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.) Disposals of business lines are also netted out of a total sales figure to derive organic sales.
Breaking Down Organic Sales
Organic sales are the product of the internal processes of a firm and are generated solely within the firm. Acquired sales, on the other hand, come from another business that a company has purchased. For the sake of simplicity, say a car parts manufacturer reports 4.5% sales growth for the year, 2.5% of which was contributed by a tuck-in acquisition that occurred in the reporting year. Organic sales growth would, therefore, be 2.0%. Once an acquisition is fully integrated into existing operations, sales from the acquired unit or business will then be counted as organic sales. It works the same way with disposals of business units, too. If a company sells a business segment, the full duration of a comparison period must pass before organic sales are equal to total sales.
Importance of Separating Organic Sales
For investors, it is important to be able to separate organic sales from sales that came from an external source. Organic sales figures will show how the company is faring with 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 product/service or segment growth; margins associated with these products, services or segments; changes of working capital; cash flow generation; return on assets (ROA), return on invested capital (ROIC), or another investment return metric that is suitable for the firm. Portions of executive compensation may also be tied to organic sales performance. Management should not be rewarded for total sales growth if the company can merely 'buy' another company's sales.
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 models. Nestle, Unilever, Danone, Pepsico - these global leaders are active in trading assets (mostly acquisitions, but also some paring of units that are unprofitable or non-core) to churn out overall sales growth that investors demand. Unilever reported organic sales growth of 4.2% in 2016. This "underlying sales growth" rate, as the company calls it, excluding the net effect of acquisitions and disposals. To further refine the organic sales number, the currency impact, which is applicable for firms selling in international markets, was stripped out to report in the home currency.