What causes a variation in profit margin and turnover ratios between industries?
Mega grocery stores, discount stores, and warehouse clubs often have small profit margins but have high turnover ratios. The small profit margins as a percent of sales exist because of intense competition. The inventory turnover ratios are high because the stores feature the fast selling brands at low prices. Their strategy is that huge sales volumes with small profit margins will still result in adequate net income dollars.
In contrast to the stores with low profit margins and high turnover ratios, is a heavy equipment manufacturer with a high demand product that takes six months to manufacture. If this manufacturer has few or no competitors, a great product, and an excellent reputation for service, its profit margin can be very large. Unlike the discount stores, its inventory turnover will be very very low.
There can also be differences within the same industry. For example, one computer company might assemble and ship computers within hours of receiving the order via its website. Its inventory turnover will be off the charts, perhaps 90 times per year. If most of its customers pay with credit cards at the time the computer is shipped, the company will have very little in accounts receivable and will enjoy great cash flow. Another computer company might sell only through retailers. This company will have to assemble the computers in advance, store them, and then extend 60 days credit to the retailers. Obviously its turnover ratios will be less impressive than the ratios of the first company.
A company's management is another variable that explains differences in the profit margin and turnover ratios. Some managements are more focused, aggressive and disciplined in processing orders, controlling inventory. and improving processes. Companies with less proficient managers could end up having less impressive turnover ratios and profits.