What is Turnover? Definitions, Examples and Practical Business Advice
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Turnover is a vital part of running a business. It's one of the most significant aspects that business owners should focus on when attempting to boost their profits and increase their business prosperity.
This article will look at the importance of turnover and explain how to use your turnover to plan for the future and increase your business success.
What is turnover?
Turnover defines the net sales that a business generates, usually within a tax year.
Net sales are the amount of money that a company has earned in a specific period minus deductions such as discounts and returns. They differ from gross sales, which are the total amount of money that a company has made over a period.
Types of turnover
There are a few specific types of turnover.
Accounts receivable turnover demonstrates how a business collects debts.
Inventory turnover illustrates how frequently a business restocks its inventory, which helps to set budgets for stock and discern which stock should be repurchased. The goal with inventories is to sell stock as much as possible and inventory turnovers can help to assess how close you are to this goal.
Asset turnover is helpful for companies who don't sell stock or who have other income streams. It evaluates the assets of a company.
What is the difference between turnover and profit?
Turnover and profit are both commonly used to assess the financial success of a business. While turnover refers to the net sales - all transactions that go into the business - profit takes away the fees that go into running a business.
These fees can include things like:
Payment for staff and freelancers.
Manufacturing costs of products or other charges for the creation of goods and services.
Rent of office or warehouse space.
There are several types of profit depending on which of these items you deduct from your overall turnover amount:
Gross profit is the amount of money after you take away the costs of creating your goods and services. For example, manufacturing costs would come under this bracket.
Operating profit is the amount of money you have from the gross profit after taking away the cost of rent and utilities.
Net profit is the amount of operating profit after administration costs, taxes, interest payments, etc.
On an income statement, you will see the net sales at the top and then deductions as you go through the various types of profits. At the bottom will be the net profit - this is the final amount that your business earned during a specific period.
It is vital to keep track of all of your profits for tax reasons. You can also use your records to look for ways in which you can cut back and subsequently boost profits. For example, you may realise that your operating profit is lower than expected. This could indicate that you are spending too much on utilities and should find ways to cut back.
Importance of turnover in business
Evaluating different types of turnovers is imperative to improving your business. By looking at your turnover, you can:
Assess how well your business is performing. You will be able to accurately consider what is selling, look at any seasonal trends and be honest about your failures as a business. Looking at your company objectively is essential to help you work out ways to improve in the future.
Analyse whether certain deals or promotions worked. You may recognise that a Christmas sale actually caused your business to make a loss. Therefore, you should think carefully about any future deals.
Look at whether you can budget for expansion or improvements to your business. You might want to hire new staff or rent out a new building for your business operations. By looking at your turnover and profits in detail, you will be able to assess whether you can afford this.
The importance of inventory turnover
If you run a business that involves selling stock, knowing your inventory turnover is essential. If your inventory sells quickly, you should have the funds available to restock and continue trading. This avoids disappointing customers and ensures that they don't turn to alternatives from your competitors.
However, if your inventory does not sell quickly - or at all - you are at risk of losing out financially. If you discover this in your inventory turnover, you will know that you need to either change your stock or your marketing methods.
How to calculate your turnover
There are a few ways to calculate your turnover depending on which type of turnover you are focusing on.
Follow this guide to work out your general turnover.
Decide on the time span for your turnover. Most turnover calculations are for a business year but if you want to be more specific, you could review turnover calculations for a month.
Using your records, work out your gross sales over a specified period.
From this sum, take away any discounts, returns and allowances.
You can use this formula to calculate general turnover: [gross sales] - [allowances] - [return] = turnover.
For example, if your gross sales were $700,000, your discounts came to $15,000, your allowances were $17,000 and your returns were $30,000, your equation would look like this:
700000 - 15000 - 17000 - 30000 = 638000
Therefore, your general turnover would be $638,000.
If you want to calculate your inventory turnover, you should first find the most suitable period for your company. Generally, business owners work out their inventory turnover annually. However, some businesses are more suited to other time-frames.
If your business is seasonal, your inventory turnover should be specific to that period. For example, if you have a snow sports shop in one of Australia's winter resorts, you will probably only operate from May to October. Your inventory turnover should just reflect these months; otherwise, the data will be skewed.
If you sell perishable goods, you may also wish to change the dates of your inventory. A food shop or restaurant may consider changing their inventory to the average lifespan of their perishable goods.
Once you have selected the best time span for your inventory turnover, follow these steps:
Take away the value of your end-of-period inventory from your start-of-year inventory. Then, add the value to your inventory expenses for the period.
You will then have the cost of goods sold.
To deduce your inventory turnover rate, divide the cost of goods sold by the cost of the average inventory.
Follow this formula to calculate your inventory turnover:
([Value of starting inventory] - [value of ending inventory]) + expenses from time period = COGS
([Value of starting inventory] - [value of ending inventory]) / 2 = average inventory value
[COGS] / [average inventory value] = turnover rate
Bearing this in mind, if your COGS was $150,000 over your winter sales period and your average inventory was $50,000, you would deduce the following:
150,000/ 50,000 = 3
Therefore, in your specified period (in this instance, from May to October), you will replace your inventory three times. This information will help you to make business decisions for the following year.
Accounts receivable turnover
To calculate your accounts receivable turnover, follow the following steps:
Decide on a suitable period for your accounts receivable turnover. This is usually a year, but you may select a more appropriate time for your business.
Add your accounts receivable totals from the beginning and end of the period together.
Divide the total by two to work out the average accounts receivable.
Divide this amount by the net credit sales. This amount will indicate your accounts receivable turnover.
Follow this formula:
([Starting accounts receivable total] + [ending accounts receivable total]) / 2 = average accounts receivable total
[net credit sales / [average accounts receivable total] = accounts receivable turnover
For example, your starting accounts receivable is $600,000 at the beginning of a year. At the end of the year, it is $900,000. Your net credit sales for the year are $3,000,000.
Therefore, your calculation is:
(600,000 + 900,000) / 2 = 750,000
3,000,000 / 750,000 = 4
You can look at this number along with the total for previous years to see if your debt collection has improved or worsened.
Tips for calculating turnovers
Always use the same period to calculate your turnover. This will help you to compare numbers more successfully.
If you have a seasonal business but you also have some trade in off-peak periods, you may want to do a biannual turnover, or a turnover a few times per year. The time of year you do a turnover will vary hugely depending on your business type and your location.
For example, if you own an ice cream shop in St Kilda in Melbourne, you will clearly trade much more over summer, when there are more tourists at the beach and the demand for ice-cream is high. Therefore, you will probably do a summer turnover from the start of November to the end of March and a winter turnover from the beginning of April to the end of October.
Turnover is an essential part of running a business. Not only does turnover help you evaluate your business's success but it assists you in planning for the future. Ensure that you are well aware of the different types of turnover and how to calculate them before your business's first year of trading is complete.
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