What Is Turnover?
By Indeed Editorial Team
Updated February 22, 2021 | Published April 17, 2020
Updated February 22, 2021
Published April 17, 2020
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 an important measure of a company's performance. It is used at every stage of a company's life, from attracting investors to selling the business. When a business is able to manage its turnover, it can run efficiently and cost-effectively. In this article, we define turnover, explain how to determine a company's turnover and discuss how turnover differs from profit.
What is turnover?
Turnover is the amount of net sales a business generates within a certain period of time. Net sales, as opposed to gross sales, refers to the amount made by the business after deducting for returns, discounts and other allowances. If your company had no deductions from sales, your gross and net sales figures would be the same. Gross sales indicates the value of the business brought in over a given period, whereas net sales indicates the actual amount of money those sales produced.
Turnover can also be defined for a few other situations, including the following:
Accounts receivable turnover: This turnover number shows a business how efficiently it collects debts relative to the amount of credit extended. If the number is low, this means the company's debtors are repaying their debt, which is good for revenue.
Inventory turnover: The inventory turnover calculation indicates how often a business needs to restock inventory. This is useful for budgeting and helps the business determine how well stock is selling. The goal is to sell as much inventory as possible and prevent it from taking up space on shelves or in the warehouse for too long.
Asset turnover: A company's asset turnover is similar to its inventory turnover but accounts for all of the company's assets rather than just its merchandise. It helps the business and investors see how well the company is using its assets to create revenue.
Related: How To Calculate ROA
What is the difference between turnover and profit?
While turnover refers to net sales over a period of time, profit generally refers to the amount a business earns after deducting major expenses. The type of profit you want to calculate depends on the major expenses you deduct.
Gross profit: To determine the gross profit, deduct the expenses that go into creating your goods and services.
Operating profit: Deduct items like rent and utilities to find this type of profit.
Net profit: For this type, you subtract taxes, administration costs and any interest payments your company made on loans.
Normally, a business calculates profit by deducting costs from net sales. On a company's income statement, you normally see the net sales listed on the top, followed by the various deductions ending with the net profit at the bottom.
Related: What To Know About Income Statements
Importance of turnover in business
Each definition of turnover is important to a business for a number of reasons, including:
Evaluating how well the business is performing
Determining what changes need to be made to improve business performance
Budgeting for future business expansion
Each of these involves additional expenses that would have to be added to the company's budget. The company would also need to budget for the cost of interviewing and hiring new employees to fill vacated positions.
It's also important for a company to keep track of inventory turnover businesses often invest a lot of money in inventory. If inventory sells rapidly, it is important they are able to quickly replenish that inventory. However, if inventory does not sell, this can be a significant financial loss to the business, especially if the inventory becomes obsolete or deteriorates. Knowing the business's inventory turnover can help the accounting department budget appropriately from year to year.
Since accountants calculate the company's gross profit from the net sales, knowing this amount is important for both creating a company budget and providing accurate financial reports. Knowing how the company's turnover compares to its profit is also important for setting and achieving profit goals. If the business needs to increase its gross profit, it could take steps to reduce sales costs, such as by renegotiating supplier contracts. To increase net profit, management could look for ways to make the business more efficient, such as cutting administrative costs.
Related: What Is Inventory Turnover?
How to calculate turnover
There are different ways to calculate various types of turnover. Use these approaches for different turnover types:
To calculate turnover, complete the following steps:
Decide the time period you wish to use for your calculation.
Determine your gross sales over that time.
Deduct discounts, allowances and return.
Use this formula to calculate general turnover:
[Gross sales] - [allowances] - [return] = turnover
Over the past year, a company's gross sales came to $1,000,000, discounts were $20,000, allowances were $30,000 and returns were $50,000. The turnover, or net sales, would be as follows:
$1,000,000 - $20,000 - $30,000 - $50,000 = $900,000
If you want to calculate inventory turnover, first select an appropriate time period. For most businesses, this is a year. However, for seasonal businesses, or businesses with perishable inventory such as restaurants, that time frame may be shorter. Once you've chosen the time period, complete the following steps:
Deduct your end-of-year inventory from your start-of-year inventory, and add that result to your inventory expenses for the year. This gives you the cost of goods sold (COGS).
Add your starting and ending inventories together, then divide by two to get an average inventory.
Calculate your inventory turnover rate by dividing the cost of goods sold by the average inventory.
This gives you the following formula:
([Starting inventory] - [Ending inventory]) + Yearly expenses = COGS
(Starting inventory] + [Ending inventory]) / 2 = Average inventory
[COGS] / [Average inventory] = Inventory turnover rate
For example, if your COGS last year was $100,000 and your average inventory was $50,000, your inventory turnover is as follows:
100,000/50,000 = 2
This means in a year, you replace your inventory twice. Knowing this helps you manage your inventory efficiently and budget appropriately for the following year.
Accounts receivable turnover
Follow these steps to calculate accounts receivable turnover:
Select an appropriate time period, perhaps a month or a year.
Add the beginning and ending accounts receivable totals together.
Divide this amount by two to find the average accounts receivable.
Divide the average accounts receivable into the net credit sales to get your accounts receivable turnover.
The accounts receivable formula is as follows:
[Starting accounts receivable total] + [Ending accounts receivable total] / 2 = Average accounts receivable
[Average accounts receivable] / [Net credit sales] = Accounts receivable turnover
For example, at the start of a given month, the accounts receivable total was $115,000, and at the end of that month, it was $270,000. The net credit sales for the month was $900,000. The calculation is as follows:
($115,000 + $270,000) / 2 = $192,500
$900,000 / $192,500 = ~4.7
The company can compare this number to previous months to see how well they are managing debt collection.
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