line between pursuing earnings growth and growing the top-line revenue.

A business can’t be successful in the long-term without earning a profit, but it also must reinvest some of its profit to grow beyond a startup, expanding into new markets or geographical territories.

Understanding the differences between earnings growth versus revenue growth will help business owners prioritize their next growth steps and to recognize the difference between increasing profitability vs. increasing sales volume.

Earnings

Understanding the difference between “earnings” and “revenue” is critical to understanding the differences between earnings growth vs. revenue growth.

The term “earnings” is simply defined as the net profit earned from the operations of a business, or the amount of money left over after the business has paid all costs associated with operating the business.

When computing earnings growth, it is important  not to include one-time events such as the sale of assets, interest income or expenses, lawsuit awards, etc.  Such income and expenses are non-operating or finance related events. Earnings growth is measured from business operating income, not business net income.  

Earnings Growth Rate Formula

• The earnings growth rate formula is as follows:

Earnings Growth Rate = {Total Earnings for a period minus Earnings for previous period/ Total Earnings Growth for Prior Period } x 100

• For example:  If the Net Earnings in Year 2 and Year 1 was  $480,000 and $400,000, respectively, then Earnings Growth Rate in year 2 would be:   $480,000 – $400,000 = $80,000 and $80,000 / $400,000 = .20 X 100 = 20 Percent Earnings Growth Rate.

Revenue

Conversely, “revenue” is defined as gross income, or the total amount of money received for the sale of goods and services before any expenses are deducted. Be aware that revenue can be misleading as it applies to profitability, since it doesn’t take into account any business liabilities and direct or indirect expenses associated with the business.

Revenue Growth Rate Formula

• The revenue growth rate formula is as follows:

Revenue Growth Rate = {Total Revenue  for a Period minus Total Revenue for Prior Period} x 100

• For example:  If the Gross Revenue in Year 2 and Year 1 was  $4,800,000 and $4,000,000, respectively, then Revenue Growth Rate in year 2 would be:   $4,800,000 – $4,000,000 = $800,000 and $800,000 / $4,000,000 = .20 X 100 = 20 Percent Revenue Growth Rate.

Earnings Growth vs. Revenue Growth

Once we have a good understanding of earnings and revenue, we can explore how earnings growth and revenue growth are important indicators of how financially healthy a business may or may not be.

Typically, earnings growth refers to the annual  rate of earnings growth as a result of investments of financial capital in the form of cash, inventory fixed equipment, real property and human resources (payroll).

Investors often use the average earnings growth to determine whether or not a business is worthy of investment. Generally speaking, the greater the earnings growth, the better!

Earnings is arguably the most important measurement of growth for a business, as earnings growth indicates the health and profitability of a business after all expenses are paid.

Conversely, revenue growth refers to the annual growth rate of revenue from total sales. The revenue growth metric is important because it provides an indication of the health of a business’s sales, and as such, revenue growth remains a popular method of assessing how successfully a business is at selling its own products and/or services.

When the revenue for a business is growing continually, and growing at an increasing rate year-over-year, it is a very good indication of a financially-healthy business.  Such a business will be very attractive when it is time to sell the business.

It is important to keep in mind that (bottom line) earnings are somewhat dependent on revenue growth.  If earnings are expected to increase over time, then it will be nearly impossible to do so unless revenue increases as well.  In other words, reducing expenses by cutting unnecessary costs and creating operational efficiencies will only go so far in improving a company’s earnings.  To achieve positive earnings growth over time, revenue growth will also be necessary.

While these two popular business measurements reveal two ways to evaluate the financial health of a business, they also work together to help business owners, lenders, and investors create a more complete picture of a business.