Turnover is the most fundamental measure of business performance. It’s probably one of the easiest metrics to get a quick picture of how a business is doing but don’t read in to it too much. Many businesses have very high turnovers while making a loss. The term is used extensively in UK self employment so let’s look at what it is in a bit more detail.
You can watch the video about this article here, or just read on below:
What is turnover in business?
Turnover is much easier to calculate than profit and it can give a very quick ‘at a glance’ picture of business performance, but not necessarily a good depiction of business health. It’s very possible that although the turnover is increasing from year-to-year, profit could easily be declining to the point of it being a loss making business. As a such when you hear high turnover figures being banded about, take it with a pinch of salt. However, it is the starting point for assessing how much tax you might owe so let’s look at what it means in a bit more detail.
Other names for turnover?
Turnover is the term commonly referred to by the HMRC, however it can go by a whole bunch of other names, including:
- Total sales
- Gross sales
- Total income
- Gross income
- Gross Revenue
- Net sales
- Top line
Different accountants might also refer to turnover with different terminology, so bear this in mind.
So what is turnover?
Turnover is simply how much money your business has made over a period of time. Not how much profit it’s made but just the total of all your business sales. As explained earlier, you can make lots of money turnover-wise while also making a loss. Imagine buying a million T-shirts for £10 each and selling them all for £1 each. Congratulations, you’re a millionaire! You’ve ‘turned over’ one million pounds… and simultaneously lost £9 million, which is obviously less great.
Let’s use an analogy of a sweet shop
- You start your day with £0 in your till.
- Over the course of a day you sell lots of sweets and make £500
- Your turnover was £500
- Now let’s imagine you had to take £100 out of the till to buy more sweets
- What was your turnover? It was still £500
- But you’ve had £100 cost of sales, leaving you £400 profit
Now, what if you made £500 every day for 365 days? That’s a turnover of £182,500… isn’t it? Well, not quite. Things get a little more complicated when you earn more than the VAT threshold (currently £85,000). Once you start charging VAT you would need to add that on to the price of your goods. However, generally you quote ‘turnover’ as an ex-VAT figure… since the VAT isn’t yours -- it belongs to HMRC. Congratulations, you’re now an unpaid tax collector!
What if you don’t deal in cash?
If you just deal in cash things are pretty simple. Add up your big wad of cash, that’s probably your turnover. BUT what if you invoice clients and get paid on credit terms? For example, you might give your customers 30 days to pay their invoice. So how do you calculate turnover over a given period? Is it based on the invoice date or on the date you were actually paid? Good question!
- Cash Basis -- turnover is based on the date you actually received the money
- Accruals Basis -- turnover is based on the date when you invoiced your customer, even if you haven’t been paid yet
For your own internal management accounts it doesn’t really matter whether you report based on Cash Basis or Accruals Basis. It should all come out in the wash anyway assuming you don’t have a huge number of debtors (people who haven’t paid you yet). However when it comes to statutory accounts it’s a whole different ball game. You MUST use the correct accounting reference dates or you’ll get in trouble! One of the many reasons why it’s so important to have a good accountant!
Don’t fret about turnover
The key thing in all this is that turnover doesn’t tell you anything about your cost of sales or operational expenses. It’s simply a measure of total sales and nothing else. You might have made £7,000 turnover and had £7,000 costs, so you’ve made zero actual money -- you might as well have twiddled your thumbs for a year.
Why might a business keep their profit low and turnover high? Well a major reason is that you have to pay tax on profits. So as long as you keep the profits low, by continually re-investing in your business, you can drive up sales and market dominance while paying very little tax. Amazon is a prime example of this. They’ve continually re-invested in every part of their business and the results speak for themselves:
And how does that high-turnover, low-profit model work in terms of overall company performance? You only need to look at Amazon’s share price to find the answer to that one.
The most important thing to remember as a small business owner is that:
TURNOVER = VANITY
PROFIT = SANITY
CASH = REALITY
You can make as much turnover and profit as you like, but successful businesses fail every day due to poor cashflow management. Especially at the earliest stages of your business, CASH IS KING. Keep it that way for as long as feasibly possible.
I’d love to be kept up to date with progress of your self employed journey! Keep in touch over on Twitter @smallbusinesstb -- best of luck!