Reading and Managing Various Turnover Ratios

Unlike those sugary rich pastries, business, the word turnover is used for calculating many important ratios. The two most common ones are turnover of inventory and turnover of employees. There’s also the cost of customers’ and suppliers’ turnover. Higher inventory turnover means improved profitability. Lower employee, customer and supplier turnover can bring important savings and contribute to higher profitability.

Turnover of inventory measures how many times your inventory turns over in a year. For example:

• If your inventory is $50,000 and your annual purchases of goods/materials $600,000, this indicates that your inventory turns twelve times a year or once a month ($600,000 / $50,000 = 12).
• If your inventory is $100,000, this indicates that your inventory turns six times a year or every two months.

The ratio is helpful because the more times you turn the inventory, the more profit you generate.

Let us compare the performance of two businesses that sell hats to see the difference.

Business A sells a hat at $100. The hat costs $50 to make so the profit is $50. Business B sells a hat at $100 but the cost of making the hat is $70, so the profit is $30. Based only on this information, we can say that business A is better because they have a higher profit margin. However, our conclusion is different when we know that business A turns their inventory of hats three times a year and business B turns their inventory of hats six times a year. Business A makes a profit of $50 three times a year, which equals $150 while business B makes a lower profit of $30. However, they make that profit  six times a year, which equals $180. In summary, business B makes 20 percent more profit than A because they turn over their inventory more times.

The lesson here? If your focus is only on the profitability of your product, you may miss on the benefit of the contribution of the faster turnover, a factor decisive in optimizing your profitability.

Another turnover percentage to consider is the ratio of employee turnover, which measures how many employees have stayed versus how many employees have left and replaced in a period of time, usually a year. If we had 100 employees and thirty left during the year and were replaced, our employee turnover would be 30 percent (30/100=0.30 x 100 = 30%).

The cost of employee turnover is often not calculated, but calculating the cost of employee turnover also is a worth-while exercise. The costs of selection, recruitment, and training can quickly add up. For example, recruiting fees can be 20–30 percent of an employee's salary. These might include the costs of advertising the job and background screenings, as well as the administrative overhead of finding the right candidate. Onboarding and training also impact the administrative costs of securing new talent.

• If the average employee compensation is $60,000, then 25 percent of that is $15,000. In our example, if we can reduce our employee turnover from 30 to 15 percent, we would save $225,000 ($15,000 x 15 employees = $225,000).
• Staying with our example of 100 employees and an average per head compensation of $60,000, we can calculate a total compensation of $6,000,000. $225,000 savings represents almost 4 percent. Now, that is a decent saving!

Finally, calculating the cost of customers and suppliers’ turnover in your organization can reveal opportunities and is another way to save money and improve overall profitability.

In conclusion: It pays (literally) to calculate the cost of turnover. Turnover can help your business (when we’re talking about inventory) or hurt your business (when we’re talking about employees, customers and suppliers). Whichever is the case, turnover is a factor you can’t ignore.

(W 620)