Meaning of Working Capital Turnover
Working capital turnover measures the revenue generated from every investment made in the form of working capital. The working capital turnover ratio helps the company to acknowledge the relationship between the working capital invested in the company to fund the routine operations and the amount of sales generated through these operations.
Working Capital Turnover Ratio Formula
The formula for calculating the working capital turnover ratio is as follows:
Working Capital Turnover Ratio = Net Sales / Working Capital
In the above formula,
Working Capital = Current Assets – Current Liabilities
The efficiency of the management can be determined by knowing the working capital turnover ratio. If the ratio is higher, the management is very competent and efficient because they can utilize the short-term assets and liabilities of the company in a better way to support its sales. A higher ratio is a sign that all the business operations are running smoothly and there is no need for additional funds in the business.
Another metric days working capital is the reciprocal of the working capital turnover ratio.
On the other hand, if it is lower, it means that the company has higher accounts receivables and inventory assets to support its sales. This is not a good sign, as it signifies that there is an excessive amount of out-of-date inventory and higher bad debts.
Let us understand the concept of working capital turnover ratio with the help of an example.
Example of Working Capital Turnover
Calculate the working capital turnover ratio of Samsung Ltd. and LG Ltd. based on the following data. Compare and find which company has a more favorable working capital turnover ratio?
|Net Sales (A)||172,215||63,982|
|Current Assets (B)||458,964||33,569|
|Current Liabilities (C)||242,439||27,149|
|Working capital (D) =||216,525||6,420|
|Working capital turnover (A ÷ D)||0.79||9.96|
We know that Samsung and LG are competitors; the working capital turnover ratio helps determine which company has better asset utilization. We have learned that a higher working capital turnover ratio signifies higher efficiency of the management of the company. We can see in the above example that LG has a better working capital turnover ratio than Samsung. This means that LG has a competitive edge over Samsung.
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We have covered the complete ratio analysis – its significance, application, importance, and limitations, and all 32 RATIOS of ratio analysis that are structured and categorized into 6 important heads.
Higher working capital is beneficial for the organization, but sometimes there are some cons attached to it.
You can also use Working Capital Turnover Calculator
Advantages of Higher Working Capital Turnover Ratio
- It ensures the smooth functioning of operations of the company.
- The working capital turnover ratio eliminates the requirement for additional funds.
- It helps to ease business expansion.
- It gives a competitive edge over its peer.
Disadvantages of Higher Working Capital Turnover Ratio
- An extremely higher ratio sometimes reflects that the company does not have enough capital to support its sales growth.
- Higher working capital turnover often leads to the insolvency of the business.
The working capital turnover ratio is significant for business organizations to compare their performance with competitors. It gives a meaningful idea to the company in determining the efficiency of utilizing the working capital. However, a higher capital turnover ratio interpretation should be made carefully. The picture is not always bright when the ratio is higher. Sometimes, a higher ratio is a sign of insufficient working capital in the business. Therefore, the analyst should use the working capital turnover ratio formula after considering the various aspects of the business and the industry.
Read Efficiency Ratios for its other types.
- Turnover Ratios
- How to Analyze and Improve Asset Turnover Ratio?
- Working Capital Turnover Calculator
- How to Analyze and Improve Debtors Turnover Ratio / Collection Period?
- Interval Measure – Meaning, Importance, How to Calculate, Burn Rate and Defensive Interval Ratio
- Capital Intensity Ratio – Meaning, Formula, Importance, and More