What Is Annual Turnover? (Differences, Types and Calculation)

By Indeed Editorial Team

Published 9 June 2022

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 and profit are key financial metrics that organisations use to assess and measure their financial performance. Accountants, financial managers and business owners may focus on improving their annual turnover to increase their profits and attract more investors. Knowing what annual turnover is and understanding the difference between the two concepts can help you create effective financial strategies. In this article, we define what annual turnover is and why it's important, discuss the steps required to calculate it and highlight key differences between turnover and profit.

Related: What Is the Role of the Finance Department in Business?

What is annual turnover?

It's important to have a good understanding of annual turnover if you're in charge of reporting the company's financial performance for the year. Annual turnover or annual business turnover refers to the net sales or income generated by a company within its financial year. Net sales is the total sales generated by the company minus deductions from returns, allowances and discounts in the same period. In addition, annual turnover can also apply to measure other aspects of a company's performance, such as:

Accounts receivable turnover

Accounts receivable is the money or debts owed to a company for goods and services delivered but not yet paid. The annual accounts receivable turnover describes the number of times a year that a company collects its average accounts receivable. It helps to measure how efficiently a business collects the credit it extends to its customers or suppliers in the year.

Read more: What Is the Receivables Turnover Ratio? (Plus Examples)

Inventory turnover

The annual inventory turnover refers to the number of times a company is able to replace the inventories that it has sold in a year. Companies usually prioritise selling stock and offloading their inventory to achieve greater sales and potential profits. If a business can restock its inventory on time, it can help with budgeting and purchasing, and also reduce unnecessary expenses due to stock obsolescence.

Importance of annual turnover

Understanding the importance of annual turnover to your organisation is critical to maximising profits and helping it to achieve its financial goals. Management or investors use this figure to evaluate the organisation's financial performance and to also gain different insights about operations, market conditions and other aspects of the business. Here are several reasons why annual turnover is important to a company:

  • Assesses performance: You may compare annual turnover in successive periods to assess how the business is performing over time and if it meets expectations.

  • Analyses market demand: Annual turnover changes may reflect demand for your products, which you can evaluate to determine any seasonal trends to capitalise on in the future.

  • Reduces expenses: When you compare turnover against profit, it measures income against earnings, which helps you to identify areas where you can reduce expenses, such as the cost of goods sold or operational costs.

Relationship between annual turnover and profit

It's beneficial to understand the relationship between annual turnover and profit as the latter is a derivative of the former. There are three main types of profit left depending on which items you deduct from turnover. Companies use their profit to set budgets for the financial year and plan business activities or strategic initiatives for growth and development. Here are the three types of profit:

  • Gross profit: Gross profit is the turnover left after deducting the cost of producing all goods and services.

  • Operating profit: Operating profit is the amount left after deducting operating costs like rent and utilities from the gross profit.

  • Net profit: Net profit is the amount of operating profit remaining after deducting all operating, interest and tax expenses.

Differences between turnover and profit

Here are some important differences between turnover and profit:

Use case

Analysing turnover allows organisations to better manage their sales and marketing activities in the short term. The company can evaluate the success of its marketing campaigns or promotions by looking at turnover figures for a particular period. Conversely, profit is a reflection of earnings and is more relevant in enabling management to plan and budget for long term business development and strategy.

Computation

Turnover and profit are concepts that relate to the financial health of a business. While annual turnover can refer to net sales and measures the business income generated during the year, it doesn't account for any additional expenses. Profit refers to the company's leftover earnings after deducting expenses and liabilities, such as labour costs, manufacturing costs and rental and administrative costs.

Related: What Is Gross Profit Ratio? (Plus How to Calculate It)

Top-line vs. bottom-line

Companies list both turnover and profit on their income statement. As the net sales of the company in the year, annual turnover is normally at the top of the income statement as a first-line item. Conversely, profit reflects the total income after accounting for business expenses and liabilities, making it a bottom-line item at the end of the income statement.

Related: Single-Step Income Statement vs. Multi-Step Income Statement

Concept

Annual turnover can refer to other aspects of a business' performance, such as inventory turnover, accounts receivable turnover or employee turnover. These ratios measure the rate of change of ownership of assets like inventory or manpower. Profit strictly refers to the financial earnings of the company and can be further categorised into net profit, which takes taxes and other interest payments on loans into consideration.

Long term financial indication

Turnover vs. profit can act as a long term financial indication of the health and viability of the business. For instance, an increasing turnover may reflect growth but if profit is lower than expected, it may suggest that the company may not be financially healthy in the long run. Even with a high turnover, a business requires profits and earnings to remain financially sustainable. A high turnover may not necessarily mean a rise in profit, especially if the costs and expenses are high.

Related: What is Operation Costing? (With Example of Calculation)

Ways to calculate different types of annual turnover

Here are the steps showing how to calculate different types of annual turnover:

How to calculate annual business turnover

To calculate annual turnover for a business, you can follow these steps and use this formula:

Gross sales - [Discounts + Allowances + Returns] = Annual turnover

  1. Compute the company's gross sales for the year. This is the total sales generated by the business in the year before any deductions.

  2. Total the value of all discounts, allowances and returns for the year.

  3. Deduct the total value of all discounts, allowances and returns from the gross sales. The resulting figure is the annual turnover for the year.

How to calculate annual inventory turnover

Depending on the nature of the business, some companies may calculate inventory turnover over a shorter time period. For instance, a restaurant that stocks perishable food items may compute their inventory turnover per quarter or a time period that accurately reflects the shelf life of their products.

In other cases, you can follow these steps and use this formula to calculate the annual inventory turnover:
[COGS] / [Average inventory value] = [Annual inventory turnover]

  1. Take the inventory figure at the end of the year and deduct it from the inventory figure at the start of the year.

  2. Add the inventory expenses for the year. The combined result is the cost of goods sold (COGS).

  3. Take the result from step one and divide it in half to get the average inventory value.

  4. Divide the COGS by the average inventory value to get the annual inventory turnover.

How to calculate annual accounts receivable turnover

To calculate the annual accounts receivable turnover, use this formula and follow these steps:
[Average accounts receivable] / [Net credit sales] = [Annual accounts receivable turnover]

  1. Add the accounts receivable from the beginning of the year to the accounts receivable at the end of the year.

  2. Divide the total by two to get the average accounts receivable.

  3. Compute the net credit sales. This is the total sales generated from customer credit purchases after deducting any allowances and returns.

  4. Divide the average accounts receivable by the net credit sales. The result is the accounts receivable turnover.

Examples of annual turnover calculation

Here are different examples of annual turnover calculation:

Example 1

Review this example to calculate the annual inventory turnover:

Star Achievers company reported $80,000 cost of goods sold for the year and $25,000 of average inventory value for the year. To calculate the annual inventory turnover:

80,000 / 25,000 = 3.2

Star Achievers company replenished their stock roughly three times during the year. Knowing the inventory turnover for the year can help them plan and budget for the following year's purchases. A low inventory turnover figure can suggest that either the company is unable to sell off its products fast enough or there's low customer demand. Holding onto stocks for too long may incur additional storage expenses, which can affect profit margins.

Example 2

Here's an example on how to calculate annual accounts receivable turnover:

Top Rank company recorded $500,000 of accounts receivable at the start of the year. The year end accounts receivable balance is $1,000,000. Total net credit sales for the year are $3,000,000. To compute the annual accounts receivable turnover:

(500,000 + 1,000,000) / 2 = 750,000
3,000,000 / 750,000 = 4

Top Rank company can monitor changes in its annual accounts receivable turnover over time and reference this against peers in the industry. This can help Top Rank company determine if it's efficient in collecting debts or whether to review its credit policies.

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