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 revenue and sales?

    In accounting terms, sales make up one component of a business's revenue. Some businesses refer to sales as operating revenue ... Read Answer >>
  2. 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 >>
  3. What can gross sales tell you about a business?

    Learn more about gross sales and net sales. Find out what the gross sales figure reveals about a business and how investors ... Read Answer >>
  4. How can I find net margin by looking a company's financial statements?

    Learn how to calculate a company's net margin using financial statements by dividing the company's net revenues by its net ... Read Answer >>
  5. 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 >>
  6. 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 >>
Related Articles
  1. Investing

    A Look At Corporate Profit Margins

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

    Understanding Profit Metrics: Gross, Operating and Net Profits

    Rather than relying solely on net profit figures to evaluate a company's performance, seasoned investors will often look at gross profit and operating profit as well.
  3. Investing

    Comparing Bottom Line And Top Line Growth

    Both figures can determine a company’s financial strength, but they are not interchangeable.
  4. Investing

    Understanding the Top Line

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

    Net Sales

    Net Sales is an accounting term used to analyze a company's performance. It is the sales revenue that remains after deducting for product returns, damaged or missing products, and discounts. ...
  6. Investing

    The Difference Between Gross and Net Profit Margin

    To calculate gross profit margin, subtract the cost of goods sold from a company’s revenue; then divide by revenue.
  7. Investing

    Earnings: Quality Means Everything

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

    The Most Important Metrics For Earnings Season

    Knowing how to read an earnings report can help investors decide which stocks to buy.
  9. Managing Wealth

    What’s a Good Profit Margin for a New Business?

    Surprisingly, the younger your company is, the better its numbers may look.
RELATED TERMS
  1. Revenue

    Revenue is the amount of money that a company actually receives ...
  2. Cost of Revenue

    The total cost of manufacturing and delivering a product or service. ...
  3. Gross Margin

    A company's total sales revenue minus its cost of goods sold, ...
  4. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
  5. Net Sales

    The amount of sales generated by a company after the deduction ...
  6. Income Statement

    A financial statement that measures a company's financial performance ...
Hot Definitions
  1. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  2. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and FINRA, after an ...
  3. Salvage Value

    The estimated value that an asset will realize upon its sale at the end of its useful life. The value is used in accounting ...
  4. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  5. Promissory Note

    A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on ...
  6. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
Trading Center