What Is Turnover in Business and Its Importance

So, What Is a Turnover?

The term "turnover" reflects a business's efficiency. It refers to the speed at which a company swaps out its assets during a specific timeframe. This can involve selling off inventory, gathering payments owed, or bringing in new employees. It can also indicate the portion of an investment portfolio that changes.

Similarly, "turnover ratio" refers explicitly to a calculated metric that quantifies the rate at which something is replaced or converted within a certain period. 

There are several types of turnover ratios, each offering a unique perspective on different aspects of your company's operations. Here are some examples. 

1. Accounts receivable turnover: This ratio indicates how efficiently your company collects customer payments.
2. Working capital turnover: This ratio assesses how effectively your company uses its working capital to generate sales.
3. Inventory turnover: This ratio reflects how quickly your company sells its inventory and replenishes it.
4. Portfolio turnover: This ratio is relevant for investment firms and measures the frequency with which assets within an investment portfolio are bought and sold.

By examining different turnover ratios, you can gain a comprehensive understanding of your company's operational efficiency.

Now, what makes a turnover ratio "good" or "bad" depends on the specific context. For example, a low accounts receivable turnover ratio may signal issues with payment collection processes or credit policies. Conversely, a high inventory turnover ratio for a retailer suggests strong sales performance.

In essence, analysing turnover ratios and calculating turnover enables you to identify areas for improvement and make informed decisions to optimise your operations and financial performance.

Understanding Business Turnover

It's crucial to note that annual turnover is not the same as annual profit. So, before determining your profit, you need to subtract these costs from your turnover. This process gives you a clearer picture of your business's financial health and true profitability.

However, you might encounter a term called "net turnover." This can be confusing because it sounds similar to profit. In reality, net turnover refers to revenue after deducting any returns or allowances, but it still doesn't account for all expenses like profit does.

To keep things clear and avoid confusion, it's best to think of annual turnover simply as revenue – the total amount of money coming into your business that year from sales before any deductions. This distinction ensures you understand your financial performance accurately and can make informed decisions to grow your business effectively. Focusing on improving turnover can lead to generating more revenue for the business, enhancing its overall profitability.

What Is Not Included in Turnover?

Turnover strictly encompasses the revenue generated from your regular sales activities, excluding sales tax since it is technically not considered part of the business's revenue. This means it does not include money from additional income sources such as interest earned on savings, profits from subletting property or equipment (unless your business focuses explicitly on rentals), proceeds from selling business assets like vehicles, tools, or property, as well as any capital injections from investors or lenders.

Understanding what turnover includes and excludes allows you, as a business owner, to gauge your revenue sources and make well-informed financial choices accurately.

Now that you know the meaning of the word turnover, let’s look at the different types of turnover for businesses. 

What Are the Different Types of Turnover for Business?

1. Inventory Turnover: 

This metric shows how quickly you sell and replace your inventory. 

To calculate it, divide the cost of goods sold (COGS) by the average inventory value. 

A high inventory turnover indicates efficient inventory management, while a low inventory turnover suggests excess stock. It's crucial because it helps you optimise inventory levels, improve cash flow, and identify sales trends.

Suppose at the beginning of the month, you had S$2,000 worth of fruits in stock at your grocery store. By the end of the month, you've sold all the fruits and restocked another S$2,000 worth. 

The cost of goods sold (COGS) for the month was S$10,000. 

To calculate inventory turnover, divide COGS by the average inventory value

= S$10,000/[(S$2,000+ S$2,000) / 2]

= S$10,000/S$2,000 = 5. 

This means you sold and replaced your fruit stock 5 times during the month. Understanding both turnover and inventory turnover is essential for a complete analysis of a company's financial health.

2. Working Capital Turnover: 

It is a metric that reflects how efficiently you're using the funds available for your day-to-day operations to generate sales revenue. 

To calculate it, you divide your total sales revenue (net sales) by the average amount of working capital you have during a specific period.

Suppose your company's working capital is S$30,000 at the beginning of the year and S$40,000 at the end. During the year, your total sales were S$200,000. 

So, working capital turnover = S$200,000/[(S$30,000+S$40,000)/2]

= S$200,000 / S$35,000 = 5.71. 

This means you generated S$5.71 in sales for every dollar of working capital invested.

3. Accounts Receivable Turnover: 

This measures how effectively you collect customer payments. 

To calculate accounts receivable turnover, divide total credit sales by the average accounts receivable balance. 

A high turnover ratio indicates prompt customer payment, while a low ratio may signal issues with collections. The ratio is important because it reflects your cash flow efficiency and helps you manage credit policies and collections effectively.

Let's say you provide IT services. In January, you billed clients a total of S$8,000. By the end of February, you collected S$6,000 of that amount. 

If your average accounts receivable balance for January and February was S$4,000, your turnover would be S$8,000/S$4,000 = 2. 

This means you collected payments twice on average during the period.

4. Asset Turnover: 

This ratio assesses how well you use your assets to generate revenue. 

It's calculated by dividing total revenue by average total assets. 

A higher ratio suggests better asset utilisation and operational efficiency. Understanding asset turnover helps you evaluate the effectiveness of your investments and allocate resources wisely.

For example, you own a retail store with total assets (including inventory and equipment) valued at S$50,000. 

If your store generates S$100,000 in revenue, your asset turnover ratio would be 

= S$100,000/S$50,000 = 2. 

This means you're generating S$2 in revenue for every dollar of assets invested.

5. Employee Turnover: 

This estimates the rate at which employees leave and are replaced within your company. 

To calculate it, divide the number of employees who left by the average number of total employees, then multiply by 100 to get a percentage. 

High employee turnover can indicate dissatisfaction or turnover costs, while low employee turnover suggests a stable workforce. It's essential because it impacts morale, productivity, and overall business performance.

Suppose your company has 50 employees at the beginning of the year and 10 employees leave during the year. 

Your employee turnover rate would be (10/50)*100 = 20%. 

This means 20% of your workforce left and must be replaced during the year.

6. Portfolio Turnover: 

For investors, this ratio shows how frequently assets within an investment portfolio are bought and sold. 

It's calculated by dividing the total value of assets bought or sold by the average value of assets held during the period. 

High turnover can increase transaction costs and tax implications, while low turnover may reduce investment risks. It's important because it reflects investment strategy and performance.

Let's say you start with a portfolio valued at S$100,000. 

Throughout the year, you buy and sell securities totalling S$50,000. 

The turnover ratio is approximately 45.45%.

7. Revenue Turnover: 

This metric reveals how quickly your total revenue changes over time. 

It's calculated by dividing the total revenue for a period by the total revenue for the previous period, then multiplying by 100 to get a percent change. 

Monitoring revenue turnover helps you assess business growth, market demand, and financial stability.

Assume your retail store's revenue was S$200,000 in the first quarter and S$250,000 by the fourth quarter. 

The revenue turnover ratio is 1.25, reflecting a 25% increase in revenue over the period.

How to Calculate Turnover for Businesses?

As we know, the term 'turnover' extends its application far beyond just financial metrics, touching various aspects of business operations. It encompasses financial turnover, indicating the volume of business conducted within a specific period, employee turnover, which reflects the rate at which employees leave a company, and inventory turnover, showing how quickly inventory is sold and replaced. Understanding the multifaceted nature of turnover is crucial for businesses aiming to optimize their performance across all these dimensions.

Because there are different types of turnover, the way you calculate it changes depending on which one you're looking at. But overall, to figure out turnover, it's essential to identify its components and then use the correct method for the type you're dealing with.

Let's look at an example of working capital turnover. 

Components:

1. Determine your working capital, which is the difference between current assets and current liabilities.
2. Gather the necessary financial information from your company's balance sheet or financial statements. Let's consider the following hypothetical figures for a Singaporean business:
   • Current Assets: S$500,000
   • Current Liabilities: S$200,000

Calculation

Calculate Working Capital: Subtract the current liabilities from the current assets: 

Working Capital = Current Assets − Current Liabilities

Working Capital = S$500,000 − S$200,000

Working Capital = S$300,000

Calculate Revenue: Obtain the total revenue generated by the business over a specific period. 

Let's assume the total revenue for the same period is S$2,000,000.

Calculate Average Capital: 

Average Working Capital = (Beginning Working Capital + Ending Working Capital​)/2 

Average Working Capital= (S$300,000+S$300,000)/2

Average Working Capital= S$300,000

Calculate Working Capital Turnover: Use the following formula to calculate the Working Capital Turnover ratio:

Working Capital Turnover = Revenue​/Average Working Capital

Working Capital Turnover = S$2,000,000/S$300,000

Working Capital Turnover = 6.67

The Working Capital Turnover ratio of 6.67 indicates that the business generates S$6.67 in revenue for every S$1 of working capital invested.

Understanding Key Financial Metrics: Comparing Turnover, Revenue, and Profit

Now that you know what's turnover vs revenue vs profit, you can explore their importance for your business. By grasping these concepts, you can make better decisions to improve your business's performance and long-term success.

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