Equity Turnover

Equity Turnover (Capital Turnover) – an activity ratio reflecting the efficiency of the firm’s equity management. It can be calculated by dividing the company’s net sales by its average stockholders’ equity. High values of the equity turnover ratio indicate the efficient shareholders’ equity use. The value of this indicator measures how much goods and services were sold per each dollar of the equity.

It is reasonable to analyze the dynamics of this ratio and to compare its current value with main competitors from the same industry. An increasing trend of the company’s equity turnover indicates the consistent optimization of the firm’s equity management.

Resolving the problems with the equity turnover exceeding the normative range:

During the problem of the low equity turnover resolution it is reasonable to take current development goals into account. If the company operates within the market with no further growth perspectives and with access to cheap loan capital, reducing a part of the equity for the benefit of investors would allow to increase the ratio value. In most cases, the equity turnover growth can be reached through the sales volume increase.

Formula(s):

Equity Turnover = Net Sales ÷ Average Stockholders’ Equity

The average stockholders’ equity can be computed as the sum of equity values at the end of every day divided by the number of days. If only monthly data available, the sum of equity values at the end of every month should be divided by the number of months. Finally, if only access to the annual information available, the average of the equity values at the beginning and the end of the year should be computed.

Example:

Company A

Balance Sheet

Equity Turnover (Year 1) = 2048 ÷ (485 + 455)/2 = 4,35

Equity Turnover (Year 2) = 1694 ÷ (351 + 485)/2 = 4,05

The company's equity turnover decreased from 4,35 times during year 2 to 4,05 times during year 3. This means that at the end of the analyzed period a firm was producing 4,36 dollars of goods and services per each dollar of the stockholders' equity. The trend of the company's equity turnover is negative, and it is connected with a notable decrease in the net sales.

Conclusion:

Computation of the equity turnover ratio is useful for both potential and existing investors of the company since it allows to estimate the amount of goods and services sold per dollar of the capital involved from stockholders (equity). The indicator has some limitations though, as it may vary depending on how capital-intensive industry is. But in most cases the increasing trend indicates positive results of the company's equity management.