About Bottom-Line Growth
Bottom line growth is a financial metric that is focused on by bankers, management, and investors. It is a quick way to see if a company is profitable and if different strategies that have been implemented are having a positive affect on the firm.
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Definition
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Bottom-line growth refers to the year-over-year growth of the net income of a company. Net income is calculated by taking all of a company's revenues and subtracting out the costs of goods sold; selling, general and administrative expenses; taxes; and any expenses outside of normal operations. The end result is a company's net income.
Importance
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Growing a company's bottom line is one of the key goals of management. Top-line or revenue growth is important as well but if it doesn't translate into net profit then the company will eventually go bankrupt. As an example, since the 1970's the major auto companies have experienced revenue growth but none of them was able to translate that into sustainable profit. As a result, the automakers have gone through many bankruptcies and restructurings over the years. If they had focused on bottom-line growth, their chances of having a sustainable, viable business would have greatly improved.
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Improving Bottom-Line Growth
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Since bottom-line growth is important, there are three main ways to improve it. The first way is to grow revenues while keeping costs under control. In an economic up-cycle that represents the easiest way to improve the bottom line. In the event that a company cannot grow top-line revenue but still wants to see some bottom-line growth, it must cut operating expenses while maintaining current revenues. Every company should look to keep expenses as low as possible no matter what the economic conditions, but it is most often during difficult economic times that this strategy is employed. The other way a company can create bottom-line growth is through mergers and acquisitions. Ideally there will be some synergies involved between the two merged companies that will lead to true bottom-line growth but otherwise this is a somewhat artificial way for the acquiring company to grow its net income.
What Bottom-Line Growth Doesn't Capture
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Bottom-line growth is a quick indicator of a company's profits but it can be fairly easily manipulated by both management and accountants. For example, a company can report a large net income but if it is selling to buyers on credit terms that are too generous or to buyers who will never be able to pay for the product, then the company will have to take a bad debt write-off down the road, negatively impacting net income. Since net income can be manipulated, other metrics can help provide the true picture of a firm's growth.
Alternatives
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One of the best metrics when assessing a company's growth is free cash flow. Free cash flow represents net income plus amortization and depreciation, minus changes in working capital and capital expenditures. Excess free cash flow allows a company to pay dividends, develop new products, reduce debt and make acquisitions. Bottom-line growth is important, but free cash flow ultimately represents the true profitability of a firm.
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