Working Capital Turnover Ratio Definition & Calculation

working capital turnover ratio formula

The average working capital turnover for another industry may be very different than in yours. The asset turnover ratio is a valuable financial metric that measures a company’s efficiency in using its assets to generate revenue. By understanding this ratio, you can gain insights into a company’s effectiveness in using its assets to drive sales.

How To Calculate The Working Capital Turnover Ratio

For example, a low ratio might encourage a business owner to lessen costs for a certain product or service as a method to boost sales. A higher ratio indicates efficient use of working capital while a lower ratio may suggest inefficiencies or excessive capital tied up in assets. Average networking capital cannot be calculated for the year 2000 because opening figure is not available. Interpretation of this ratio should be done when inter-firm or inter-period comparison is being done.

working capital turnover ratio formula

Accounting Ratios

It is important to note, however, that the interpretation of working capital turnover ratio varies by industry and business type. Therefore, it is crucial to compare ratios with companies in similar industries to avoid drawing the wrong conclusions. The working capital turnover ratio measures how well a company is utilizing its working capital to support a given level of sales.

  • You’ll then be able to better gauge where your business lands on the spectrum.
  • If a company’s ratio is lower than industry averages, it may indicate that it is not using its working capital as efficiently as its competitors, and action may need to be taken to improve profitability.
  • The following article will help you understand what working capital turnover ratio is and how to calculate it using the working capital turnover formula.
  • Visit our page about the best working capital loans to review and compare offers of the online lenders we recommend.
  • A lower ratio implies that the sales generated are lower than they should be, considering the amount invested in the business by way of working capital.

Step 3: Apply the Asset Turnover Ratio Formula

The overarching goal of working capital is to understand whether a company can cover all of these debts with the short-term assets it already has on hand. The amount of working get ready for taxes capital needed varies by industry, company size, and risk profile. Industries with longer production cycles require higher working capital due to slower inventory turnover.

When you are good at managing capital, you also have a strong cash conversion cycle (CCC). This means that you can convert assets and liabilities into revenue (cash) quickly. Take your average current assets and subtract your average current liabilities. In order to get an understanding of your business’s working capital turnover ratio, you’ll need to plug your net annual sales and your average working capital into the simple formula.

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Other financial ratios and factors such as industry trends, market conditions, and competition should also be considered. Additionally, the working capital turnover ratio may vary depending on the industry and the nature of the business. For example, a manufacturing company may have a lower working capital turnover ratio compared to a service-based business due to the higher inventory and accounts receivable turnover. Therefore, it is crucial to analyze the ratio in the context of the specific business and industry. The working capital turnover ratio shows the revenue generated by the working capital of your business.

A low ratio may suggest that a company is carrying too much inventory or struggling to collect payments from its customers, which can tie up cash and lead to cash flow problems. Analysing the working capital turnover ratio can help a company identify potential cash flow issues early on and take corrective action to address them. It is important to note that the working capital turnover ratio should be used in conjunction with other financial ratios and metrics to get a complete picture of a company’s financial health. The working capital turnover ratio doesn’t consider profitability directly, focusing solely on the relationship between sales and working capital.

A “good” ratio is contingent upon the industry and the nature of the business. Generally, a higher ratio is perceived positively, as it indicates more efficient use of (and a higher return on) working capital. For example, if two of your close competitors have their WC turnover ratios of 3.2 and 3.8 and yours is 6, then yours would be deemed as high within your industry. A WC turnover ratio is generally confirmed as being higher or low when compared to similar businesses running in the same industry.

The goal of the working capital turnover formula is to track efficiency over time and identify the areas of improvement. Improving your working capital is the most obvious tip to upping your ratio, as doing so is integral to enhancing your company’s financial health and operational efficiency. But let’s take a look at some more specific strategies that can help you improve your working capital turnover ratio.

This doesn’t mean delaying payments to the detriment of supplier relationships, but rather, seeking mutual agreements that benefit both parties’ cash flow needs. Faster collection of receivables improves cash flow, which in turn can be used to generate more sales. Consider offering discounts for early payments, employing stricter credit checks, and using invoice factoring to expedite cash inflow from sales. What’s more is that creditors and investors often scrutinize this ratio to assess a company’s viability and financial stability.