The size of any business, in general, is measured by its turnover. Larger the turnover, larger the size of the operations. However, applying the same logic to real estate business is inappropriate.
To understand this one needs to revisit the definition of ‘turnover’. Turnover in any business is the measure of the rate at which the goods are ‘sold’ and ‘replaced’ by other goods, i.e. the rate at which the inventory is ‘turned over’. So, in a retail store, a garment is sold and is typically replaced by another garment resulting in turnover for the store. The rate at which it is done measures the scale of operations of the store. Essentially, turnover is not just about revenues but also about the ability of the business to replenish the sold stocks.
In real estate, it is not easy for replenishment of inventory to immediately follow the sale. Inventory is sold every month but land purchase has a very long lead time. Opportunities to buy land are not available off the shelf and the process of land buying is very time consuming.
In businesses like manufacturing, no sooner finished goods are sold, raw material is replenished to produce more goods -- classifying the activity as turnover. Similar phenomenon is seen in retail business. And therefore, in these businesses, turnover (i.e. sale receipts) provides a good measure of the scale of operations. In real estate, sale figure tells only half the story about the size of operations. The unsold inventory/land bank, which is the engine for next year’s revenues, is also very critical for measuring size of operations.
Secondly, since developers generally recognise revenue when the project is complete, the turnover gives a measure of projects completed in that year and not the size of overall business. Accordingly, turnover in a particular year may have no relation to cash flow or to actual amount of business activity in that year. In most other businesses, cash flows and sales, generally have a high co-relation, hence for these businesses sales (or revenues) remain a good measure of the scale of operations as well as of cash flows.
However, in special cases, revenues of a real estate company could give a good measure of the size of operations. For example, when the company derives most of its income through rental business, the cash flows and revenues have a very high correlation. Also, inventory replenishment is hardly an issue; property once available for rent will also be available during the next month.
So those of you, who find it challenging to analyse balance sheets of real estate, should now be happy. You are not the only ones.
Deepesh Salgia is Director, Shapoorji Pallonji Real Estate. Watch the video . here Follow the Myth Series here.
Myth Series: What is its purpose?
While real estate is among the fastest growing businesses in India, it rarely finds respectable space in curriculums of business schools. Also, there are hardly any case studies available to explain the intricacies of the sector.
For these reasons, many facts and theories floating about real estate follow a ‘common sense-ical logic’. Unfortunately, many of these are misconceptions, myths or even downright false.The purpose of this series, therefore, is to take one real estate myth in each blog and provide insights on the real issues.