What is turnover? A clear guide for Hong Kong entrepreneurs

What is turnover in business?

In its simplest form, business turnover refers to the total revenue or net sales generated by a company from its primary business activities over a specific period. This period is typically a financial quarter or a full fiscal year.

In the UK, turnover is often referred to as gross income from sales before expenses. It’s the top-line figure on an income statement, representing the total amount of money brought in from selling goods or services before any expenses are deducted. For example, if a retail store sells HK$500,000 worth of products in a year, its annual turnover is HK$500,000.

Turnover is calculated based on all the money received from core business activities, such as goods and services sold, during a certain period, such as a financial year. Sales revenue is the total value generated from the company's operations, and total turnover is the aggregate of all sales before deductions.

When calculating turnover, it's important to only include money received from the sale of products and services that are part of the company's core business activities, and to avoid including income from other sources. Common mistakes that confuse turnover with other metrics can lead to errors in financial reporting and compliance issues.

Understanding turnover is critical for several reasons:

• Performance Measurement: It’s a primary indicator of your business’s sales performance. A rising turnover suggests growing demand and market presence, while a declining turnover can signal potential issues.
• Financial Health Assessment: While not the same as profit, turnover provides a snapshot of the scale of a company’s operations. Investors, lenders, and stakeholders look at this figure to gauge the size and sales vitality of the business.
• Tax Obligations: In many jurisdictions, turnover is used to calculate taxes, such as Value Added Tax (VAT) or Goods and Services Tax (GST). Accurate reporting is therefore a legal requirement.
• Strategic Planning: Analysing turnover trends helps business owners make informed decisions about pricing, marketing strategies, product development, and expansion plans.
• Business Comparison: Turnover is used to measure total income and total business income, which is important for comparing business performance across different companies or periods.

Accurate reporting of the company's turnover is essential for compliance with the tax office, as errors or misreporting can result in penalties or fines.

It’s also important to distinguish between gross turnover (the total sales figure, including things like sales tax) and net turnover (total sales minus returns, allowances, and sales discounts).

Gross turnover refers to total sales revenue before any deductions. Sometimes, it is reported as total sales before returns or discounts, but it usually excludes VAT/GST since these are passed to tax authorities.

For financial analysis, net turnover is the more accurate and commonly used figure. After determining net turnover, gross profit is calculated by subtracting direct costs from turnover, and net profit is the final earnings after all expenses, including operating expenses and other expenses, are deducted.

When calculating turnover, ensure you only include money received from core business activities and avoid including non-operational income or double-counting services sold. Calculating turnover accurately is crucial, as including non-core activities or making other errors can distort your financial picture and affect compliance.

What is a turnover ratio, and why is it important?

While the turnover figure itself tells you the scale of your sales, it doesn’t tell you how efficiently you achieved them. This is where turnover ratios come in. Turnover ratios are key indicators of business performance and help evaluate a business's performance over time.

A turnover ratio, also known as a turnover rate, is a financial metric that measures how efficiently your company is using your assets to generate revenue. In essence, it shows how many times your company “turns over” its assets (like inventory or receivables) into sales during a given period.

The general principle behind most turnover ratios is:

• Turnover Ratio = Sales / Average Assets

These ratios are profoundly important because they provide deep insights into your operational efficiency. A higher turnover ratio generally signifies greater efficiency, meaning your company is generating more revenue for every dollar of assets it employs. Conversely, a low turnover ratio might indicate poor management, underutilisation of assets, or issues with sales and marketing.

By tracking turnover ratios, you can:

• Benchmark Performance: Compare their efficiency against industry averages and direct competitors.
• Identify Inefficiencies: Pinpoint specific areas of the business—such as inventory management or credit collection—that are underperforming.
• Improve Cash Flow: Optimise the conversion of assets into cash, which is vital for liquidity and daily operations.
• Make Data-Driven Decisions: Use concrete data to justify changes in strategy, such as liquidating slow-moving stock or tightening credit policies.
• Monitor Turnover Increases: Recognise when turnover increases, which can signal improved business performance and operational success.

Types of other turnover ratios in business

Several key turnover ratios offer a panoramic view of your company's operational health. Each one focuses on a different category of assets, providing a unique piece of the efficiency puzzle.

Accounts Receivable Turnover

The accounts receivable (AR) turnover ratio measures how effectively your company collects the money owed to it by customers. It indicates the number of times per period that you collect your average accounts receivable.

Formula: Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable

• Net Credit Sales: Total sales made on credit, excluding cash sales and returns.
• Average Accounts Receivable: The sum of the beginning and ending accounts receivable balances for a particular period, such as a month or year, divided by two.

Interpretation:

A high AR turnover ratio is desirable. It suggests that your company has an efficient credit and collection process and that your customers are paying their debts quickly. This ratio shows how efficiently you collect payments from your customers, leading to better cash flow and reducing the risk of bad debt.

A low AR turnover ratio can be a red flag. It may indicate that your company's credit policies are too lenient, its collection process is ineffective, or that it's extending credit to non-creditworthy customers.

A related metric, Days Sales Outstanding (DSO), translates this ratio into the average number of days it takes to collect payment after a sale. DSO = 365 / AR Turnover Ratio.

Sales turnover

While “sales turnover” is often used interchangeably with the total revenue figure itself, in the context of analysis, it's the foundational metric against which asset efficiency is measured. It’s the numerator in many key ratios and represents the total value generated from operations.

Sales turnover includes the value of both products and services sold, so it reflects not just the quantity of goods but also the services you sold. When business owners say they want to “increase turnover,” they're referring to boosting this core revenue number.

Inventory Turnover

The inventory turnover ratio is a critical metric, especially for retail, wholesale, and manufacturing businesses. It measures how many times a company’s inventory is sold and replaced over a specific period.

Formula: Inventory Turnover = Cost of Goods Sold (COGS) / Average Inventory

• COGS: The direct costs of producing the goods sold by a company. This includes materials and direct labour.
• Average Inventory: The sum of the beginning and ending inventory balances for the period, divided by two.

Interpretation:

A high inventory turnover ratio generally indicates strong sales or efficient inventory management. It means your company sells its inventory quickly, which is a sign of operational efficiency. Your company isn't tying up excess cash in stock that isn’t selling. However, a ratio that is too high might signal a risk of stockouts, potentially leading to lost sales.

A low inventory turnover ratio suggests weak sales, overstocking, or obsolete inventory. This can lead to increased holding costs (storage, insurance) and tie up cash that could be used elsewhere in the business.

The Days in Inventory (DII) metric shows the average number of days it takes to sell the entire inventory. DII = 365 / Inventory Turnover Ratio.

Asset turnover

The total asset turnover ratio provides a big-picture view of efficiency. It measures how well your company uses its entire asset base—including cash, equipment, property, and more—to generate sales.

Formula: Asset Turnover Ratio = Net Sales / Average Total Assets

• Net Sales: The total revenue figure from the income statement.
• Average Total Assets: The sum of the beginning and ending total asset balances for the period, divided by two.

Interpretation:

A higher asset turnover ratio is more favourable, as it implies the company is efficient at generating revenue from its assets. A company with a ratio of 2.0 generates HK$2 in sales for every HK$1 of assets.

This ratio is highly industry-dependent. A software company with few physical assets will naturally have a much higher ratio than a capital-intensive manufacturing firm. Therefore, it's most useful for comparing companies within the same sector.

Working capital turnover

The working capital turnover ratio measures how effectively your company uses its working capital to support sales and growth. Working capital is the difference between current assets and current liabilities, representing the liquidity available for day-to-day operations.

Formula: Working Capital Turnover = Net Sales / Average Working Capital

• Average Working Capital: (Beginning Working Capital + Ending Working Capital) / 2.

Interpretation:

A high working capital turnover ratio shows that a company is using its short-term assets and liabilities efficiently to generate sales. It means the company needs less money tied up in working capital to produce a given level of revenue.

A very low ratio could indicate that the business is investing too much in accounts receivable and inventory, potentially leading to bad debts and obsolete stock. If the ratio is negative (current liabilities exceed current assets), it could be a sign of serious short-term financial distress.

To make you better understand these ratios, you can take a look at the comparison table below:

Which is the most important turnover ratio?

There is no single "most important" turnover ratio. The relevance of each ratio depends heavily on the industry, the company's business model, and the specific goals of the analysis.

• For a retail or e-commerce business, inventory turnover is arguably the most critical. Managing stock efficiently is the lifeblood of the business.
• For a consulting firm or a service-based business with no physical inventory, accounts receivable turnover takes centre stage. Efficiently collecting payments for services rendered is paramount.
• For a heavy manufacturing or utility company, asset turnover is extremely important, as it shows how well they are utilising their massive investment in machinery and infrastructure.

The most powerful analysis comes not from looking at one ratio in isolation, but from examining them together. A holistic view provides a comprehensive picture of a company's operational strengths and weaknesses.

Turnover vs revenue: Are they the same?

The terms “turnover” and “revenue” often cause confusion, and their interchangeability depends on context and geography. As an entrepreneur, you need to understand the key differences between turnover and revenue, as they help clarify how each metric reflects business performance and informs better financial decisions.

In the UK, Australia, and many other Commonwealth countries, turnover is used synonymously with revenue. It refers to the net sales figure at the top of the income statement, and terms like gross revenue and total income are often used interchangeably with turnover in these regions.

In the US, revenue is the more common term for this top-line figure. The word “turnover” is more frequently used in the context of ratios (e.g., “inventory turnover”) to describe the rate at which an asset is converted to cash or sales. Additionally, gross turnover refers to the total sales revenue before any deductions such as taxes, discounts, or returns.

So, are they the same?

• When referring to the total sales value: Yes, in many regions, turnover and revenue mean the same thing.
• When used in a ratio: No, here “turnover” refers to the rate of conversion, not the total dollar amount.

The most crucial distinction to make is between turnover/revenue and profit. Turnover is the total amount of money a business brings in from sales. Total turnover is the sum of all sales before any deductions, representing the aggregate gross sales figure. Profit (or net income) is the amount of money left after all expenses—including COGS, operating costs, interest, and taxes—have been deducted from turnover.

Understanding these figures is crucial for measuring financial success, as both turnover and profit margins are key indicators of a business's overall health and attractiveness to investors. A company can have a very high turnover but be unprofitable if its expenses are too high.

Streamline your cash flow management with Aspire

Effectively managing your turnover and the underlying operational efficiencies it represents is fundamental to maintaining healthy cash flow. When you can collect receivables faster (improving AR turnover) and sell inventory more quickly (improving inventory turnover), you accelerate the conversion of your assets into cash. This cash is the fuel that powers your daily operations, from paying suppliers and employees to investing in growth.

However, manually tracking sales, recording turnover, and calculating turnover ratios can be time-consuming and prone to error. This is where Aspire can help.

With Aspire’s Business Accounts, you can manage your receivables more efficiently. Create and send invoices to your clients with just a few clicks, and view the status of all your receivables on a single dashboard. To ensure timely payments, you can also set up automatic reminders for clients, helping you maintain consistent cash inflows.

On the cash outflow side, Aspire’s Expense Management solution provides real-time tracking, control, and monitoring of all spending, ensuring that your expenses always align with your budget.

To further streamline expense management, you can equip your team with Aspire’s unlimited Corporate Cards. Set spending limits and assign each card to specific merchants or projects, allowing your team to make purchases quickly without losing control over expenses.