Working Capital Turnover
What Is Working Capital Turnover?
Working capital turnover is a ratio that measures how efficiently a company is utilizing its working capital to support sales and growth. Otherwise called net sales to working capital, working capital turnover measures the relationship between the funds used to finance a company's operations and the revenues a company produces to proceed with operations and make money.
The Formula for Working Capital Turnover Is
where:
- net annual sales is the sum of a company's gross sales minus its returns, allowances, and discounts throughout the span of a year
- average working capital is average current assets less average current liabilities
What Does Working Capital Turnover Tell You?
A high turnover ratio shows that management is by and large exceptionally efficient in involving a company's short-term assets and liabilities for supporting sales. At the end of the day, it is generating a higher dollar amount of sales for each dollar of working capital utilized.
Conversely, a low ratio might demonstrate that a business is investing in too numerous accounts receivable and inventory to support its sales, which could lead to an over the top amount of terrible obligations or obsolete inventory.
To check just the way that efficient a company is at utilizing its working capital, analysts likewise compare working capital ratios to those of different companies in a similar industry and take a gander at how the ratio has been changing over the long run. Notwithstanding, such examinations are useless while working capital turns negative on the grounds that the working capital turnover ratio then likewise turns negative.
Working Capital Management
Working capital management usually includes monitoring cash flow, current assets, and current liabilities through ratio analysis of the key components of operating expenses, including working capital turnover, the assortment ratio, and inventory turnover ratio.
Working capital management keeps up with the smooth operation of the net operating cycle, otherwise called the cash conversion cycle (CCC) — the base amount of time required to change over net current assets and liabilities into cash. At the point when a company needs more working capital to cover its obligations, financial insolvency can result and lead to legal difficulties, liquidation of assets, and possible chapter 11.
To oversee how efficiently they utilize their working capital, companies use inventory management and keep close tabs on accounts receivables and accounts payable. Inventory turnover shows how frequently a company has sold and supplanted inventory during a period, and the receivable turnover ratio shows how effectively it broadens credit and gathers obligations on that credit.
Special Considerations
A high working capital turnover ratio shows a company is running without a hitch and has limited need for extra funding. Money is coming in and flowing out consistently, giving the business flexibility to spend capital on expansion or inventory. A high ratio may likewise give the business a competitive edge over comparable companies as a measure of profitability.
In any case, a very high ratio could show that a business needs more capital to support its sales growth. Hence, the company could become wiped out soon except if it raises extra capital to support that growth.
The working capital turnover indicator may likewise be misleading when an association's accounts payable are exceptionally high, which could demonstrate that the company is experiencing issues paying its bills really.
Instance of Working Capital Turnover
Say that Company A has $12 million in net sales over the previous 12 months. The average working capital during that period was $2 million. The working capital turnover ratio is in this way $12,000,000/$2,000,000 = 6.0. This means that each dollar of working capital produces $6 in revenue.
Highlights
- A higher working capital turnover ratio is better, and shows that a company can create a bigger amount of sales.
- Working capital turnover measures how effective a business is at generating sales for each dollar of working capital put to utilize.
- Nonetheless, assuming working capital turnover ascends too high, it could recommend that a company needs to raise extra capital to support future growth.
