Importance

A- Importance of sales analysis

The analysis of sales is by far the most important part of financial analysis regardless of the purpose of the analysis. For a banker, the cash flow which will repay a loan is generated from sales revenue, not from fixed assets or any other item of the balance sheet. Cash and receivables are nice to have, but there is no guarantee that they will be there in the future: only projected sales can tell. Determining the reliability of sales revenue projections is therefore essential. For investors, long term lenders or managers, sales is the only source of long term prosperity.

Although reliable and unbiased predictions are crucial, sales revenue is the item the most subject to outside influence and the most difficult to predict. The threats to continued sales come from many directions: primarily form
- strategies of direct competitors
- new products emerging in other markets
- dissatisfied customers with changing life styles
and also from
- government regulations
- disruptions in production
- insufficient purchasing power of customer due to economic recession
but most importantly for management from
- insufficient production or inventory
- excessive price
- inappropriate distribution channels
- poor effort to inform customer (i.e. lousy advertisement)
- inattention to customer preferences
- defective design or packaging

Future sales revenue even for staple tried-and-true products is uncertain. Maintaining sales, however, is usually not enough. One who stands still will see the world pass by and lose ground to those who are more aggressive. In following sections, discussion of how companies can and must seek to increase their sales and market share will be a recurring theme. Such expansion of sales, while essential for the life of a business, is naturally more chancy than retaining existing customers. It goes without saying that introducing new products is even more difficult.

In traditional Russian financial analysis, little attention is given to sales. As previously outlined, analysis is primarily oriented toward the balance sheet. Profitability is studied in the context of efficiency. Sales are taken for granted. If we look at Moscow neighborhood grocery stores where shortage of desirable items is common place, even in 2000, it is obvious that supply not demand determines sales. This condition is a sad consequence of history, but it needs not to be true in the future. In the Western world demand determines sales. It can be easily predicted that this will also be true in Russia as well.

In a philosophical sense, as well as in a practical real sense, commercial firms are created to serve society by providing customers with products customers want. Adam Smith's "invisible hand" sees to it that those firms who serve their customers well, thrive, and those who don't, go bankrupt. But the products must in the first place be available for sale on the counters of a retail store and in the finished goods inventory of a manufacturer. Failure to offer products which a firm was created to distribute is such a commercial capital offense that it deserves bankruptcy. Dowd, the head of a major department stores chain, part of Allied Stores in the U.S., would tell management trainees that if a supermarket were to be out of tooth paste or butter on a Saturday morning, it might as well close down. Such small items, worth little more than a dollar, are essentials for customers coming to shop and spend $50, $100 or more for a week's groceries. The store does not lose one but one hundred dollars in sales from not having tooth paste. Next time, that customer, as many others, will go down the street to the next supermarket that has tooth paste.

Missing sales is unforgivable. Opportunities to get a customer back are rare and costly. The financial analyst must establish that the firm has an adequate level of conservatism in its approach to its market. That is, it must have developed a defensive strategy to retain its customer base and market share. How this conservative strategy translates into specific steps differs from industry to industry. Essentially, such a strategy is reflected in intimate knowledge of company's typical client and how to satisfy the client so that the client returns repeatedly to buy company's products.

Brand loyalties and customer preferences are stable in Russia as they are in most countries. The example of Stimorol comes to mind. Stimorol holds on to the major share of the chewing gum market in Russia over Wriggley and other worldwide better known brands, simply because it was there first. (Wriggley was first in Poland and holds the major share of the market there.) Notwithstanding Russian skeptics, the manager of Stimorol affirms that advertising works in Russia as it does everywhere else in the world. Well developed distribution channels and advertising does the trick for Stimorol.

A strictly conservative sales strategy is never enough. To face future challenges, a firm must always seek to serve customers better. Innovation is essential in each and every market. While retaining customers is the first commercial imperative, innovation is the second credo of commercial firms. The financial analyst must read the business plan or annual report of the firm with a constant eye for efforts to improve customer satisfaction: in better packaging, in training and retraining its sales personnel, in more convenient sales locations, in more convincing advertising slogans, and in more affordable pricing. Sometimes, it does not take much to increase market share. An old supermarket chain upstate New York, called Price Chopper, was losing its customers in the late 1980's. After injection of new funds from a new German owner to rebuild each store with clean counters and flowers, the chain quickly became a leader in price and products in the region.

Will efforts and outlays devoted to modernization, market expansion, innovation and new product introduction pay off? Obviously, not always. The method to quantify and rationalize business decisions in this area will be undertaken in next chapter, as it is usually looked upon as part of capital budgeting which deals with projects extending over several years. This chapter is devoted to an analysis in the context of the current operating cycle. But even here, there must be a mixture of two somewhat conflicting management attitudes: preserving a market and seeking new opportunities.

One recalls that evaluation of companies is often tied to sales, such as in the sales multiplier method, or in the discounted dividend model and price to earning methods where sales growth in embedded in the formula. Predicting sales or sales growth in the coming year is at the heart of much analytical work. It is not just a numerical exercise, as the previous comments suggest, but much more an evaluation of management decisions and attitudes.

The following sections will look at sales from the points of view of different analysts. From an outsider's point of view, one needs to unravel what is the firm's current position and strategy. Because of the importance of sales revenue as the basis for management decisions and company evaluation, it is clear that manipulation with appearances is to be investigated. Once this is clarified, then the question is to determine if the strategy is the right one. This second, more important investigation takes two directions: one outwardly, toward the market, customers and competitors; and one inwardly, toward costs and determinants of costs.

See review questions Q-9A.1 through Q-9A.7.

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Last modified: Jun/01/01 Next: Recognition