Do Turnover Rates Affect ROE?
Return on equity is often the most important success metric for a business; ROE tells you if the hard work you put in and the money you risk to run your business really is paying off. Turnover can refer to the speed of sales in relation to assets or to inventory. Two turnover ratios impact your ROE and must be kept in check at all times.
Return on equity tells you how rapidly the funds invested in your business are growing. To calculate ROE, divide net income after taxes by average stockholder equity, which equals stockholder equity at the beginning of the period plus stockholder equity at the end of the period, with the total divided by two. Assume that your laundromat earned $140,000 for the year and that your investment in the business was $1.2 million and $1.4 million at the start and end of the year, respectively. ROE equals $140,000/(($1,200,000 + $1,400,000)/2) = 0.1077 or 10.77 percent.
Asset turnover equals sales revenue divided by total assets. A business that took in $3 million during the year and has $450,000 in assets has an asset turnover rate of $3,000,000/$450,000 = 6.67. If this were a supermarket with all assets invested in groceries, it would have emptied and refilled its shelves 6.67 times during the year. If sales are profitable, the higher the asset turnover ratio, the greater the profits and the higher the ROE. Especially if shelf or retail space is limited, increasing asset turnover can be the best method to raise the ROE.
Another type of turnover, inventory turnover, equals cost of goods sold divided by average inventory. The inventory turnover ratio tells you how many times the business emptied its warehouse. The higher this ratio, the higher the sales in relation to average inventory kept in stock. You can raise inventory turnover either by selling more or by keeping less inventory. If sales are profitable, both practices are good for profitability, and a higher inventory turnover ratio boosts ROE.
The two turnover ratios measure similar aspects of a business but also have key differences. When most of the business assets are kept in inventories, as would be the case for a dealership selling luxury cars, for example, asset turnover and inventory turnover figures likely will be close. However, if most assets are in real estate or machinery and equipment, with little product kept in inventory, the ratios will differ. A restaurant owner, for example, will invest heavily into the establishment but will have very little in inventory.