Equity turnover definition
/What is Equity Turnover?
Equity turnover is a ratio that measures the proportion of a company's sales to its stockholders' equity. The intent of the measurement is to determine the efficiency with which management is using equity to generate revenue. A high equity turnover indicates strong utilization of equity, while a low ratio may suggest underperformance or overly conservative capital use.
When to Calculate Equity Turnover
Calculating equity turnover makes sense when a business wants to assess how efficiently it is using its shareholders’ equity to generate revenue. This ratio is especially useful for companies with significant investments from owners or shareholders, as it shows how effectively that capital is being put to work. It is most relevant in evaluating asset-light businesses, service firms, or growing companies where equity plays a key role in funding operations. Analysts and investors also use it to compare companies within the same industry to determine which ones are generating more sales per dollar of equity.
How to Calculate Equity Turnover
To calculation equity turnover, divide annual net sales by the average amount of stockholders’ equity outstanding over the course of the measurement period. For this calculation, the net sales figure is gross sales minus all sales returns and allowances. The calculation of equity turnover is:
Annual net sales ÷ Average stockholders' equity = Equity turnover
In order to conduct this calculation on a monthly basis, use the trailing 12 months' sales figure in the numerator, and match it to the average stockholders' equity during the same period. For a more accurate outcome, use the weighted average stockholders' equity for the measurement period.
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Example of Equity Turnover
As an example of the equity turnover calculation, a business generates $1,000,000 of sales over a one-year period. During that time, the organization maintains an average equity balance of $200,000. Based on this information, the company has a 5:1 equity turnover ratio, which is calculated as:
$1,000,000 Annual net sales ÷ $200,000 Average stockholders' equity = 5x Equity turnover
Equity Turnover Considerations
There are a number of issues to consider when using this measurement, which are noted below.
Capital intensiveness of industry. The ratio varies substantially, depending on how capital-intensive an industry may be. Thus, an oil refining business may have a much lower ratio than a services business, since the refinery business requires a significantly larger capital investment. Thus, if the measurement is being used to compare the performance of different companies, only do so for companies located in the same industry.
Debt to equity mix. Company management can skew the ratio in their favor by using more debt instead of equity. Doing so will increase the ratio, but can place a business in serious jeopardy if margins fall, since the organization will no longer be able to pay its debts.
Emphasis on sales. The ratio assumes that the key company improvement standard is sales, when in fact it is usually more important to generate cash flow or profits. Thus, the ratio may place an emphasis on the wrong target.
Terms Similar to Equity Turnover
Equity turnover is also called capital turnover.