Definition and Examples of Growth Rate
How to Calculate Growth Rate
Advantages and Disadvantages of Growth Rate
What It Means for Investors
Definition and Examples of Growth Rate
The growth rate is a forecast of a company’s future financial results based on current financial data. The growth rate uses current financial data to estimate the company’s future performance. It can be utilized by investors, business owners, analysts, and advisors to make executive decisions. The use of the growth rate is most relevant when analyzing new companies or newly launched products. It is not a reliable number for individual sales campaigns and companies with seasonal revenues. The context of the company and the type of company you are analyzing should always be considered when calculating the growth rate.
How to Calculate Growth Rate
To calculate the growth rate of a company, simply take the company’s revenue over a certain time period and divide it by the number of days in that period. Then, multiply that number by 365 to get the annual growth rate. This is the formula format:
For example, if company BSL had revenue of $900,000 in the first quarter of the year, you would first divide that by the number of days in that quarter (900,000 / 90 = 10,000). Then multiply that number by 365 to get an annual growth rate of $3.65 million.
You can also calculate the growth rate by taking the current month’s revenue and multiplying it by 12 to get the annual growth rate: Annual Growth Rate = One Month Revenue × 12 Months. For example, if company HWG had revenue of $500,000 in January, you would multiply that number by 12 to get an annual growth rate of $6 million.
Advantages and Disadvantages of Growth Rate
Advantages:
– Can be useful for new companies: Companies without a profit record have little information to use in making financial forecasts and projections. Using the growth rate can be a great starting point for predicting how the company will perform in the future.
– Better for predicting long-term sales contracts or newly launched products: Products with long-term contracts make the growth rate more accurate. Why? Because contracts provide stability to the estimated future revenues. Newly launched products have little historical data to work with; thus, the growth rate is best for predicting sales.
Disadvantages:
– May be unreliable for companies with seasonal revenues: Seasonal revenues mean that tagged figures will be inaccurate as sales may vary from month to month. For example, let’s assume an athletic wear company performs better in winter than in summer. If we use sales figures during a month to calculate the company’s growth rate, it would not be reliable since we know sales are high only during winter months. The annual growth rate is likely to be incorrect.
– Irrelevant for estimating sales of individual products: If a company decides to sell a product for only a short time without plans to sell that product in the next year, the growth rate will be irrelevant because the product will not exist in the future.
What It Means for Investors
The growth rate can help determine whether a company will be profitable in the long run. This can be useful in making an investment decision in a company. If you calculate the growth rate and it shows that the company will generate revenue, you might want to invest in it early to benefit from that success. However, since the growth rate applies more to new companies, you are likely investing in a startup. The growth rate is just one component in deciding whether a company will be profitable, so make sure to weigh all risks and do not invest money that you cannot afford to lose entirely.
Source:
https://www.thebalancemoney.com/what-is-run-rate-5192879
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