Testing the Top Line

Analyzing a company's sources of revenue can bring insights into growth.

Less Disclosure

Companies disclose little of this information to the public, but that reticence has less to do with a desire to keep it from competitors, as one might assume, than with regulatory concerns. First Data, for instance, once shared its revenue analysis with investors but no longer does, as a result of new Securities and Exchange Commission rules. “We moved away from talking about it to investors due to the new accounting rules for non-GAAP measures,” explains Patmore. The rules would require the company to reconcile the numbers to GAAP earnings, which could be risky, since they include estimates of market growth and churn rates that could be questioned.

Now First Data’s SRS reports are used primarily for annual budgeting decisions and long-term planning. In fact, Patmore says they have become a key component of the company’s five-year growth plans. First Data also uses the model to decide whether acquisitions will produce enough growth to justify the cost. “We’re trying to access what really moves the needle,” says Patmore. A small acquisition in a high-growth segment may seem like a no-brainer, but close revenue analysis can show it to be not sufficiently meaningful if the overall market opportunity is too small or crowded. While evidence of success is hard to come by, First Data has averaged a growth rate of 10 percent since it began compiling sources of revenue data in 1998. Like Alcoa, First Data has yet to use the model as a basis for incentive compensation.

Treacy envisions a time when companies spend as much time analyzing revenue as they do costs, and when revenue accounting focuses on more than when revenue is recognized. “It’s not going to happen overnight. After all, cost accounting has a 100-year head start,” he says. “It’s convenient to blame the market when things don’t go well,” he adds, “but it’s not fair. Revenue growth is controllable.”

Joseph McCafferty is news editor at CFO.

How to Create an SRS

To product a sources-of-revenue statement, five steps are required in addition to establishing total revenues for comparable periods, as is commonly done for purposes of completing an income statement or a P&L.

  1. Determine revenue from the core business by establishing the revenue gain or loss from entry to or exit from adjacent markets and the revenue gain from new lines of business, and subtracting this from total revenue.
  2. Determine growth attributable to market positioning by estimating the market growth rate for the current period and multiplying this by the prior period’s core revenue.
  3. Determine the revenue not attributable to market growth by subtracting the amount determined in Step 2 from that determined in Step 1.
  4. To calculate base retention revenue, estimate the customer churn rate, multiply it by the prior period’s core revenue, and deduct this from the prior period’s core revenue.
  5. To determine revenue from market-share gain, subtract retention revenue, growth attributable to market positioning, and growth from new lines of business and from adjacent markets from core revenue. —J.McC.

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