What Is Turnover And Why Is It Important In Business?
By Indeed Editorial Team
Published 4 May 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Turnover is a metric that is used to measure the profitability and performance of a business. Inventors, clients and stakeholders refer to the turnover rate of a company to assess its financial health and effectiveness in generating profits. Learning about the different types of turnover can help you identify how to use these rates to improve a business's performance. In this article, we discuss what turnover is, explore the different types of turnover, understand the difference between turnover and profit and learn about the importance of turnover in business.
What is turnover?
"What is turnover?" is a common question, as there are different types of turnover in business. Also known as gross sales or income, it is the total amount of sales that a business generates in an accounting period. It is the sum of the overall earnings of a business before you deduct any expenses.
Often, people confuse turnover with profit, but they are essentially the top-line revenue and the bottom-line results. While turnover is the total sales of a business, profit is the total money that stays with the business after deducting major expenses, such as cost of goods sold, operating expenses and taxes. Since turnover is the net sales before any deductions, companies record them at the top of their income statements.
Different types of turnover in business
Apart from accounting turnover, there are other types of turnover that explain different situations in a business. Here are the different types of turnovers:
Accounts receivable turnover
Accounts receivable turnover refers to the effectiveness with which a business is able to collect the debt that it extends to customers and other businesses through credit sales. This figure refers to the time it takes businesses to manage their account receivables in a given accounting period. Businesses aim for high numbers as it indicates a greater ability to collect the debt. In balance sheets, businesses record accounts receivable under current assets. You can calculate accounts receivable turnover by dividing the net credit sales by the average accounts receivable.
Example: The net credit sales of a company for a year are ₹50,00,000 and the average accounts receivable for the same period is ₹37,50,000. By dividing the net credit sales by accounts receivable, the turnover is 1.33. This number indicates the number of times or the efficiency with which you are able to collect the money. You can calculate the average accounts receivable by dividing the sum of the opening and closing accounts receivables by two.
Accounts payable turnover
Accounts payable turnover is used to measure the ability of a business to pay its debts to vendors. It is a liquidity ratio that measures the number of times a company repays the money that it owes over an accounting period. In balance sheets, businesses record accounts payable under current assets. A high accounts payable turnover ratio shows that the company pays its debts quickly and can be a good measure of its creditworthiness. You can calculate accounts payable turnover by dividing the total purchases by the average accounts payable.
Example: Company ABC purchased raw materials worth ₹10,00,000 this year and their average accounts receivable is ₹4,10,000. Then, by dividing the total purchases by the average accounts receivable, their accounts payable turnover ratio is 2.43. Investors and other stakeholders may consider this number low while evaluating the liquidity and creditworthiness of the company.
Inventory turnover, also known as stock turnover, is used to measure the rate at which businesses sell inventory, replace or sell it. It shows the efficiency at which businesses manage their inventory levels according to the number of sales. A high inventory turnover ratio indicates high sales volumes and may also indicate optimal use of inventory. You can calculate inventory turnover by dividing the total cost of goods sold by the average inventory.
Example: The cost of goods sold by a company last year was ₹3,00,000 and their average inventory value was ₹60,000. According to the formula, the inventory turnover ratio is five. While a higher ratio indicates that they are converting their inventory into sales quickly, a number between two and four is also desirable. Ratios below two indicate that the investment in inventory in much more than the yearly sales cycle.
Capital employed turnover
Capital employed turnover is a profitability ratio that refers to the efficiency with which businesses generate sales by using the capital employed in the business. A high capital employed turnover ratio shows the ability of a business to utilise the assets and the investments made in a business for growth and sales. You can calculate it by dividing the total sales generated by the average amount of capital employed in the business.
Example: The sales last year were ₹140,00,000 and the average amount of capital was ₹70,00,000. According to the formula, the capital employed turnover is 2. This means that every rupee invested in the working capital produces ₹2 in revenue. You can calculate the average capital employed by calculating the sum of the capital employed at the beginning and end of the year and dividing it by two.
Working capital turnover
Working capital turnover is the efficiency with which businesses are able to generate sales in relation to the working capital put in the business. It is a profitability ratio and shows that the company is able to generate large volumes of sales. You can calculate working capital turnover by dividing the total sales generated in an accounting period by the working capital put in the business. You can calculate working capital by subtracting the current liabilities from current assets.
Example: The total sales of company XYZ were ₹120,00,000 in the last year and their working capital was ₹60,00,000. Then, by applying the formula, the working capital turnover ratio is 2. This means that every rupee of working capital generates ₹2 for the business.
Employee turnover rate is used to measure the rate at which employees have left an organisation in a given period. It includes voluntary turnover and involuntary turnover. You can calculate the employee turnover ratio by dividing the total number of employees that left the company in a given period by the average number of employees in the firm. This ratio is expressed as a percentage. Companies try to keep their turnover ratio low, as it is an indication of the work culture and the existence of underlying issues within the organisation.
Example: At the beginning of the year, a company had 400 employees and by the end they had 350. 100 employees left the company that year and 50 new employees joined. The average number of employees that year was 375. Therefore, according to the formula, the employee turnover ratio was approximately 27%.
Difference between turnover and profit
While some people confuse turnover with profit and use the terms interchangeably, there is a lot of difference between them. Turnover is the net sales that a business generates, while profit is the residual earnings of the business after deducting all the major expenses from the net sales. Just as there are different types of turnover, there are different types of profit. The three main types of profit are as follows:
Gross profit is the total income that remains after you deduct the cost of manufacturing and selling goods from the total revenue.
Operating profit is the income that remains after deducting all operating expenses except taxes and interest on any debt.
Net profit is the residual income left after deducting all the expenses, including taxes and interest from the total revenue.
What is the importance of turnover in business?
Since there are different types of turnover, analysing each turnover ratio can tell you about the overall health of a business. Primarily, it refers to the profitability of a business by calculating the total sales generated. It is then used to determine the creditworthiness of a business and the effectiveness with which it is able to collect debts. You can compare a business' turnover across different time periods and understand its pattern of growth. Different turnover ratios can also highlight the areas that need improvements, such as inventory turnover or employee turnover.
High employee turnover is an indication for employers to identify the common underlying causes of employee resignation. Similarly, low inventory turnover may be an indication of excess inventory or low sales volumes. Knowing turnover is also important for businesses because it is used to calculate the gross and net profits of a business. If the net sales are high but the net profit is low, it indicates that the expenses are on a higher side and the business can look for ways to reduce costs, such as operational costs, administrative costs and other miscellaneous costs.
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