The Calculus of Revenue Growth
- Which metrics you should use to measure revenue and revenue growth
One of the most common questions entrepreneurs ask us is what is the best way to measure and analyze revenue? Usually most of the discussion and debate centers around software vs. services, recurring vs. non-recurring and organic vs. inorganic growth. Almost no time is allocated to discussing what metric should be used to analyze revenue growth. The defacto measure is growth measured as a percentage of the previous period’s revenue. While this metric is easily understood it does not tell the whole story or even the most interesting part of the story.
The two biggest issues with percent revenue growth are 1) it doesn’t scale well and 2) it does not tell you anything about the rate of change of the growth. When a company is very small ($500k in annual revenue), growing 100% isn’t astounding. Conversely, if a company has $1 billion in recurring revenue growing 30% is highly impressive.
A more insightful approach is to measure the dollar value growth (think velocity from physics) or the rate of change of dollar value growth (acceleration). Paying attention to the acceleration or lack thereof gives you much more insight into the health of the revenue growth. See example below.
In this example both companies have the exact same Compound Annual Growth Rate. However, not only is Company A growing faster in recent years (56% vs. 33% in the most recent year) but its current year acceleration is 3x ($14/yr2 vs. $5/yr2). Company A is a more attractive investment or acquisition candidate from a growth perspective and its even more attractive than the simple revenue growth percentage implies.