Weighted average explained

How to calculate a weighted average? In this video, we go through examples of calculating a weighted average from the world of financial analysis.
Let’s start off with calculating the weighted average revenue growth for a company consisting of three business units: Business Unit A generating $800 million revenue in year 0, and Business Unit B and C generating $100 million revenue each. Business Unit A is large and stable, but has no revenue growth. Business Units B and C are much smaller, but have more attractive growth rates of 10% and 20%. What is the revenue growth for the company as a whole? The easiest way to calculate the weighted average revenue growth is to first translate the percentage growth to absolute amounts. The 0% growth of Business Unit A equates to $0 extra revenue. 10% growth in Business Unit B equals $10 million in incremental revenue. 20% growth in Business Unit C equals $20 million. If we sum this across the business units, we get to $30 million revenue growth for the company in total. $30 million revenue growth on a base number of $1 billion equals 3%. A second way to calculate the weighted average revenue growth is to look at the relative contribution of each of the business units. In terms of relative size, Business Unit A brings $800 million out of the total $1 billion in revenue for the company, or 80% of the total. Multiply that 80% relative size by 0% revenue growth. Business Unit B brings $100 million out of the total $1 billion in revenue for the company, or 10% of the total. Multiply that 10% relative size by 10% revenue growth. Business Unit C, like Business Unit B, brings 10% of the total revenue. Multiply that 10% relative size by 20% revenue growth. Now sum the percentages: 0% + 1% + 2% equals 3%.
Philip de Vroe (The Finance Storyteller) aims to make strategy, #finance and leadership enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better investing decisions. Philip delivers #financetraining in various formats: KZbin videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!

[@TheFinanceStoryteller]

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[@austin2150]

So helpful! Thank you

[@TheFinanceStoryteller]

You're so welcome! 🙂

[@narakdk]

What happens when the Gross Margin is negative in one of the units?

[@TheFinanceStoryteller]

That will dilute the average. You use the same method: sum the absolute amounts of Gross Margin $ for the business units in order to get total Gross Margin on the company level. Then divide GM$ by revenue $ to get the average Gross Margin % for the company. This can be a negative number on the business unit or the total company level.