The turnover of a business is the amount of revenue it has earned in a particular accounting period. The profit is the amount remaining after deducting from the turnover the expenses incurred in earning it. Gross profit is the amount of revenue earned from sales minus the direct costs of production, such as the cost of materials and direct labor. Net profit is arrived at by deducting from the gross profit the indirect expenses, including overheads. Net profit is, therefore, the net amount earned by the business in an accounting period; further payments, such as taxation or dividends, also may need to come from these funds.
A difference between turnover and profit is that a rising turnover may be a sign that the business is growing but profit is an indicator of the health of the business. If the business cannot earn profits, it cannot continue in the long term. A profitable business can generate cash for further investment and can remain in a liquid position. Investors in the business may want to see an increase in both turnover and profit to ensure they will obtain a satisfactory return on their investment. Increased turnover does not guarantee rising profits, particularly if the business is unable to control its costs.
The relationship between turnover and profit depends on the industry in which the business is operating. The level of turnover required to earn a healthy profit may vary from one industry to another, depending on the profit margin on sales. Enterprises in a very competitive industry, such as food retailers, may earn only a small amount of profit on each sale after deducting the direct and indirect costs relating to the sale. Businesses such as service stations and supermarkets must maintain a high annual turnover to ensure that they make adequate profits. Other types of business, such as fashion clothing outlets, quality furniture stores and some service industries, are making a high margin on sales and may earn a satisfactory profit on a lower turnover.
Management decisions must take into account the effect those decisions will have on both turnover and profit. To grow a business, management must not focus only on increasing annual turnover; it also must look at controlling costs and, thereby, increasing profits. Continuation of a loss-making product line will increase turnover but it will increase costs even more and, therefore, reduce profits. The management should discontinue the loss-making product to increase profits but, if the focus is only on turnover, the decision to stop producing that item may not be made. When incentives for managers are based on sales and turnover rather than profits, they may take on unprofitable contracts to increase turnover in the short term, even though profits will be reduced in the longer term.
