Top Line Definition
Top line is the revenue earned by the business by selling goods or services and is reported in the income statement for a defined period (monthly, quarter, semi-annual or yearly). Further, it is calculated after deducting the discounts given to the customer and also net off the sales reversed during the year.
Explanation
For any entity or its stakeholders, the most critical item in the entire set of financial statements is the total sales. It is not the number of goods sold, but the “amount” of total revenue generated from the business of the entity. Revenue means quantity multiplied by the price charged per unit.
We treat the increase in sales growth as growth in the top line. Other income earned is not linked to the primary business, and therefore, it is not included.
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Please see below some of the top companies as examples and what forms their top line.
How to Analyze and Calculate Top Line?
Let’s have an example:
Income Statement: Amount in $ Million
We can calculate the top line as follows:
Explanation
- The top line of the entity is only “Gross Revenue” and not the “total income”. Other income may include rebates earned from suppliers, interest income on fixed deposits, write-back of provisions, etc. Other income is
- Sales are increasing as the capacity utilisation of the plant capacity is increasing. Also, the selling pricing per unit is increasing consistently.
- The bottom line (net profit) is increasing as reflected in the growth in net profit margin over the years.
- Company’s major cost is dedicated to employee cost and marketing cost. Further, the cash profits are also increasing in line with an increase in the top line.
Why Top Line Matters?
- Top line drives the business. Lower sales mean the lower scale of business and higher sales mean a larger scale of business. We compare this scale to what competitors are achieving.
- Everything in the financial statements is linked to the top line. Several employees working in a company are based on the amount of business to be handled. Their paychecks are dependent again, dependent on the business.
- Companies keep the pricing of raw material relatively low to ensure higher gross margins. They also keep other direct overheads low to ensure sufficient gross profits.
- The indirect expenses are managed in the way to ensure sufficiency of operating profit margins (i.e. EBITDA margin). EBITDA is an important figure for an entity which means earnings before interest, taxes, depreciation and amortisation.
- Increase in sales should reflect the increase in EBITDA. In case the EBITDA margin is steady and not increasing over the years, it means a company has reached the maturity stage of the business cycle. At this stage, innovations will only help the business to survive in the long term.
- Various ratios are linked to the top line, such as gross margin, net margin, efficiency ratios, EBITDA ratio, EBIT ratio, Cash ratio, etc. All such ratios reflect the growth of the entity over the years.
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