What Are Organic Sales?
Organic sales are revenues generated from within a company. Organic sales encompass those streams of revenues that are a direct result of the firm's existing operations as opposed to revenues that have been acquired through the purchase of another company or business unit in the past year. (Acquired businesses are typically integrated within 12 months post-closing.) The sale or disposal of business lines are also netted out of a total sales figure to derive organic sales. Measuring organic sales is important because it can show the amount of growth that's the direct result of a company's business plan or sales strategy.
- Organic sales are revenues generated from within a company that are a direct result of the firm's existing operations.
- Organic sales do not include sales revenue growth as a result of an acquisition of another company within the last year.
- Organic sales figures are important since they show sales revenue growth from a company's core operations.
Understanding Organic Sales
Organic sales are the product of the internal processes of a company and are generated solely within the firm. Organic sales provides management and investors with the level of revenue that was generated from the sale of a company's products and services. If a company generates increases in organic sales, it's typically referred to as organic growth. Revenue growth from organic sales is usually measured on a year-to-year basis, but many companies also monitor organic growth from quarter-to-quarter.
Organic Sales Growth Strategies
Companies might achieve organic growth of their sales through internal strategies such as:
- New product and service offerings
- A marketing campaign for a particular offer to customers and prospects
- Optimization of internal processes, which might involve boosting efficiency by making changes to the internal structure of a company
- A new sales strategy with commissions or bonuses to employees who hit sales targets
- Reallocating resources, such as sales and marketing staff, to products and services that are in higher demand
Sales Growth via Acquisition
Acquired sales, on the other hand, result from a company purchasing another business through an acquisition. An acquisition of another company would likely lead to sales and revenue growth for the acquiring company but would typically be referred to as inorganic growth. Achieving sales growth inorganically can be a benefit to companies that need access to a new market, product, or service. However, the integration process of two companies, following an acquisition, can be time-consuming. Also, acquisitions can negatively impact organic sales if the company is in a state of flux due to employee layoffs or consolidation of departments.
As a result, it's important to bifurcate the financial reporting of organic sales and inorganic sales if there's been a recent acquisition. For example, let's say a car parts manufacturer reports 4.5% sales growth for the year, 2.5% of which was contributed by an acquisition of a smaller company that occurred in the reporting year. Organic sales growth would, therefore, be 2.0%.
Once an acquisition is fully integrated into a company's existing operations, sales from the acquired unit or business would then be counted as organic sales. The same principle applies to the sale or disposal of business units, which is called a divestiture. If a company sells a business segment, the full duration of a comparison period must pass before organic sales are equal to total sales.
Benefits of Organic Sales
It's important for investors to be able to separate organic sales from sales that came from an external source. Organic sales figures will show how much revenue the company is generating from its core operations from period to period.
A breakdown of total sales into organic and acquired enables improved analysis of all aspects of a company's fundamentals, including:
- Organic growth in sales of products and services or by specific segments
- Profit margins, which help measure the percentage of revenue from sales that become profits
- Changes in working capital, which measures a company's current assets, such as cash and money received from sales versus its short-term bills or current liabilities
- Cash flow generation, which represents the net cash inflows or outflows during a period
- Return on assets (ROA), which shows how efficient a company is at utilizing its assets to generate profit from sales
- Return on invested capital (ROIC), which measures the return or profit above the cost of borrowing or issuing equity shares
- Portions of executive compensation may also be tied to organic sales performance
Real World Example of Organic Sales
Large companies in the consumer staples industry have matured to the point where growth through acquisition is an essential component of their business model.
PepsiCo Inc. (PEP) is a global leader in the beverage and snack business and active in trading assets through acquisitions primarily. Pepsi had recently closed its acquisition of Rockstar Energy Beverages in 2019. However, the company's Q1-2020 earnings report shows that Pepsi reported organic revenue growth of 7.9% compared to Q1 of 2019.
By reporting the organic growth without the distortion of revenue from acquisitions, investors can determine whether the company's product lines saw sales growth, which include Pepsi beverages, Frito-Lay, and Quaker Foods.