That is the company generates a high revenue price for each dollar of working capital spent. A low ratio indicates your business may be investing in too many accounts receivable and inventory to support its sales. This could lead to an excessive amount of bad debts or obsolete inventory.
- A high Working Capital Turnover ratio is a significant competitive advantage for a company in any industry.
- Here, assets can be cash, receivable income like customer’s unpaid bills, and stocked inventory of raw materials and finished goods.
- The more sales you bring in per dollar of working capital deployed, the better.
- A high ratio may also give the business a competitive edge over similar companies as a measure of profitability.
- It requires fixed monthly interest payments and is used by companies experiencing rapid growth.
The turnover ratio portrays the efficiency at which a company’s operations can create sales, which supports the statement from earlier about net working capital (NWC) being preferable over working capital. All this information required for the working capital turnover ratio is available from the company’s financial statements. The Working Capital Turnover Ratio indicates how effective a company is at using its working capital.
Working capital turnover ratio definition
The ratio is a measurement that defines the relationship between the cost of a company’s operations and the corresponding revenue. These operations generate revenue which in turn helps companies to continuously fund the operations and turn a sizeable profit. Using the assumptions above, the net working capital (NWC) equals the difference between operating current assets minus operating current liabilities, which comes out to be $95,000.
It’s used to gauge how well a company is utilizing its working capital to generate sales from its working capital. It reveals to the company the number of net sales generated from investing one dollar of working capital. The ratio can as well be interpreted as the number of times in a year working capital is used to generate sales. An extremely high working capital turnover ratio can indicate that a company does not have enough capital to support its sales growth; collapse of the company may be imminent. This is a particularly strong indicator when the accounts payable component of working capital is very high, since it indicates that management cannot pay its bills as they come due for payment. To manage how efficiently they use their working capital, companies use inventory management and keep close tabs on accounts receivables and accounts payable.
Working Capital Turnover Ratio
The working capital turnover ratio (WCTR) gives the number of times the working capital is turned over in a year. The number indicates effectiveness in the utilization of working capital such that a higher ratio indicates efficient utilization of working capital and vice versa. The ratio is used to show how the company’s finances and sales are related. Working Capital Turnover Ratio is a financial ratio which shows how efficiently a company is utilizing its working capital to generate revenue. The Working Capital Turnover Ratio is also called Net Sales to Working Capital. To fully understand this ratio, first, we must fully understand Working Capital.
- A high working capital turnover ratio shows a company is running smoothly and has limited need for additional funding.
- You can use the working capital turnover ratio calculator below to quickly calculate the number of net sales generated as a result of investing one dollar of working capital by entering the required numbers.
- Analysts also compare the ratio of past years to understand the trends and suggest improvements where ever necessary.
For instance, an NWC turnover ratio of 3.0x indicates that the company generates $3 of sales per dollar of working capital employed. There are two ways to best make use of the Working Capital Turnover Ratio. The first is to compare the calculated ratio with the companies own historical records to spot trends.
Example of the Working Capital Turnover Ratio
Meanwhile, a low ratio is a sign of power management of the business resulting in the accumulation of inventories and accounts receivable. Hence, they’re taking longer to be converted into cash leading to sales on credit. The inventory becomes outdated and accounts receivable become written off as bad debt.
When a company does not have enough working capital to cover its obligations, financial insolvency can result and lead to legal troubles, liquidation of assets, and potential bankruptcy. In contrast, a low ratio may indicate that a business is investing in too many accounts receivable and inventory to support its sales, which could lead to an excessive amount of bad debts or obsolete inventory. A high turnover ratio shows that management is being very efficient in using a company’s short-term assets and liabilities for supporting sales.
What does a negative working capital turnover ratio mean?
A low turnover ratio in turn implies that the return on working capital expenditure is low. The working capital turnover ratio is also known as net sales to working capital. The NWC turnover metric can be a useful tool for evaluating how efficiently a company is utilizing its working capital to produce more revenue.
Accounting practices, tax laws, and regulations vary from jurisdiction to jurisdiction, so speak with a local accounting professional regarding your business. Reliance on any information provided on this site or courses is solely at your own risk. In other words, this ratio shows the net sales generated as a result of investing one dollar of working capital. Analysts also compare the ratio of past years to understand the trends and suggest improvements where ever necessary.