Working Capital Turnover Ratio: Meaning, Formula, and Example

Additionally, a high working capital turnover ratio may indicate that a company is not investing enough in its current assets, which could limit its ability to grow and expand in the long run. Therefore, it is important to consider other financial ratios and metrics in conjunction with the working capital turnover ratio to gain a more comprehensive understanding of a company’s financial health. Working capital management monitors cash flow, current assets, and current liabilities using ratio analysis, such as working capital ratio, collection ratio, and inventory turnover ratio. The working capital turnover ratio is a financial metric that measures a company’s efficiency in using its working capital to generate revenue. This ratio can be used to identify potential cash flow problems and take corrective action to improve cash flow management. Several factors can affect working capital turnover ratio, including the time it takes for a company to convert inventory into sales, the company’s payment terms, and the cash conversion cycle.

Helping organizations spend smarter and more efficiently by automating purchasing and invoice processing. However, it is important to consider industry benchmarks, as different industries have varying working capital requirements. In the landscape of business, the pursuit of growth is a constant endeavor. However, if the ratio was much lower in the previous year, this could signal that the company is possibly taking on very large orders that it cannot fulfill and is therefore overtrading. Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting. However, when a company’s working capital turnover is significantly higher than its peers, there is a chance that the company does not have enough working capital to support its growth.

While effective working capital management can help a company avoid financial difficulties, it may not necessarily lead to increased profitability. Working capital management does not inherently increase profitability, make products more desirable, or increase a company’s market position. Because cash is always considered a current asset, all accounts should be considered. However, companies should be mindful of restricted or time-bound deposits. The Receivables turnover ratio indicates the effectiveness of a company in collecting its debts. On the balance working capital turnover ratio sheet, the company reports working capital (after calculating it manually) of $30,000 in 2021 and $20,000 in 2020.

How to interpret the working capital turnover ratio?

The asset turnover ratio is a measure of a company’s ability to utilize its assets for the purpose of generating revenues. For investors, a company’s inventory turnover ratio is best seen in light of its competitors. In a given sector where, for instance, it is normal for a company to completely sell out and restock six times a year, a company that achieves a turnover ratio of four is an underperformer. As you navigate your business finances, understanding how quickly your business turns assets into sales is very important.

Identifying Areas For Improvement

A company can conserve cash by choosing to stretch the payment to suppliers and make the most of available credit. Working Capital is the difference between the current assets and current liabilities of a company. Similarly, the asset turnover and working capital turnover ratios gives an idea about the level of asset utilization and effective sales generation using the working capital of the business respectively. An alternative measurement that might provide a more solid indication of a company’s financial solvency is the cash conversion cycle or operating cycle.

By inputting the data into the first equation above, we get working capital 4 times ($100,000 / ( $20,000+ $30,000)/2. So, the company can use it to pay bills, increase working capital, or be invested. Thus, it can increase profitability and support more revenue in the future. AMZN on the other hand is not a competitor of GE or UTX so comparison between GE/UTX and AMZN based on working capital turnover ratio is not appropriate. It’s worth mentioning know that just because you have working capital at your disposal doesn’t guarantee that you’ll be using it effectively.

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1. Grant Gullekson is a CPA with over a decade of experience working with small owner/operated corporations, entrepreneurs, and tradespeople.
2. Working capital management tries to improve the collection speed of receivables.
3. In case of perishable goods this cost goes up because of some special arrangements that these products require during the transportation and storage process.
4. Even worse, the company can be left strapped for cash when it needs to pay its bills and make investments.
5. However, if the ratio was much lower in the previous year, this could signal that the company is possibly taking on very large orders that it cannot fulfill and is therefore overtrading.

At the end of the day, having completed a sale does not matter if the company is unable to collect payment on the sale. First, the company must increase sales by adopting a more appropriate marketing mix. If successful, the inventory is quickly released and replaced with new ones to meet high sales. In addition to getting revenue faster, the company can also minimize the capital tied up in inventory. And, if market demand remains high, insufficient working capital can cause the company to run out of money to fund its business and not optimize for high sales in the future.

Advantages And Disadvantages Of Using The Working Capital Turnover Ratio

Regularly monitor WCTR and adjust strategies as needed to maintain financial health. This is a complete guide on how to calculate Working Capital Turnover Ratio with detailed interpretation, example, and analysis. You will learn how to utilize this ratio formula to examine a company’s operating efficiency. The working capital turnover ratio is also known as net sales to working capital. The formula for calculating this ratio is by dividing the company’s sales by the company’s working capital. It does not address the long-term financial health of the company and may sacrifice the best long-term solution in favor of short-term benefits.