What is a turnover ratio?

A turnover ratio represents the number of assets or liabilities that a company replaces in relation to its sales. There are different types of turnover ratios including;

1. Receivables: The accounts receivable turnover ratio measures the time it takes to collect an average amount of accounts receivable. It can be impacted by the corporate credit policy, payment terms, or the accuracy of billings.

   It can also be impacted by the activity level of the collections staff or the promptness of deduction processing. To calculate receivables turnover, add together the beginning and ending accounts receivable and divide by 2 to get the average. Then divide it into the net credit sales for the year.

   Net Annual Credit Sales / ([Beginning Accounts + Ending Accounts] / 2)

2. Inventory: The inventory turnover ratio measures the amount of inventory that must be maintained to support a given amount of sales. It can be impacted by the type of production process flow system used, the presence of obsolete inventory, or inventory record accuracy.

   To calculate inventory turnover, divide the ending inventory figure into the annualized cost of sales. If the ending inventory figure is not a representative number, then use an average figure instead, such as the average of the beginning and ending inventory balances. The formula is:

   Annual cost of goods sold / Inventory

3. Fixed asset: The fixed asset turnover ratio measures the fixed asset investment needed to maintain a given amount of sales. It can be impacted by the use of throughput analysis, manufacturing outsourcing, capacity management, and other factors.

   The formula for the ratio is to subtract accumulated depreciation from gross fixed assets and divide that amount into net annual sales. The formula is:

   Net annual sales / (Gross fixed assets - Accumulated depreciation)

4. Accounts payable: The accounts payable turnover ratio measures the time period over which a company is allowed to hold trade payables before being obligated to pay suppliers. It is primarily impacted by the terms negotiated with suppliers and the presence of early payment discounts.

   To calculate the accounts payable turnover ratio, summarize all purchases from suppliers during the measurement period and divide by the average amount of accounts payable during that period. The formula is:

   Total supplier purchases / ((Beginning accounts + Ending accounts) / 2)

5. Investment fund: The turnover ratio concept is also used in relation to investment funds. It refers to the proportion of investment holdings that have been replaced in a given year. A low turnover ratio implies that the fund manager is not incurring brokerage transaction fees to sell off and/or purchase securities.

   The turnover level for a fund is typically based on the investment strategy of the fund manager, so a buy-and-hold manager will experience a low turnover ratio, while a manager with a more active strategy will be more likely to experience a high turnover ratio and must generate greater returns in order to offset the fees.