Sales is a term commonly substituted for revenue. However, sales are sub element of revenue. Gross sales are total customer purchases and net sales include adjustments to those sales. Adjustments include returns, allowances and discounts.

Value Investing – Principle #3: Financial Analysis (Lesson 8)

Financial analysis is the basis to set up a predictable and reasonable market price for the respective stock. This becomes the sell price point or what is often referred to in this series of lessons as the recovery point. If all three forces (economic, industry and company level) are performing reasonably, then the stock price for the company will recover to this sell point within a short period of time. Therefore, it is important for value investors to understand the importance of having knowledge about financial analysis.

Financial analysis is an assessment of a company’s performance in the form of dollars. The goal is to establish a trend line of financial accomplishments. It is safe to assume that the historical results can predict future results with accuracy. Again, large corporations are money generating machines; it will take several adverse actions to slow down or diminish the ability to earn profits.

Financial analysis starts with gathering research data, specifically annual and the most recent quarterly financial reports. With this information, certain data is loaded into a spreadsheet so that ratios can be determined. With the spreadsheet data, trends are tracked and from there, summarized. This summary of pertinent outcomes assist the value investor with determining the most likely outcomes for the next several quarters. Take note, value investors are not as interested in extended time frames as this methodology is designed to determine an expected recovery value for the stock in the short-term. Value investors are not interested in holding to collect dividends, there are interested in the buy low, sell high tenet of business. Thus, long-term expectations are irrelevant.

Other key information is extracted from the quarterly and annual reports to confirm trends, validate business ratios and finally, determine the expected market recovery price.

Price to Sales Ratio: A Poor Indicator of Value

The price to sales ratio is a marginal valuation ratio at best. It is really an offshoot of an antiquated concept of valuing a business. In the past, one of the more common methods to value a business deal was to use a multiplier of sales. The price to sales ratio used with business ratios is similar. Simply stated, the price to sales ratio is the entire market value of the company (the price) as a function of revenue (sales).

Revenue (Sales) Codes

Revenue Codes

Revenue (sales) codes are unique identifiers for products sold or services rendered. They are used to organize information so management can better understand customer demands and the company’s profitability related to the items sold.

Gathering Data from Sales

Sales Data

In business the best source of new business is the existing customer. Discovering the customer’s habits and characteristics allows the sales department to expand into new geographical territories with similar customer characteristics and/or modify the existing product lines. The key to success is gathering the proper information at the point of sale.

Marginal Revenue in Business

Marginal Revenue

The scholarly definition and reality are two different perspectives. The student is taught that marginal revenue equals the additional dollars generated for an additional single unit of sales. It is literally taken right down to the micro measurement. This is simple to understand but in small business, the scope of its meaning and impact are substantial to the bottom line.