What is turnover?
In accounting, turnover refers to the amount of money a business receives from the sales of goods and/or provision of services over a given period of time.
The period of time could be a quarter, a half-year, or a financial year.
Turnover is sometimes referred to as gross sales. However, many accountants and analysts prefer to consider turnover to be the same as net sales, which is gross sales minus it allowances, returns, and discounts.
Turnover is also applicable in the following aspects of a business:
- Turnover of staff, indicating the proportion of employees leaving a business over a set period of time.
- Turnover of assets, signifying how efficiently a company uses its assets to generate sales.
- Turnover of inventory, showing how many times the inventory of a business is sold, consumed, and replaced during a given period.
Regarding investments, turnover refers to the percentage of an investment portfolio sold during a specific time period.
What is the difference between turnover and profit?
As mentioned, turnover refers to the sales (gross or net) generated by and/or services rendered by a business. Conversely, profit is the amount remaining after the deduction of the cost of goods sold (COGS) and other expenses from net sales.
Put differently, turnover appears at the top of the income statement of a business, while profit is recorded at the bottom of the income statement. Hence, turnover is called the top line of the income statement and profit the bottom line.
The importance of turnover illustrated in accounting ratios
Turnover is an important metric of a business and is used in various accounting ratios to determine the performance of a business in different ways. Accounting ratios such as:
Accounts receivable turnover ratio
The accounts receivable turnover ratio also called the debtors turnover ratio, is an accounting ratio that determines how effectively or quickly a company is collecting revenue related to its credit sales.
Put in other words, the ratio measures how many times a company collects its average accounts receivable over a given financial period, such as a quarter or financial year.
The formula for the accounts receivable turnover ratio:
Accounts receivable turnover ratio = Net credit sales/Average accounts receivable
Where:
- Net credit sales are purchases made by customers who are allowed to pay at a later date for the purchases. Net credit sales are calculated by deducting sales returns, sales allowances, and sales discounts from gross sales on credit.
- Average accounts receivable is the sum of the starting and closing balances of the accounts receivable for a given financial period, divided by 2.
Example of the accounts receivable turnover ratio:
Company Good Luck reported the following figures for the past financial year:
- Gross credit sales: R600 000
- Credit sales allowances: R20 000
- Credit sales returns: R30 000
- Opening balance of accounts receivable: R60 000
- The closing balance of receivables: R75 000
The receivables turnover ratio of company Good Luck is calculated as follows:
- Net credit sales = R600 000 – R20 000 – R30 000
= R550 000
- Average accounts receivable = (R60 000 + R75 000)/2
= R67 500
- Accounts receivable turnover ratio = R550 000/R67 500
= 8.1
Thus, the company Good Luck received its average accounts receivable approximately 8.1 times during the previous financial year.
Accounts receivable turnover in days
This calculation shows the average number of days a customer takes to pay the company Good Luck for credit sales.
The formula for the accounts receivable turnover in days is as follows:
Receivables turnover in days = 365/Accounts receivable turnover ratio
= 365/8.1
= 45.1
Hence, it takes the average customer approximately 45 days to pay for goods purchased on credit. If the company Good Luck has a credit policy that allows debtors 30 days to pay their accounts, the calculation above indicates that the average debtor makes late payments.
Inventory turnover ratio
The inventory turnover ratio, also called sales turnover, measures the rate at which inventory is sold and replaced by a company during a given financial period.
The formula for the inventory turnover ratio is as follows:
Inventory turnover ratio = COGS/Average amount of inventory
Where:
- COGS = Cost of goods sold
- The average amount of inventory = (Opening inventory + Closing inventory)/2
A high ratio can either be an indication of strong sales or insufficient inventory.
Conversely, a low ratio means weak sales and/or too much inventory, referred to as overstocking.
Asset turnover ratio
The asset turnover ratio also referred to as the total asset turnover ratio calculates how efficiently a company uses its assets to generate sales.
Put differently, the ratio indicates the revenue generated by a company per one South African rand (ZAR) (or whichever currency is applicable) of assets.
The formula for the ratio is:
Asset turnover ratio = Net sales/Average total assets
Where:
- Net sales = Gross sales less sales returns, sales allowances, and sales discounts.
- Average total assets = (Assets at beginning and closing of the financial period)/2. Many analysts use the closing amount of assets instead of the average total assets.
A high asset turnover ratio shows that a company utilises its assets efficiently to generate revenue (sales). Contrarily, a low ratio signals that a company is inefficient in the way it uses its assets.
Staff turnover
In the business world, staff turnover (also called employee turnover or labour turnover) enables a business to determine how effectively it manages its employees.
Staff turnover refers to the number of employees who leave a business over a given period of time, expressed as a percentage of the total number of employees of the business.
For example, if a business has a total number of 250 employees working during a calendar year and 75 employees leave, the employee turnover rate would be 30 percent ((250/75) x 100).
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