Knowing how well your business is doing at any point in time is important for a number of reasons, if you’re trying to attract new investment, arrange a loan, plan for the future, or trying to sell the business.
Turnover is one key indicator and profit another although the two are not be confused – something new business owners need to learn fast! Our quick guide will explain exactly what turnover is, why it matters, and how to differentiate it from profit.
The official definition of turnover according to the Companies Act is stated as “the amount derived from the provision of goods and services after deduction of trade discounts, value added tax (VAT), and any other taxed based on the amounts so derived”. In other words, think of turnover as the amount you invoice your customers for through the sale of products or delivery of services, minus any discounts and VAT. You may also hear it called gross income or revenue.
Turnover includes some things you may not expect, for instance, the amount you add on for shipping an item is part of your turnover, as are any expenses you invoice customers for. You should also calculate turnover as the total amount before taking off fees (for example, PayPal) or commission. Why this matters is that your turnover is the number that determines when you have to register for VAT so if you’re not calculating turnover accurately, you may think you don’t have to register when in fact you are legally required to.
Something else that catches new business owners out is the fact that turnover is to be calculated at the point when you provide services or goods and not when you send out an invoice or when you receive payment. Excluded from turnover is income derived from an investment such as interest or a dividend, as this is not related to the goods or service the business provides.
So what’s the difference between turnover and profit?
The key thing to remember here is that turnover is distinct from profit and is the total income the business generates over a specified period such as a quarter, half-year, or end-of-year. Profit is a measure of earnings once all costs have been deducted and for the sake of clarity, there are two ways of measuring profit: gross profit and net profit.
The first is the sum you’re left with after the cost of the goods or services has been subtracted, in other words, your sales margin. Net profit is what you’re left with after ALL expenses, including tax, are deducted.
Calculating your turnover
Provided your accounts are up to date, you should be able to quickly work out the total sales for a specific period. To calculate profit, simply deduct costs; for net profit, deduct all other expenses, including tax. For example, if your turnover is £100,000 and the cost of the goods sold are £20,000, gross profit is £80,000. Once you take operating costs of say £10,000 into account, you’re left with a net profit of £70,000
Why knowing your turnover matters
By knowing your turnover you can compare it to profits and make informed decisions about how to run the business more efficiently. For instance, if turnover is high but gross profit is low per item, you can try and renegotiate with your existing supplier to reduce costs, or look for another supplier. If net profit is low relative to turnover, you should look again at your admin costs and whether or not your tax arrangements are in order. Are you claiming all the business allowances you’re entitled to?
Other types of turnover
You may also hear ‘turnover’ being used to refer to the number of staff that leave a company during a specific period, sometimes called ‘labour turnover’ or ‘churn’. It’s another important metric, especially for larger companies, and will often be compared with staff retention rates. Businesses who extend credit to clients may also use ‘accounts-receivable’to indicate the time it takes clients to settle invoices, when calculating turnover.