June 29, 2022
Explainer

How to manage your top and bottom lines in today’s troubled economy

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The top line and bottom line of a company’s income statement are the two most important metrics in its financial statements. Their growth rates and relationship to one another are vital to understanding a company’s recent performance and future prospects. 

 

Managing them effectively is particularly important during times when the business cycle, the economy’s normal oscillation between periods of growth and contraction, is reversing course. This looks to be the case today. After an unprecedented 13 years of economic growth, analysts and market participants are worrying that the U.S. economy might soon head into a recession. The country is also experiencing substantial inflation for the first time in decades.

 

The cost of goods and services is rising at the fastest rate in nearly 50 years. In May, it hit an annualized 8.58%. If that rate persists, it will cause overall prices to double in less than nine years. The combination of a recession and inflation is very rare. It was last seen in the early 1970s, and dubbed “stagflation” at the time. A good understanding of how to manage your top and bottom lines through such a period is crucial to your company’s health.

 

Spending falls in a recession, and this affects how much money a company can bring in by selling goods or offering services. Inflation raises the cost of the goods and services a company needs to make its products and operate its business. These two economic crosswinds affect how much a company will make and how much it (or its shareholders) will keep. Those two dollar figures are, respectively, its top line and its bottom line.

 

Both of these figures reside on the company’s income statement, the quarterly report filed with financial regulators where it reports its revenues and expenses. The top line of the income statement refers to gross sales or gross revenues, which is all the income a company makes during the reporting period—a quarter or a full year.

 

The first step to learn how much of a company’s gross revenue—if any—it will be able to keep or distribute as profit is to subtract the cost of creating the product or service sold—manufacturing a car, building a house, brewing a cup of coffee, offering legal services and so on. These costs are variable, because they depend on the availability and cost of the components the company needs to create the product—metals for cars, lumber for houses, beans for coffee shops.

 

When these expenses, called the Cost of Goods Sold (COGS), are subtracted from revenue, what remains is the company’s gross profit. Gross profit is what is left of sales after the variable costs of the goods or services sold are subtracted.

 

This is where the economic environment makes a big difference. Gross profit can be reduced by falling revenue due to difficulty making sales in a recession. It can also be reduced by rising COGS because of rising prices for the goods and services needed to make the product. Being squeezed by a recession and inflation at the same time would be particularly damaging for many companies' gross profit.

 

Sample income statement

 

The bottom line refers to net income or net earnings, which is listed at the bottom of the income statement. It is the company’s revenues minus all its costs, both variable and fixed, including taxes.

  

Company executives and investors emphasize top line and bottom line figures differently in different economic cycles. For example, during the dotcom era, from about 1996 until the internet technology crash in early 2000, investors valued many companies with no or minimal bottom line growth, including Microsoft, Amazon, Cisco, and Intel solely based on their top line growth rates.

 

Most dotcom high fliers went out of business when investors returned to traditional methods, and began valuing companies based on bottom line performance using earnings multiples and earnings per share as their yardsticks.

 

Others, like Microsoft and Amazon, took a decade or more to regain their dotcom era valuations. 

These days, growing the bottom line via smart operating expense management, and gross profits via smart variable cost management, is key to a company’s success.

  

What is top line growth?

Top line growth is an increase in all the revenue a company manages to pull in during a reporting period. This could be through the sale of manufactured goods, activities as a market maker, middleman, or trader, or the provision of professional services, be they law, accounting, financial, or skilled work like plumbing or carpentry.

The top line is all the money a company receives from its clients and customers. So top line growth shows how good a company is at generating new sales.

Top line growth is the expansion of these revenues. This can be done by growing the customer base, raising prices, expanding product lines and other methods, which we will turn to next.

How companies can improve top line growth

A company can increase its top line in a number of ways. Here are some common approaches:

  • Launching a new marketing or advertising campaign to gain new customers
  • Increasing the price of its products
  • Adding new product lines
  • Improving its products to gain new customers
  • Increasing the efficiencies of manufacturing its products by finding cheaper raw materials
  • Acquiring a rival to gain market share

However, achieving top line growth is not a panacea, and should not be pursued as the sole priority. A company that jacks up prices to boost top line growth in one quarter might see customers turn to its rival’s products in the next.

 

Top line growth typically slows as a company matures because of market saturation for its products, competition from rivals, supply constraints, and counterproductive price hikes. Apple discovered this in 2019, when it sold fewer iPhones than projected, and its revenues fell by $5.4 billion from the previous year.

 

The top line is used as the denominator in a number of important ratios. For example:

  • Profit margin: This is a measure of all of a company’s costs. It is (revenues - total costs)/revenues. A good profit margin depends on the industry, but generally runs between 5 and 10%.
  • Gross profit margin: This shows a company’s variable costs. It is gross profit/revenue, where gross profit is (revenue - COGS). Retail stores need a 50% gross profit margin to cover their distribution costs.

What is bottom line growth?

Bottom line growth comes from managing resources carefully and keeping a tight rein on costs. It shows how good a company is at managing spending and operating costs.

The bottom line, meaning a company’s earnings, is arguably the most important metric. It is used to set the company’s market valuation. (Share and venture capital investment values are usually informed by, if not determined by, some multiple of a company’s earnings.)

As the sample income statement above shows, for a company to grow its earnings, it must either

  1. Increase revenues while holding costs steady, or
  2. Cut costs

How companies can improve bottom line growth

Management can grow a company’s bottom line, first and foremost, by growing its top line and keeping expenses from rising.

But since the bottom line reflects the company’s management of its fixed costs and expenses, you can also:

Viewing the top line and the bottom line together

Top and bottom line growth often diverge in mature companies, where cost control measures and plateauing sales can cause earnings to grow faster than revenues. However, this is unsustainable over the longer term, since there are only just so many costs that can be cut.

 

Similarly, if revenues grow consistently faster than earnings, something is amiss. Costs may be out of control or management has become complacent.

 

External factors like a recession, during which a company might have flat sales and decide to cut its workforce to reduce expenses also have uneven effects. Apple’s revenues blew out in 2021 by over $90 billion, to $365.8 billion, compared with 2020. Its bottom line went up by over $35 billion.

 

How to improve top line and bottom line growth with expense management

Develop a healthy financial culture

To manage and reduce selling, general and administrative (SG&A) expenses, many companies today focus on developing a healthy financial culture. A better spend culture for modern organizations is one where employees feel trusted to spend responsibly.

 

These positive behaviors should permeate every aspect of your company, from product development and go-to-market strategy to financial operations. You don’t want people to fear spending. Rather, you want people to understand the guardrails for healthy spending and saving, and what positive financial behaviors look like.

 

This helps curtail tail spend, too. Tail spend is high-volume, low-value expenses that make up 80% of the average company’s transactions and 20% of total spend. A recent study by Deloitte found that companies who manage their tail spend effectively have savings between 5-20% in total spend. It provides visibility into spending so you can:

  • Uncover spend that is outside of your procurement policy or doesn’t contribute to your top-line initiatives
  • Track billing inconsistencies over time to find areas you can save
  • Identify duplicate services and supplies
  • Get more accurate budget forecasts by adopting a rolling budget

Conduct a spend analysis

To identify and understand these types of SG&A expenses, you can conduct a spend analysis. This is the process of reviewing external spend across various expense categories to determine whether you could spend less going forward.

 

All this can lead to your development of a spend control plan. As you build it, consider implementing some of these strategies to help manage your company’s spend and make effective, data-driven choices.

Practice continuous accounting

Continuous accounting involves updating financial information throughout the month rather than waiting until month-end like many manual processes do. These real-time updates allow the finance department and key players in the company to see where money is going and better manage cash flow.

Using the right financial management software for this can save your team hours, sometimes even days, of time.

Automate your expense reports and spend policies

When you automate your expense reports, it becomes much easier to control any ad hoc spending. It’s also easier to eliminate any human entry errors that could cause issues later down the line.

 

Expense management software, like the platform Ramp offers, has the capability to let employees submit receipts on the spot. The software then takes the information from that receipt and reconciles it to an automatically created expense report.

Within the system, you can also create digital expense policies that will remind the employee of everything they need to enter to document their purchase, avoiding a long back-and-forth process in the event they forget a key piece of information, and leading to better spending habits among employees. Employees are also typically reimbursed the next day.

Use employee corporate cards

If your employees are often waiting for expense reimbursements, you may want to switch to a spend management solution that also offers the benefits of employee credit cards with built-in controls. They can be virtual cards or physical cards. The company can place limits on them, restrict what merchants employees buy from, and more.

These cards allow employees to buy things they need to do their jobs, such as home office equipment or software—and those purchases are then logged into your software, often removing the need to create expense reports.

Approve spend ahead of time and use multi-level approval to stay in control of spend

Empower employees by making it easy for them to request spend and route requests for approval. To do this, you’ll need to use software that lets you instantly generate corporate cards for employees to use upon approval. If you’re having trouble controlling spend, you can set up multi-level approval for bills. This approach provides accountability across the company, gives managers and executives a better view into what employees are doing, and reduces maverick spending.

With the right software, you can also create custom workflows that will send the bills along to the right people automatically so that employees don’t use up their time chasing down approvals—this is especially valuable in companies with a distributed workforce.

Keep your company spending in check with Ramp

At Ramp, we know how easy it can be to fall victim to poor spend control practices—that’s why we created our corporate credit cards and financial management software that works together to help you be as efficient as possible.

If you want to see how Ramp could help your organization streamline spend control, you can sign up for free today.

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