Working Capital Turnover Ratio

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

Let us look at how to calculate the working capital turnover ratio:

Working Capital Turnover Ratio = Net Sales / Working Capital

If the ratio 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 This is not a good sign, as it signifies that there is an excessive amount of out-of-date inventory and higher bad debts.

On the other hand, if it 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. But not always. Sometimes a higher ratio also has a lot of drawbacks. We will also learn about those drawbacks in the later part of this article.

Let us take an example to understand the concept with more clarity.

Example of Working Capital Turnover

Suppose you are provided with the data of five companies, LG, Omega, Camron, Sky, and MG. You are required to calculate and interpret the working capital turnover ratio of all these five companies.

Particulars	LG	Omega	Camron	Sky	MG
Current Assets	2,000	3,450	1,730	900	750
Current Liabilities	3,500	3,200	1,500	800	690
Sales	2,000	1,750	800	500	550
Returns	500	285	165	120	145
Discount & Taxes	167	300	40	90	70

Calculation of Working Capital:

Company	Current Assets (CA)	Current Liabilities (CL)	Working Capital (CA – CL)
LG	2,000	3,500	(1,500)
Omega	3,450	3,200	250
Camron	1,730	1,500	230
Sky	900	800	100
MG	750	690	60

Calculation of Net Sales:

Company	Sales (1)	Returns (2)	Dis. & Taxes (3)	Net Sales (1)-(2)-(3)
LG	2,000	500	167	1,333
Omega	1,750	285	300	1,165
Camron	800	165	40	595
Sky	500	120	90	290
MG	550	145	70	335

Working Capital Turnover Ratio:

Company	Net Sales	Working Capital	Ratio
LG	1,333	(1,500)	(0.89)
Omega	1,165	250	4.66
Camron	595	230	2.59
Sky	290	100	2.9
MG	335	60	5.58

You can also use Working Capital Turnover Calculator

Interpretation

As discussed above, a higher ratio is better and suggests that the company does not require more funds. Similarly, a lower ratio depicts poor management of short-term funds. But an extremely higher ratio may also have drawbacks attached. In the above example, LG has a negative ratio while Omega and MG have a very high ratio. Camron and Sky have the optimum working capital turnover ratio.

Since Omega and MG have a very high ratio, this may be due to the underutilization of working capital. And a lower or negative ratio depicts poor performance. A company and its management, hence, carefully allocate funds in the short run too. Efficient management of working capital will lead to less financial cost and lesser unnecessary expenses and diversions.

Advantages of Higher Working Capital Turnover Ratio

• It ensures the smooth functioning of the operations of the company.
• It 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 exceptionally higher ratio may also reflect that the company has insufficient funds to support sales growth.
• Higher working capital turnover often leads to the insolvency of the business.

Conclusion

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 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 this ratio after considering the various aspects of the business and the industry.

There is another metric called days working capital. It helps in determining how many days are required by a business to convert its working capital into cash.

Read Efficiency Ratios for its other types.