Understanding how your business’s finances are behaving is critical to determining its success. However, with so much terminology, acronyms, and KPIs (key performance indicators) used to define business finance, it’s easy to become perplexed. Turnover, on the other hand, is one of the simplest measures to understand in business and will tell you whether you’re meeting your financial targets or not.
However, while business turnover is an important indicator of success, it is frequently misconstrued as profit. So, how do you solve it? This article defines business turnover and walks you through the calculation process.
What is the Definition of Turnover?
Turnover is the entire amount of money a business makes in a certain time period. It is also known as ‘gross revenue’ or ‘income’. Profit, on the other hand, is a measure of earnings.
It’s a crucial indicator of how well your business is doing. Knowing your turnover figure is useful throughout your business’s life cycle, from planning and securing funding to monitoring performance and valuing your firm if you plan to sell.
There are a few more definitions of turnover that do not immediately relate to your finances. For example, the term “turnover” can also refer to the number of employees who leave a business in a given time period, often known as the “employee churn rate.”
Alternatively, if you provide credit to consumers or clients, you may also track ‘accounts receivable turnover,’ or the time it takes your customers to pay.
Turnover can also refer to how frequently your inventory or stock is replaced. A low inventory turnover may imply slow sales, while a high inventory turnover may suggest good sales performance. Our post examines turnover in terms of business income.
Understanding Turnover
Turnover ratios measure how rapidly a business runs its activities. This evaluates its efficiency and how effectively it uses its resources.
Accounts receivable and inventory are two of a business’s most valuable assets. Both of these accounts necessitate significant cash input, and it is critical to track how rapidly a business earns cash. Fundamental analysts and investors use turnover ratios to judge whether a firm is a worthwhile investment.
The following are examples of common forms of turnover:
- Accounts receivable turnover
- Inventory turnover
- Portfolio turnover,
- Working capital turnover
Companies can improve their operational efficiency by examining a variety of these ratios, frequently with the purpose of maximising turnover.
Why is Turnover Important?
It might be argued that turnover only tells half of the story and that net profit is the best way to correctly measure financial success because it includes not only the cost of goods and services but also additional expenses such as tax and administrative fees. However, as a flat figure to work with, turnover is extremely significant, not only in determining how to meet profit, but also in courting investors.
It’s also an excellent figure for comparing to other measures. For example, if your gross profit is low in relation to your turnover, it may be time to look at measures to reduce your sales costs. If your net profit is low in relation to your turnover, you should consider making your business more financially effective.
What is Turnover in Business?
Turnover includes not just the cost of a product or service (minus any VAT, of course), but also any expenses paid for by the client, such as shipping costs. Before deducting fees or commissions, turnover should also be computed. This is significant since your exact turnover figure will be required for your tax return and when you register for VAT. If you overestimate your turnover, you may believe you don’t need to register when you actually must, which could find you in legal trouble.
Also, keep in mind that turnover must be supplied from the time the transaction is made, not when the invoice is sent or money is received. This is a common occurrence in small businesses.
Why Knowing Your Turnover Helps Your Business
Some experts believe that knowing your net profit is a stronger indicator of financial success than knowing your business turnover. Indeed, you can have amazing sales but also incredibly high costs, resulting in a very poor profit. However, turnover can show much more than just profit margins.
Knowing your turnover figure can help you attract investors. It can also serve as a reference when determining profit margins and determining how to achieve profit-related objectives.
For example, money that falls short of expectations suggests poor sales. This can give you a heads-up if something isn’t right, as well as an opportunity to fix it. Prices that are too high and/or a poor marketing plan are two examples of where you may be going wrong.
How to Calculate Turnover
As long as you’ve kept an accurate record of your sales, calculating your turnover should be a breeze. If you sell things, your turnover is equal to the total sales value of those products. If you offer services like consulting or labour, your turnover is the total amount you charge for these services.
Also, if you are VAT-registered, make sure to omit VAT when computing turnover because this sales tax technically belongs to HMRC rather than your business.
Calculating turnover is as simple as summing all of your total sales for a particular time, as long as your accounting department keeps exact and accurate records. However, in most cases, turnover is calculated by the calendar year. You may then use your turnover to compute gross profit (after deducting the cost of products sold) and net profit (after deducting all operational expenditures).
Remember that turnover is calculated over a certain time period, such as a fiscal year.
- To calculate gross profit, subtract the cost of your sales from your turnover.
- To calculate net profit, take your gross earnings and deduct all other expenses, including your tax liabilities.
Here’s an example calculation.
| Amount | |
|---|---|
| Turnover | £50,000 |
| – Cost of goods sold (COGS) | £20,000 |
| = Gross profit | £30,000 |
| – Operating expenses | £15,000 |
| = Net profit | £15,000 |
Turnover vs Profit – what’s the difference?
Turnover in business is not the same as profit, despite popular belief.
- In other words, the net sales figure, or turnover represents your whole business income during a specific time period.
- Profit, on the other hand, refers to your earnings after expenses are eliminated.
It’s worth noting that there are two ways to calculate profit. ‘Gross profit’ is defined as sales less the cost of the goods or services sold, also known as the’sales margin’.
‘Net profit’ is the amount left over after all expenses (such as administration and tax) have been deducted within a certain period.
What is Accounts Receivable Turnover?
At every point in time, accounts receivable indicates the entire dollar amount of unpaid customer invoices. Credit sales divided by average accounts receivable is the accounts receivable turnover formula, assuming that credit sales are transactions that are not immediately paid in cash. The average accounts receivable balance is simply the average of the beginning and ending balances for a given time period, such as a month or year.
The accounts receivable turnover formula calculates how rapidly you receive money in comparison to credit sales. For example, if credit sales total £300,000 for the month and the account receivable amount is £50,000, the turnover rate is six. The goal is to maximise sales, reduce receivables, and generate a high turnover rate.
What is Inventory Turnover?
The inventory turnover formula is similar to the accounts receivable formula in that it is presented as the cost of goods sold (COGS) divided by the average inventory.
When you sell merchandise, the remaining balance is transferred to the cost of sales account, which is an expenditure account. As a business owner, your goal is to maximise inventory sold while minimising inventory held on hand. For example, if your monthly cost of sales is £400,000 and you have £100,000 in inventory, your turnover rate is four, indicating that your company sells its entire inventory four times per year.
Inventory turnover, also known as sales turnover, assists investors in determining the level of risk they will incur if they provide operating capital to a business. A company with a £5 million inventory that takes seven months to sell, for example, will be considered less profitable than a company with a £2 million inventory that sells in two months.
What Is Portfolio Turnover?
Turnover is also used to describe investments. The percentage of an investment portfolio that is sold in a given time period is referred to as turnover in this context.
Assume a mutual fund manages £100 million in assets and its portfolio manager sells £20 million in securities during the year. The turnover rate is calculated as £20 million divided by £100 million, or 20%. A 20% portfolio turnover ratio might be read as one-fifth of the fund’s assets being represented by the value of the trades.
Actively managed portfolios should have a higher rate of turnover, whereas passively managed portfolios may have fewer trades during the year. The actively managed portfolio will incur higher trading costs, lowering the portfolio’s rate of return. Excessive turnover in investment funds is frequently regarded as a sign of poor quality.
Why Is High Turnover Bad for Mutual Funds?
High turnover ratio funds may incur higher transaction expenses (such as trading fees and commissions) and create short-term capital gains, which are taxable at the investor’s regular income tax rate. Lower turnover funds typically have lower fees and long-term capital gains that are taxed at a reduced rate.
What Is Working Capital Turnover?
Working capital turnover evaluates a business’s ability to generate sales for every dollar of working capital invested. The gap between a company’s current assets and current liabilities is represented by working capital.
What Is the Difference Between Turnover and Profit?
Profit is defined as a company’s total revenues less its expenses. In contrast, turnover can refer to how rapidly a company’s inventory is sold or payments are collected in comparison to sales over a certain time period. In general, turnover considers the speed and efficiency of a company’s operations. Profit measures how much money a corporation makes after deducting its expenses.
Does Turnover Mean Profit or Loss?
Although the two are frequently confused, they are not the same! As previously stated, turnover is the overall income of a business over a specified time period. Profit, on the other hand, is what remains after expenses have been eliminated.
Does Turnover Mean Profit or Loss?
Although the two are frequently confused, they are not the same! As previously stated, turnover is the overall income of a business over a specified time period. Profit, on the other hand, is what remains after expenses have been eliminated.
The Bottom Line
Turnover can be viewed as an accounting or an investing notion. It is a measure of how swiftly a business conducts its operations in accounting. The percentage of a portfolio that is sold in a given time period is measured by turnover in investing.
There are various sorts of turnover to measure in a business, but the most typical are inventory and accounts receivable. Accounts receivable turnover demonstrates how rapidly a business collects payments. Inventory turnover measures how quickly a company’s whole inventory is sold. Investors can analyse a company’s efficiency by looking at both types of turnover.
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