Increased sales, decreased profits...exploring key financial indicators​

By Jake Rickman​

What do you need to know this week?

According to the Financial Times, despite companies around the world reporting improved revenues for the first quarter of 2022 (i.e., 1 January to 31 March) compared to previous periods, profit margins are, on average, decreasing.

Market analysts predict that on average, S&P 500 companies’ revenues in Q1 2022 are projected to rise nearly 11% year-on-year (YoY). However, in the same period, profit margins are expected to contract 0.05% to 11.8% on average.

As the article notes, this would be the first time in 30 years that there was double-digit growth in sales on average despite decreasing profit margins.

Why is this important for your interviews?

In an interview setting, particularly in a case study, having a fundamental grasp on how to analyse a business's performance can distinguish you from other candidates.

Revenue refers to the amount of money a company has brought in through sales and other activities like returns on investments. Revenue can go up or down either by increasing or decreasing the cost of each unit sold or the number of units sold (or both).

Profit has a few different meanings depending on the context, but the definition we are most familiar with is “revenue minus expenses”, which is sometimes referred to as net income. Expressed as a percentage of revenue, this is called the profit margin.

However, analysts use profit to refer to different figures, depending on the context. Gross profit refers to the amount of money left over after any expenses directly related to sales is deducted from sales. These expenses include the cost of materials, equipment, and labour (input costs). Interest payments made on any company debt would not be included in this figure because it is not central to the company’s operations.

Gross profit is, therefore, a strong measure of the company’s underlying performance because it does not include any ancillary costs.

From this perspective, increased sales in the face of declining profits may likely be explained by increased input costs offset by increased sales, which would be reflected in the gross profit figures.

Of course, this might also be explained through other causes: a large one-off ancillary expense or substantial interest payments. But given we are looking at averages across many different companies, what common cause might many companies be facing to explain this?

As the analysts conclude, this is yet another symptom of inflation: companies are paying more to produce their products and are in turn raising the prices. This increases sales figures but lowers profits.

How is this topic relevant to law firms?

When you are dealing with the leadership of large companies, this means being able to (quite literally) understand the bottom-line.

Of course, lawyers are not expected to provide financial advice, but as key strategic advisers, providing competent advice means being able to consider the financial implications. Therefore, corporate lawyers are expected to develop their financial numeracy.