Formula for Working Capital Turnover Ratio
The Working Capital Turnover Ratio Formula contains the phrases “Working Capital” and “Turnover.” Understanding working capital and what business turnover includes is necessary before we can understand the working capital turnover ratio.
A business needs working capital to carry out its daily operations. For a business to succeed, working capital is essential. If a company does not properly manage its working capital, it risked getting caught in the middle.
A form of short-term funding is working capital. The working capital of a corporation must be routinely assessed, and corrective action must be done as necessary. Positive working capital is advantageous to a company’s operations since it shows that it has sufficient cash on hand to cover its immediate obligations.
Working capital is the difference between current assets and current liabilities. The equation for working capital is as follows.
Working Capital = Current Assets – Current Liabilities
Current assets include things like cash and bank balances, various debts, short-term loans and advances, short-term deposits, and inventory.
Current Liabilities include amounts owed to bank OD, CC, and other creditors for purchases, expenses, taxes, and other payables made during a given year.
The company’s net sales are referred to as “turnover of business.” Net sales are equivalent to gross sales less all discounts, credit notes, and taxes. Turnover is a common factor in the calculations of ratios. The following equation can be used to represent turnover:
Sales, discounts, credit notes, and taxes make up turnover.
Now that we are aware of what Working Capital and Turnover are, we can understand the Working Capital Turnover Ratio.
Working capital turnover ratio
How effectively short-term resources are being used for sales is evaluated using the working capital turnover ratio. The working capital turnover ratio is the proportion of net sales to working capital.
Formula for Working Capital Turnover Ratio
Employing Money Turnover (Net Sales) Ratio = Turnover (Working Capital)
The quantity of working capital used per unit of sales is the basis for the working capital turnover ratio formula. In other words, this ratio shows how much working capital is needed for every unit of revenue.
A greater working capital ratio means the business has enough cash on hand to finish its sales. There is room to increase sales with present working capital, it should be noted that exceptionally high working capital has a negative impact. For competitive analysis, the ratio needs to be compared to those of comparable businesses in the same sector.
The company’s working capital management for completed sales is worse, or the company fails to use working capital efficiently, the lower the working capital turnover ratio. The long-term viability of the company is impacted by this.
Applications and Importance of Working Capital Turnover Ratio
The working capital utilization per unit is determined using the working capital turnover ratio formula. This is especially helpful because it enables the organisation to assess whether or not working capital usage is being carried out correctly, which aids a business’ long-term survival and growth.
Q. Can the working capital turnover actually be negative?
Ans: Mathematically, the working capital turnover may be negative. This may occur when average current assets are lower than average current liabilities.
As working capital is the money used to carry out daily activities, a company with negative working capital is unlikely to last for very long.
Q. What exactly does working capital mean?
Ans: The money a business utilises to carry out its daily operations is known as working capital. The difference between the typical current assets and liabilities can also be used to explain it.
Q. What constitutes a favourable working capital turnover ratio?
Ans: Working capital turnover characteristics vary between industries. As a result, it is critical to compare working capital turnover to the average of its peers rather than the market average.
Q. Is a high working capital turnover advantageous?
Because it shows that its operations are effective, a high working capital turnover is typically a positive sign for a company.
However, there is a risk that a business may not be able to fund its expansion if its working capital turnover is significantly higher than that of its competitors.