Do Turnover Rates Affect ROE?

by David Ingram Google

Turnover in business can be defined in two ways. Inventory turnover refers to how frequently a company sells and restocks its inventory. Employee turnover refers to the rate at which employees leave a company and are replaced. Return on equity (ROE) is a financial ratio used to compare a company's total owners' equity with its net income. ROE is calculated as net income divided by owners' equity. Both inventory turnover and employee turnover can have slight effects on a company's ROE, making both types of turnover of interest to potential lenders and investors as well as business owners.


Increasing inventory turnover translates into higher sales numbers, which can result in higher total revenues. Assuming costs remain the same or decrease, higher revenues ultimately increase net income, which raises ROE. A higher ROE number is always more desirable than a lower value. Increasing employee turnover in sales or marketing departments can have the effect of temporarily reducing company revenues, subsequently reducing net income and negatively affecting ROE. If a high-performing sales team leader leaves his job, for example, he is likely to be replaced by someone who will take some time before reaching the performance level of his predecessor, which can bring in less sales and less revenue. The same can be true of your most creative and innovative advertising designers, sponsorship solicitors or other marketing employees whom you rely on to push sales revenue higher.


Higher inventory turnover usually has the effect of increasing a company's direct costs as the company buys higher volumes of inventory or makes more frequent purchases. However, the increase in costs is most often accompanied by increased total revenues, as mentioned above. This is not always the case, however, as purchasing and pricing decisions can have different effects on total revenue and profitability regardless of sales volume. If higher inventory turnover causes costs to rise higher in proportion to revenue, the result could be a decrease in net income and a corresponding decrease in ROE. Higher employee turnover almost always results in higher costs, due to the additional recruiting and training expenses as well as lost productivity as new employees become familiar with their jobs. New hires are almost always less productive than more experienced team members, altering the variables that influence ROE and having a negative impact on the ratio.

Attracting Investors

Low employee turnover and high inventory turnover can attract new investors to a small business. If a company accepts outside investment, the equity variable in the ROE equation will rise, which can actually dampen the ROE valuation. Consider a company with net income of $1 million and owners' equity of $300,000, for example. That company's ROE would come to about 3.33 ($1 million / $300,000). If investors were impressed by this number and jumped on board to the tune of an additional $300,000, for a total owners' equity of $600,000, the ROE figure would instantly drop to about 1.7. However, since the goal of accepting the investment would ultimately be to increase revenues, it might not take long for the ROE figure to correct itself to an even higher level than before.

Influencing Turnover

Small companies can employ a range of tactics to increase inventory turnover and decrease employee turnover. Increasing inventory turnover is centered around product quality and marketing, creating products that customers value and effectively spreading the word. Decreasing employee turnover is all about enhancing job satisfaction and doing whatever you can to keep your employees happy, fulfilled and engaged at work.

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