When we talk of evaluating companies on a fundamental basis, two commonly used terms are the top-line and the bottom line. The top line refers to the sales or the revenues of a company which is the total income generated during a particular period. The bottom line is the net profit of the company which is after all operating expenses, depreciation, interest and taxes. The bottom line is what the company actually generates for shareholders. Companies report their top line and their bottom line on a quarterly basis apart from doing a detailed disclosure on an annual basis. What do we understand by top line growth and bottom line growth and what are the factors that led to difference in top and bottom line growth? Let us look at top line vs bottom line growth of a company from a deeper perspective.
What to look at in top line growth
Top line growth refers to the growth in sales and this can either be looked at on a QOQ basis or a YOY basis. Here are 3 things you need to know about top line growth.
You need to understand if the top line growth is arising due to a rise in volumes. Rise in volumes either comes from sharp expansion, acquisition of new companies or from getting a bigger market share from competition. In sectors like FMCG, it is the volume growth that really matters for top line.
Can top line also increase due to price? The answer is a clear yes. You either grow your top line due to growth in volumes or due to growth in pricing power. In sectors like cement and steel, volume growth does not happen quickly so it is the pricing power that matters a lot more.
Top line growth must always be seen on a relative basis. For 15% growth in top line may look great on paper but if the sector as whole is growing at 20% and the peer group companies are growing at above 20%, then it still means that the company is a laggard in terms of top line growth. That calls for correction action.
What to look for in bottom line growth?
AS the name suggests, bottom line refers to the bottom of the income statement or the net profit. Here are two things you need to understand about bottom line growth.
If the bottom line growth is a direct outcome of growth in sales revenues, then it is a good sign as it indicates that higher revenues are directly translating into profits for the company in question.
Higher profits could also come from better cost control as was evident in the last two years when the profit growth was better than sales growth due to low prices of crude oil which was pushing costs lower.
Adjust the bottom line for any extraordinary incomes or expenses or any kind of one-off kinds of items in the income statements. This will give you a more sustainable idea of the profitability of the business.
Can top line growth and bottom line growth diverge?
In fact, this divergence is quite common in companies. There are two possible situations here.
There are cases when the profit growth is much faster than the sales growth. This typically happens either due to strict cost control measures taken or due to a sharp fall in the input prices. We saw a lot of Indian companies in the paints and tyre industry benefit from lower crude prices. As a result in the previous two years, the profit growth tended to be much better than the sales growth.
The second case is when the profit growth is slower than the sales growth. This is a common cue when the company is growing fast. Look at companies like retail players which are growing sales but expenses are growing much faster. This leads to profit growth being slower than sales growth. In the last two quarters of 2018, we have seen most companies taking a hit on profits due to higher prices of crude oil and other inputs. In the September 2018 quarter, bottom lines grew at just 11% against 22% growth in top line.