A:

In order to operate and make money, a company must spend money. Revenue - the dollar amount of sales - can be seen on a company's income statement. From there, various expenses are deducted such as cost of goods sold and marketing. But it is the earnings figure, or net income, that reveals what the company retains from all its sales. The incongruity arises from the steps a company takes to go from sales to earnings. If sales are rapidly rising but earnings are falling, it means costs are growing faster than earnings.

sales1.gif

As can be seen above, sales have risen 100%, but in order to generate these sales, the company raised its marketing efforts by 200% for a 243% increase in COGS. These higher costs outweigh the increased sales, which lead to a 9% decrease in earnings. Here are some possible reasons why an increase in revenue can hurt earnings:

  • Operating Expenses - This is a company's overhead, or the cost of doing business. As a company attempts to boost sales, it may have to pay more employees, lease more office space or buy new equipment to increase production. Unless a company raises its productivity, it may, by increasing sales, simply become bloated. This will lower its margins, which leads to lower earnings.
  • Marketing Costs - Advertising, free trials, discounts and other promotional material can all be used to increase sales. While these tactics are often effective, they cost money, ultimately affecting the bottom line.
  • Lower Prices - When a company lowers the price of its product, it can stimulate greater sales. While the price is lower, the amount sold may greatly increase, which lifts revenue. However, if costs are not going down, the company's margins will be smaller, leading to lower earnings.

It is important to recognize the distinction between sales revenue and earnings: while earnings may rise, so could expenses. Ideally, revenues and earnings should be moving in the same direction. Decreasing revenues and increasing earnings mean greater profit margins. Higher revenues and lower earnings means that income is being eroded by expenses.

It should be noted, however, that increased revenue amid lowered earnings is not uncommon. In maturing industries, companies must fight for their market share. This can mean price wars, huge marketing campaigns and other promotions that hurt margins. Many companies allow lowered earnings because taking a loss is necessary to expand customer base, which eventually helps to recoup losses.

(To learn more, see Understanding The Income Statement.)

RELATED FAQS
  1. What is the difference between earnings and revenue?

    Understand how a company makes revenue and how it makes earnings. Learn the difference between revenue and earnings and how ... Read Answer >>
  2. What's the difference between retained earnings and revenue?

    See why retained earnings and revenue are both considered important measurements of a company's financial performance, and ... Read Answer >>
  3. What is the difference between revenue and sales?

    Learn to distinguish between a company's revenue and its sales, and see why the distinction is important when analyzing a ... Read Answer >>
  4. For a company, is it more important to lower costs or increase revenue?

    Examine the question of whether a company's desire for increased profitability is better served by focusing on cutting costs ... Read Answer >>
  5. How is revenue related to retained earnings?

    Learn what business revenue is and how it relates to retained earnings. See how accountants calculate these key figures and ... Read Answer >>
  6. What are the best ways for a company to improve its net margin?

    Learn about what businesses can do to increase their net margin, including ways to increase sales revenue and decrease operational ... Read Answer >>
Related Articles
  1. Investing

    Understanding the Income Statement

    The best way to analyze a company—and figure out if it's worth investing in—is to know how to dissect its income statement. Here's how to do it.
  2. Investing

    Earnings: Quality Means Everything

    It's quantity that generates all the hype, but there are more meaningful factors that gauge true performance.
  3. Investing

    IBM Stock: An Earnings Case Study

    Learn the main drivers behind IBM's earnings model and why analysts predict a decline in 2016 followed by a strong recovery in 2017.
  4. Investing

    Everything Investors Need To Know About Earnings

    We go over the concepts behind the excitement over the most important figure in the stock market.
  5. Investing

    Understanding the Top Line

    Top line refers to a company’s gross sales without any reductions for discounts or returns.
  6. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
  7. Investing

    What are Earnings?

    The amount of profit that a company produces during a specific period, which is usually defined as a quarter (three calendar months) or a year.
  8. Investing

    Find Investment Quality In The Income Statement

    Use these key attributes to uncover top-level investments.
  9. Investing

    Comparing Bottom Line And Top Line Growth

    Both figures can determine a company’s financial strength, but they are not interchangeable.
RELATED TERMS
  1. Revenue

    The amount of money that a company actually receives during a ...
  2. Quality Of Earnings

    The amount of earnings attributable to higher sales or lower ...
  3. Earnings

    The amount of profit that a company produces during a specific ...
  4. Gross Sales

    A measure of overall sales that isn't adjusted for customer discounts ...
  5. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
  6. Bottom Line

    Refers to a company's net earnings, net income or earnings per ...
Hot Definitions
  1. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  2. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  3. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  4. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  5. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  6. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
Trading Center