Turnover relates to net sales of a business, whereas profit is the bottom line of a business. Many businesses go wrong when they over-drive on turnover at the expense of profit. So the maxim: Turnover is Vanity and Profit is Sanity. Let me explain how this situation comes about.
Firstly, let me define the terms turnover and profit:
Turnover: In any business sales less sales commission and trade discount is treated as turnover. This figure is generally shown for a complete financial year of 12 months. In mid-way of a financial year this figure is shown as turnover to date or turnover up to such a month. Turnover is the first and primary figure one should look at
Profit: In a business profit is shown in two different ways:
Gross Profit: Turnover less Cost of Sales equals Gross Profit sometimes referred to as Gross Margin. Gross profit is often shown as a percentage of the turnover
Net Profit: Gross Profit less Operating and Financial Cost equals Net Profit, sometimes referred to as Bottom Line or Net Margin. Net Profit is often shown as a percentage of the turnover. In this blog profit means Net Profit
Turnover is Vanity: A business must ensure that turnover grows from year to year. The basic parameter is that it should make sizable gross profit from its operations. It has to cover the cost of sales by a wide margin so that it can absorb operating cost as well as financial cost and return an attractive net profit. When a business goes on over-drive and increases the turnover but at the same time decreases the gross profit percentage, the situation is bad. To support the increase in turnover the business would offer extended credit terms. For example if normal credit terms offered are for 60 days, the business is inclined to double the offer to 120 days. Moreover, to support increase in turnover the business would hold more inventory than it used to be. Both developments mean more money is tied up resulting in increase of financial cost. But there are exceptions. In a business where the goods sold are of low value, it is necessary to have large turnover to ensure a safe bottom line. Caveat: Do not have vanity in jacking up turnover at un-manageable level.
Profit is Sanity: Whatever the level of turnover, it is the bottom line that matters. A business must manage its level of turnover keeping a sharp eye on the percentage of both gross profit and net profit. There are instances where you get high gross profit percentage but it does not lead to a high net profit percentage. In this case either operating cost or financial cost or both spiral up sponging all the profit of a business. From another point of view let us assume a business where the goods sold are of high value. Here, it is necessary to have reasonable turnover to ensure an attractive bottom line. Sanity prevails in a business that constantly monitors the turnover level as well as receivables & inventory level as against the cost of credit. Needless to say, healthy bottom line makes a business vibrant and indicates solvency in the short term. Furthermore, it impacts positively on the growth momentum of the business.
Choosing the Right Mix: How much shall be the turnover and how much profit could be made out of this turnover is purely a business budgeting exercise. But in most cases despite all these admonishing of “turnover is vanity and profit is sanity” businesses do get the mix wrong. Three reasons cause this problem:
1. The planning and budgeting department has not done its job well
2. Owners / directors are just crazy or egoistic or megalomaniacs
3. Cosmic balance is lackadaisical; cosmics are aspects that are beyond facts & figures but still influence the conduct of a business; cosmics reside in every individual and by extension in every business. A business that understands its cosmics can choose the right mix of turnover and profit to enhance its survival in both short and long terms.
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