Are You Winning the Turnover Battle?
By Bill Burnham | November 22, 2024
In football it’s not uncommon for the announcers to say whoever wins the turnover battle will win the game. A study by the Harvard Sports Analysis Collective proved this point when they found the team with fewer turnovers wins 70 percent of the time. So, what about in business? What are some turnover measures you should be paying attention to and how are they measured? In this article we will examine two ratios, Accounts Receivable Turnover and Inventory Turnover.
Accounts Receivable Turnover
Accounts Receivable Turnover measures the rate at which your receivables are being collected. For example, an accounts receivable turnover of five means the average dollar volume of accounts receivable is being collected five times during the year. The formula for calculating this ratio is: sales over accounts receivable (Sales / Accounts Receivable).
The smaller the accounts receivable turnover is, the longer it is taking to collect receivables. The turnover rate can be converted to days receivable, which measures how long it takes on average to collect receivables. Days receivables is calculated in this way: 360 divided by the accounts receivable turnover (360 / Accounts Receivable Turnover). Days receivable is often an easier concept to grasp and more meaningful to the business owner.
Inventory Turnover
Inventory Turnover measures the rate at which inventory is being used on an annual basis. An inventory turnover rate of five means the average dollar volume of inventory is used up five times during the year. The formula for calculating this ratio is: Cost of Goods Sold divided by Inventory (COGS / Inventory). The smaller the inventory turnover is, the longer it is taking to sell inventory. The turnover rate can be converted to days Inventory, which measures how long it takes on average to sell inventory. Days Inventory is calculated in this way: 360 divided by Inventory Turnover (360 / Inventory Turnover).
Operating Expenses
Both receivables, which take too long to collect, and inventory, that takes too long to sell, are a drain on cash that could be used to fund the growth of a business. Every dollar sitting in accounts receivable or tied up in inventory is a dollar that can’t be used to buy additional assets the business may need or pay their operating expenses. The old saying that time is money is certainly true in this case.
Real-Life Example
To prove the point about operating expenses, let’s look at an example. Assume your business averages $730,000 in accounts receivable and it’s currently taking you an average of 40 days to collect even though your terms are net 30. Each day of receivables is worth $18,250 ($730,000/40). If you could improve your collection process so that you were collecting in 30 days your cash position would improve by $182,500! The same principle applies to inventory.
So, what’s true in football is true in business, winning the turnover battle improves the odds of success. Thus, evaluating your processes and coming up with a way to efficiently win the turnover battle can result in better business results.
Bill Burnham
Burnham, Consultants, Growth Acceleration Consultants, Hernando, TampaSpecialty: Accounting, Business Planning, Business Valuation, Cash Flow Management, Financial Management, Growth, QuickBooks Bill Burnham is a lifelong resident of the Tampa Bay area. He is a graduate of the University of South Florida where he majored in accounting. He obtained his MBA from Florida Institute of Technology. Burnham has more than 25 years of experience working with Fortune 500 companies, nearly 20 of those years in management positions. During that time he managed more than 200 employees and spent time in accounting, finance, manufacturing, production control and strategic planning. He managed government contract budgets in excess of $50 million dollars and operating budgets of more than $25 million dollars. He prepared analysis for potential acquisitions, proposals for government contracts and conducted company-wide training programs on several different topics. Complementing his large company background, Burnham also has 15 years of experience as a small business owner in industries as diverse as dry cleaning and home health care. In addition to those endeavors he has also worked as a business broker and business valuator performing valuations and selling business throughout the state of Florida. He has hands on knowledge in business planning, budgeting, forecasting, profit and loss management, cash management, business sales, business valuation and franchise operations. Burnham is also a Certified LivePlan Expert Advisor, QuickBooks Online ProAdvisor, Strategic Management Performance Systems certified, and a Profit Mastery Facilitator. Burnham was the 2018 Consultant of the Year for the Florida SBDC at USF region.