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Equity turnover, more commonly known as capital turnover, is a business formula applied to a company’s annual sales and stockholder equity. This is a measurement of how well the company is using its equity, and a high turnover shows both a good return for stockholders and good business potential. There is no standardized good or bad equity turnover; instead, the number should be compared with similar businesses. Another comparison business owners and stockholders should make is the company’s present equity history versus past history, to see if the business is doing better or worse for stockholders.
When a business goes public, it enables investors to purchase and sell stocks associated with the company, in hopes of gaining more capital for the company's projects. After getting the extra capital, known as stockholder equity, the business has to show that it can use the money well, so investors will keep their money invested so both parties will make a profit. To determine whether a business is fulfilling its part of the deal, the equity turnover formula can be used to figure out how much money the business is making when using the equity.
To calculate the formula, both average stock equity and annual sales are needed. Companies usually release annual sales information, so this is easy to retrieve, but the other aspect requires some math. The amount of stock equity at the beginning of the year must be added to the amount of stock equity at the end of the year and then divided by 2. For example, if the company started with $10,000 US Dollars (USD) of stock equity and at the end of the year has $20,000 USD, this equals $30,000 USD. Dividing $30,000 USD by 2 results in $15,000 USD.
The annual sales amount is then divided by the average stock equity to determine equity turnover. If annual sales are $45,000 USD, then $45,000 USD divided by $15,000 USD results in an equity turnover of 3. A higher number signifies better returns for stockholders.
There is no such thing as a standardized good or bad equity turnover rate; this should instead be compared with similar businesses. When comparing the similar businesses, the one with the higher number has a better chance of netting a higher return but, since business can always slip, this is not guaranteed. The equity formula also can be used to figure out if a business is doing better or worse for stockholders.