January 26, 2022

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Meaning of Turnover and key Explanations

Meaning of Turnover and key Explanations
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Turnover is an important metric of any business. Although it is mostly used in trading firms, the term is applicable to service entities. Whenever the word is heard the first though is “sales.” But Turnover means more than that. It can be used to describe certain accounting ratios. And it is used in personnel management to measure employees availability.

Definition of Turnover

Turnover is defined as total sales of an entity. In this case, Turnover is synonymous to gross sales or revenue. It is the number of times a business makes sales or rendered services within a period of time. In the same vein, it is referred to as how fast a business carries out its operations within a time period.

Read: Meaning (Calculation) of Gross Operating Cycle and Key Explanations

Key Explanations

Any of the definitions you choose is correct. You can define turnover as total sales or the rate business operations are conducted overtime. But the definition depends on the usefulness of the term. If you are referring to sales, then it is the gross or net sales of a business. If you’re examining it as a ratio, then it is the number of times the entity’s operation occurs within a time period.

Gross or net revenue. It is seen as gross or net revenue of a business. Here, the term represents the sum of all sales for a period of time. While gross revenue is the total amount of inventory sold or services rendered, net revenue is arrived at after deducting returns inwards and inventory used by the business owner at selling price. In practice however, turnover is rarely used to replace revenue.

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How fast or number of times. The quickness of sales or services rendered is an important aspect of the term. The faster a firm’s inventory is sold the more revenue and profit are earned. However, the slower inventory is sold, there will be low sales. It may also result in spoilage of goods.

Owners of a business as well as investors use turnover as an important business metric. It tells users of financial statements how the entity’s capital is utilised. Capital is tied up if there are slow sales of inventories. Also, investors look at how high or low of the various turnover ratio or matrices to determine if the investment is viable.

Period of time. Although it is usually stated in number of times, it is easy to convert to number of days, weeks, months or year. For example, if turnover is 7 times, it can be converted to number of days by multiplying 365 days by the reciprocal of 7. The reciprocal of 7 is 1 ÷ 7. This gives 0.14. Then, 365 ➗ 0.14 gives 52.14 days.

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Meaning of Turnover and key Explanations

Types of Turnover Matrices

Inventory Turnover. This is the most common metrics and it is what I have explained in the previous subheading. This is the rate at which inventory are purchased or sold overtime. It is defined as the member of times goods are turn over.

The formula is credit sales divided by average inventory. (Average inventory is: {opening inventory + closing inventory} ÷ 2). The higher the rate, the smaller the time it takes to sell inventory, therefore, capital is not tied down and vice versa.

Account Receivable Turnover. This refers to the number of times it takes an entity to collect cash from debtors. It shows how quickly an entity management is able to recover cash from debtors over time. The formula is credit sales divided by average account receivable. A high rate indicates that the entity quickly collects cash from customers who buy goods on credit.

Account Payable Turnover. It is the number of times an entity is able to pay creditors. When goods are purchased on credit, it is expected that the entity repays it as quickly as possible. The mathematical formula is credit purchases divided by average Account Payable. Just like every other types, a high rate is a prove that the business quickly pays off its obligations to creditors.

Read: Business term: Statement of profit or loss

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Assets Turnover. This refers to the rate at which assets are utilised by an entity to its business operations. The ratio is net sales divided by total assets. This turnover tells users how efficient the business is using its assets to generate revenue. A strong ratio or high ratio shows that the business uses its assets efficiently. A week one is a signal that the business is inefficient in its assets usage.

Portfolio Turnover. The number of times the portfolio of an investment company turns over in a year. The ratio is the net sales of portfolios divided by the total portfolio assets managed by the portfolio manager. As usual, a high rate is a proof that the entity sold more portfolios for the year. And a week rate is an indication of poor portfolio trades.

Conclusion

Turnover is total or net sales for a period. As a ratio, it is the number of times one or all parameters (inventory, assets, portfolio, Account Payable and Account Receivable) are utilised. It tells the stakeholders how efficient the business is overtime. In addition, it reveals if the management is doing their job properly.

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