Organic sales are income generated within a business. Organic sales include the revenue streams that result directly from the company’s existing activities, as opposed to the revenues that have been acquired through the purchase of another company or business unit in the past year. (Acquired companies are generally integrated within 12 months of closing.) Divestments of business sectors are also deducted from total turnover to derive organic sales.
Break down organic sales
Organic sales are the product of a company’s internal processes and are generated only within the company. Acquired sales, on the other hand, come from another business purchased by a business. For simplicity’s sake, let’s say that an auto parts manufacturer posted sales growth of 4.5% for the year, of which 2.5% was contributed by a group acquisition that occurred during the reference year . Organic sales growth would therefore be 2.0%. Once an acquisition is fully integrated into existing operations, sales of the unit or business acquired will then be recorded as organic sales. The same is true for sales of business units. If a business sells an industry, the total duration of a comparison period must elapse before organic sales are equal to total sales.
Importance of separating organic sales
For investors, it is important to be able to separate organic sales from sales from an external source. The organic sales figures will show how the company is doing with its core business from one period to the next. A breakdown of total sales organically and acquired allows a better analysis of all aspects of the fundamentals of a business, including the growth of products / services or segments; the margins associated with these products, services or segments; changes in working capital; cash flow generation; return on assets (ROA), return on invested capital (ROIC) or another measure of return on investment that suits the business. Parts of executive compensation may also be linked to organic sales performance. Management should not be rewarded for growing total sales if the business can simply “buy” sales from another business.
Example of organic sales
Large companies in the consumer staples sector have matured to the point where growth by acquisition is an essential component of their business models. Nestlé, Unilever, Danone, Pepsico – these world leaders are active in asset trading (mainly acquisitions, but also within the framework of a certain number of unprofitable or non-essential units) in order to generate overall growth in sales that investors are asking for. Unilever recorded organic sales growth of 4.2% in 2020. This rate of “underlying sales growth”, as the company calls it, excluding the net effect of acquisitions and disposals. To further refine the number of organic sales, the currency impact, which applies to companies that sell on international markets, has been removed to be presented in national currency.