Table of Contents
What Is Turnover?
Turnover in business is the total sales which a business made in a particular period of time. Sometimes scholars refer to it as gross revenue or income. The term is different from profit which is the measure of earnings or the excess of sales over purchases and/or expenses. This income is an important factor that helps in measuring the performance of a business. It is an accounting concept that evaluates how quickly a business carries out its operations.
Turnover also describes how swiftly a company or an organization collects cash from its accounts receivable and also how fast a company is able to sell its inventory.
Some other definitions of the term do not directly to one’s finances but are relevant in understanding what it is all about. For instance, turnover can also imply the number of employees that leave a business or an organization within a particular period of time and it is sometimes known as churn. In the course of this article, the elaboration will be made more vivid.
The overall turnover is synonymous with the total revenues of a company which is commonly used in Europe and Asia.
The two largest assets a business owns are accounts receivables and inventory. These two assets require a large cash investment and it is, therefore, important to understand how fast a business collects cash.
Turnover ratios evaluate the speed at which a business collects cash from its accounts receivable and as well as inventory investments. Investors and fundamental analysts use these ratios to determine a company’s viability for a good investment.
Rate of turnover
The meaning of the rate of turnover which some people call turnover ratio varies across different aspects.
In the context of that of employees, it is the percentage of employees who left an organization over a specified period of time.
In the aspect of inventory, it is the percentage of a company’s inventory replacement over a specific period of time.
For the accounts receivable, it is the percentage sum of the currency amount of unpaid customer invoices at a particular point in time.
In the area of the portfolio, the term refers to the percentage of a portfolio that an organization sells in a particular period of time, say a month or a year.
For a company’s assets, the rate of turnover is the percentage value of the sales or revenue of a company in relation to the value of its asset. In other words, it is the total sales or revenue (in percentage) with regard to the average assets.
Types of turnover
There are different types or aspects of turnover such as;
- Accounts receivable turnover
- Inventory turnover
- Portfolio turnover
- Employee turnover
- Asset turnover
A) Accounts receivable turnover
Accounts receivable is the sum of the currency amount of unpaid customer invoices at a particular point in time. Credit sales are those sales that the buyers do not pay in cash immediately. The formula for calculating the accounts receivable turnover is credit sales divided by average accounts receivable. The average accounts receivable is the average of the accounts receivable at the beginning and at the end for a specific period of time, say in a month or a year.
This formula indicates how quickly one is collecting payments compared to credit sales.
For example, if the total credit sales for a month are $300,000 and the account receivable balance is $50,000. The rate of turnover is 6 the objective is to maximize sales, maximize the accounts receivable balance, and generate a large rate of turnover.
Accounts receivable turnover ratio
The accounts receivable ratio is the ratio that measures a company’s effectiveness in handling collections. If money is not flowing in from customers based on the agreement and expectation, it can lead to the cash flow drying to a very thin flow. In essence, the ratio helps businesses and accountants to assess how well a company is managing the credit facilities that it extends to its customers. This takes place through the evaluation of the length of time it takes in collecting all the outstanding debts throughout the accounting period. It is also referred to as the debtors turnover or receivables turnover ratio which is an efficiency ratio.
On the other hand, when a company manages collections effectively, it becomes easier to predict its cash flow. The costs of collection are lower thereby making the balance sheet healthier. This is something that every company chases after and obtain credit, invest in growth, and attract investors.
The ratio reveals relevant information with regard to a firm’s financial stability as well. A high accounts receivable ratio is a desirable thing but credit policies should not be restrictive and should not impact sales negatively.
The nature and type of business, as well as industry, have an impact on the accounts receivable ratio. The score may not the quality of a company’s customer base or the effectiveness of its retention efforts. A company can improve its ratio by having an effective billing effort and improving its cash flow.
How to calculate accounts receivable turnover ratio
This, in other words, is an efficiency ratio and it is an activity financial ratio in specific terms. It is a very vital component in analyzing financial statements which evaluate a company’s efficiency and speed in converting its accounts receivables into cash in a given accounting period.
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Accounts receivable turnover formula
The accounts receivable turnover calculation is done by dividing the net sales by the average accounts receivables thus;
ART = Net sales / average accounts receivable
We calculate net sales as;
Net sales on credit – Sales returns – Sales allowances
We calculate the average accounts receivable as;
Average accounts receivable = AR(1) + AR (2) / 2 Where,
AR (1) = Accounts receivable at the beginning of a specific period (e.g monthly or yearly)
AR (2) = Accounts receivable at the end of a specific period (e.g monthly or yearly)
This accounting period can be monthly, quarterly, or yearly.
The formula for calculating the accounts receivable turnover rate for one year period is;
Accounts Receivables Turnover = Net Annual Credit Sales ÷ Average Accounts Receivables
For example, a company selling out floral arrangements for corporate events and accepts credit. The shop’s gross sales were $100,000. Its starting accounts receivables for the year were $10,000 while its ending accounts receivables for the year were $15,000.
Therefore;
Accounts Receivable Turnover Ratio = $100,000 – $10,000 / ($10,000 + $15,000)/2 = 7.2%
B) Inventory turnover
Also known as sales turnover, refers to the level at which a company replaces inventory in a particular period of time as a result of sales. The calculation of inventory turnover helps businesses and companies in making better and efficient decisions with regard to pricing, manufacturing, marketing, and purchasing. When a company manages its inventory level properly, it shows a desirable level of sales and cost control. Inventory has to do with all the goods a company has in stock for sale. This includes raw materials, work-in-progress, and finished goods that the company will ultimately sell.
In essence, inventory turnover is the number of times a company sells its goods in stock and replaces them in a specific sales period. In essence, inventory turnover is a reflection of how effective a company is in managing costs that relate to its sales efforts. It also reveals whether the sales of a company and purchasing departments are in harmony. Also, it is ideal for inventory to correspond with sales. It is an expensive venture for a company to stick to an inventory that is not selling. Inventory turnover is an indicator of the rate of sales effectiveness and operating costs management. This implies that making use of less inventory for a given amount of sales improves inventory turnover.
The inventory turnover helps investors in determining the level of risk they will face in the course of providing capital for the company.
Inventory turnover ratio
An inventory turnover ratio is a measurement of the effectiveness of a company in terms of generating sales from its inventory. When a company’s inventory turnover ratio is high, the better it becomes for the company. This is because a high inventory ratio implies that a company is selling goods swiftly which is a result of considerable demand for the commodities. On the other hand, a low inventory ratio is an indicator of weaker sales and a falling demand for a company’s goods.
Also, there are times that a high inventory ratio can amount to a loss of sales if the inventory is insufficient to meet rising demands. It is advisable for a company to compare the turnover ratio to the industry benchmark to enable the assessment of whether it is successful in its inventory management or not.
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Inventory turnover formula
The formula for calculating inventory turnover ratio is the cost of goods sold divided by the average inventory for the same period of time thus;
Inventory turnover ratio = Cost of goods sold ÷ Average inventory
Here, the average inventory is very important and vital in the ratio. This is because companies may have higher or lower levels of inventory at specific times of the year. For example, a retailer may have higher inventory in the first quarter and have a lower inventory in the fourth quarter.
Cost of goods sold refers to the measure of a company’s cost of production of goods and services. This includes the cost of materials, direct labor cost, and other factory overhead or fixed costs that directly have to do with the production of goods.
For example, a company’s cost of goods sold is $98, 000, its higher inventory level is $9,550 while its lower inventory level is $7,600. We will first calculate the average inventory.
Average inventory = $9,550 + $7,600 / 2
= $17,150 /2
=$13, 350
Inventory turnover ratio = $98, 000 / $ 13, 350 = 7.34%
C) Portfolio Turnover
We can also use the term for investment. Portfolio turnover refers to the percentage of a portfolio that an organization sells in a particular period of time, say a month or a year. A quick rate of turnover generates more commissions for a broker who carries out the trade. It measures the frequency and speed of the purchases and sales of assets within a fund which the managers undertake in.
To calculate the portfolio turnover, we take either the total amount of new securities purchased or the total amount of securities sold (whichever that is less), then divide it by the total net asset value (NAV) of the fund. Reporting the measurement is usually for twelve months period.
When investors actively manage their portfolios, they should have a higher rate of turnover. On the other hand, investors who passively manage their portfolios tend to have fewer rates of turnover within that specific period of time. Active portfolio management generates more trading costs, in turn, reduces the portfolio’s rate of return. most times, when investment funds have excessive turnover, they tend to be of low quality.
An investor can consider the portfolio turnover measurement before making decisions on the purchase of a given mutual fund or a similar financial instrument. This is because a fund that has a high rate of turnover will incur more costs of transactions than a fund with a lower rate. Except for the superior asset, selection possesses some benefits that compensate for those transaction costs, a trading posture that is less active may generate higher returns funds.
A fund investor who is cost-conscious takes into consideration the transactional brokerage fee costs that are not included in calculating the operating expense ratio of a fund and represent what is likely to be in high turnover portfolios, a significant expense that reduces returns on investment.
Let us look at an example in which a company’s portfolio begins one year at $10,000 and ends the year at $12,000. The total purchases are $1,000 and the total sales $500.
We will first determine the average portfolio, then divide the smaller amount, either the total sales or the total purchases by the average portfolio. Thus;
Average portfolio = $10,000 + $12,000 /2
= $22000 /2
=$11,000
Portfolio turnover = $11,000 / $500 =4.54%.
D) Employee Turnover
Employee turnover means the number of employees that leave an organization in a specific period of time. Talking about the employee turnover rate, it measures the number of employees who leave an organization at a certain period, either monthly, quarterly, or yearly. While an organization evaluates the total number of employees that leave, this is also applicable to the individual departments and subsections within the organization as well as demographic groups.
Employee turnover is divided into two categories;
- Voluntary
- Involuntary
Voluntary
This is a case whereby the employee chooses to leave actively. Employees actually chose to leave as a result of some factors like better job opportunities, disputes at the workplace, disengagement, etc.
Involuntary
This is a case whereby the employer decides to terminate an employee’s appointment in an organization. That is to permanently remove the employee from the organization or a group. This is usually a result of poor performance, toxic behaviors, etc.
It is important to note that in calculating the employee turnover within a single group or department, turnover does not necessarily mean employees who are leaving an organization. It is just a group analysis.
This factor is a natural phenomenon for any firm or organization. Low employee turnover is a goal that most organizations desire to achieve. What determines whether employee turnover is low or high is how one is able to compare the actual turnover to a typical or expected rate. This can vary depending on the type of industry, company size, job type, region, etc. It is rare for the rate to be equal to zero.
Calculating employee turnover
In calculating employee turnover, we pick two major components. The total number of employees that leave and the average number of employees that work within a specific period. This period could be monthly, quarterly, or yearly. Divide the former by the latter and multiply them by 100.
For example, an organization has an average of 140 employees working during a month time. If 26 employees leave, the estimated turnover rate of the organization would be 18.6%.
Therefore, the equation will be;
Turnover rate = (26/140)×100 = 18.57%
In carrying out this calculation, a firm should not include temporary employees/staff who go on temporary leave in either factor of the equation. Including temporary staff will cause the rate to skew higher than the actual rate.
E) Asset turnover (total assets turnover)
Asset turnover is the value of the sales or revenue of a company in relation to the value of its asset. In other words, it is the total sales or revenue with regard to the average assets.
Asset turnover ratio
The asset turnover ratio is the measurement of the value of the sales or revenue of a company in relation to the value of its assets. This ratio indicates how efficiently a company is using its assets to generate revenue.
Then the asset turnover ratio is high, it is an indicator that the company is more efficient in generating revenue from its assets. On the other hand, if a company’s ratio is low in this regard, it is an indicator that the company is not efficient enough in using its assets to generate sales or revenue.
This ratio is important because it helps investors to assess how effective companies are in using their assets to generate sales. Understanding this helps them to determine whether to invest in a company or not. With this ratio, investors are able to compare similar companies in the same sector, group, or industry.
So in essence, large sales of assets are the factors that impact the asset turnover ratio of a company. Also does a significant purchase of assets in a given year. In the assets turnover ratio, the company’s asset value is the denominator in the formula. For a company to determine the value of its assets, it has to first calculate the average value of the assets for the year.
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Asset turnover formula
For you to calculate the asset turnover ratio of your company, you should divide the net sales by the average total assets. The formula is, therefore, is thus;
Asset turnover ratio = Net sales ⁄ average total assets Where;
Net sales = The amount of revenue generated after deducting sales returns, sales discounts, and sales allowances from the gross sales.
Average total assets = The average of the total assets at the end of the fiscal year (current or preceding fiscal year).
In analyzing this ratio, you can either use either the average assets or the end-of-period assets.
For example, a company recorded its beginning total assets as $190,500 while its ending total assets value is $190,203. In that same period of time, the company generated sales of $325,300 and it has sales returns of $15,000.
First, calculate the net sales and the average total assets individually;
Net sales = $325,300 – $15,000
= $310,300
Average total assets = ($190,500 + $190,203) / 2
= $380,703 / 2
= $285,601.5
Now, the actual ratio is;
Asset turnover ratio = $310,300 / $285,601.5
= 1.0865%
Revenues and earnings
Companies use the terms revenues and earnings to describe their financial performance over a specific period of time. In the financial statements of companies, they are the most reviewed figures. It is the figures of these terms that investors use to determine the profitability of a company as well as to evaluate its investment potential.
For investors to effectively evaluate a company’s financial performance, they must take into account both revenue and earnings. However, revenues and earnings seem to be the same but they mean two different things. Let us look at the differences.
Revenue is the amount of money a company generates from its business activities, including sales of goods and services. On the other hand, earnings are the representation of the profits a company gains or earns.
While we calculate earnings by deducting expenses such as interests and taxes from revenue, revenue signifies the income a company generates before deducting expenses.
evenue is regarded as the top-line because it sits at the top of a company’s income statement. It also refersR to the gross sales of a company, though some companies refer to it as their net sales since net sales include all merchandise returns by customers. Earnings on the other hand are the reflection of the bottom line on the income statement. This is the profit a company has earned over a specific period of time. Investors refer to it as the net income or the profit of a company.
Turnover Vs Revenue
Though people use these terms interchangeably depending on the context, they can both mean the same thing in some cases. An instance is where assets and inventory turn over when they flow through a business either through sales of assets or the assets living longer than their useful lives. When these assets generate income through sales, we term them as revenue.
Also, turnover can imply business activities that do not necessarily involve sales such as employee turnover.
Here are few differences;
While revenue is the income a business entity generates by selling its goods or services in the course of its business operations, turnover is the total sales which a business made in a particular period of time, also referring to the company’s gross revenue or income.
Most times, revenue comes as sales on the income statement and it is compulsory for every company to report. On the other hand, turnover is not compulsory to report it adds more understanding to the financial reports. The two terms do not have the same calculation.
The importance of understanding revenue is to help determine a company’s growth and sustainability. Understanding turnover is important because it helps in managing levels of production and ensuring proper asset and inventory management.
Frequently asked questions
What is the turnover of a company?
Turnover of a company is the total sales which a business made in a particular period of time. This also applies to the company’s accounts receivable, portfolio, assets, and employees. See the types of turnover above.
What is an annual turnover?
Annual turnover is the rate at which something changes ownership over a period of one year. To compute the ratio with regard to this, we count the number of times an asset, portfolio, inventory, receivables, or employees change hands over a period of one year.
What does HMRC mean in turnover?
The full meaning of HMRC is Her Majesty’s Revenue and Customs. This is a UK tax authority. It mandates companies to include their turnover in their tax filing as well as collecting tax on the income.