Organic Growth

Observe the photo: on the left is an organization that grew rapidly and then experienced a sharp decline in its growth rate, while on the right is an organization with relatively stable growth.

Historically, sales growth forecast distortions are typically caused by three factors: 1. Changes in exchange rates, 2. Mergers and acquisitions, and 3. Changes in accounting standards.

Currency: When an organization operates internationally and conducts transactions in foreign currencies, changes in exchange rates impact the growth rates reported in the home currency. For example, an American company selling products in Europe may not see an increase in prices or sales volume in euros compared to the previous year, but if the euro strengthens against the dollar, the reported revenues will show growth. Failing to account for this factor can lead to errors in sales forecasting.

Mergers: When another organization is acquired and accounts are consolidated, revenues are also consolidated. Consequently, the reported growth rate will be higher because the previous period’s reports did not include the acquired organization’s revenues. It’s important to understand that we typically do not forecast growth through acquisitions and mergers, as such operations almost never create value. In these cases, to accurately predict the growth component, it’s better to consider the organizations separately and determine the forecasted growth rate based on their weighted contributions.

Finally, changes in accounting standards often lead to the rearrangement of figures in financial reports, even though these adjustments do not alter actual cash flows or the organization’s value. For example, changes in GAAP revenue recognition rules in 2017 caused a shift in the timing of revenue recognition.

Source:

#VALUATION – Measuring and Managing the Value of Companies, 7th Edition

McKinsey & Company, Tim Koller, Marc Goedhart, David Wessels