In our work we frequently hear entrepreneurs or managers talking about the turnover of the company they lead. This indicator is known and used by most managers and entrepreneurs, being perhaps the most common, but our experience has shown us that most of the time it is only partially known. Why do we say this? Because when referring to turnover, most entrepreneurs refer exclusively to income. But in reality, the turnover that really matters in business is the "effective turnover", also known practically as "operating turnover" or, more precisely, as "operating income". So what is the difference between "turnover" and "effective turnover"? The difference is simple but extremely important.
For a better differentiation, we must say that, in practice, the turnover assumes all the company's revenues and the effective turnover is constituted by the total revenues minus the raw material costs (for example, in the case of an industrial production company, from the revenues total all direct and indirect raw materials are subtracted; in the case of a distribution company we will assume the total revenues minus the value of the products it distributes) or, for service companies we remove from the equation the basic services included in our service (for example a company that sells software has effective turnover equal to total revenue less the cost of making the software applications it sells.)
Why is it more useful to look at actual turnover rather than turnover? Because its relevance resides in the real economic income that we obtain, or rather it is the added value generated by our company, more precisely the one that customers are willing to pay.
Overall turnover can be misleading because it increases or decreases depending on the costs of the raw materials or services we use in our business, not directly conditioning the added value generated by our business. For example, in the period 2020 - 2022, many raw materials, from plastics to raw materials made of metal, wood or even fuels, had major fluctuations, materialized both by accelerated increases and by subsequent decreases. Thus, many companies have experienced significant increases in turnover without actually having an increase in volumes or the number of customers. There have even been companies that have seen an overall increase in turnover in the face of declining volumes or reduced customer numbers. So, at first glance they had a positive business evolution, but if we analyze the actual turnover, we notice a stagnation or even a reduction in the real income of the respective companies. In the case of using actual turnover, fluctuations in raw materials or services integrated in own services do not in any way influence the analysis of the company's financial performance.
How can we build such a budget, oriented towards highlighting the actual turnover? This will not be very different from a conventional budget, but it is recommended to include a structural categorization of the main expenses. It is also recommended that these expense categories be aligned with the company's functional organizational chart, thus making it easier for us to connect expenses with each direct or support operational function. Thus, within the subcategories related to each main expenditure category, it is important to fully align with the process and the sequence of activities/operations included in the process. Thus we will have each segment of the business covered in the budget structure and we will be able to identify, at any time, the level of losses or waste, but this is a topic that we will address in another article.
Within this model, all budget categories are directly related to productive activity. What happens to the value of raw materials or integrated core services? These become a related category of expenses, similar to VAT, advances for settlement, short-term loans; we will title them "Blocked amounts" (blocked because we are going to recover them from the client with the sale of the products or services so that they can later be directed to suppliers to purchase the raw material or services needed for the next business cycle). Therefore, this category of expenses is not taken into account in the analysis of the financial performance of the business activity, but becomes useful only from the perspective of cash-flow control.
Businesses managed according to this model are healthier, more dynamic and much more resistant (antifragile) to economic shocks generated by crisis situations or moments of blockage such as the recently concluded pandemic. Through this model, the accuracy with which the business is understood and coordinated is much greater and much closer to economic reality. For this reason, this turnover is called "effective turnover". Within the Adaptive Management Financial (AMF) application, the category of blocked amounts is preset, along with the category of "capital withdrawals" which also do not represent an effect of the activity that generates added value.
An image of the business as close to reality as possible and as "in real time" is the most useful managerial tool for any businessman and we warmly recommend, to all entrepreneurs, to look at their own business from the most critical perspective, even if this picture is "harder" than the conventional approach or than the accounting analysis.
Good luck in the activity!