Working Capital Turnover Ratio: Meaning, Formula, and Example

In order to get an understanding of your business’s working capital turnover ratio, you’ll need to plug your net annual sales and your average working capital into the simple formula. The most common examples of operating current assets include accounts receivable (A/R), inventory, and prepaid expenses. Having a good handle of your company’s cash flow is crucial to be able to manage the current business operations and execute intended business projects. The Average Working Capital is the company’s average current assets less its average current liabilities. Calculating Working Capital Turnover Ratio provides a clear indication of how hard you are putting your available capital to work in order to help your company succeed.

• To match the time period of the numerator with the denominator, using the average NWC balances between the beginning and ending periods is recommended.
• Accounts receivable balances may lose value if a top customer files for bankruptcy.
• In addition, Days Payable Outstanding (DPO) shows the duration a company takes to pay its suppliers – a key factor in cash flow management.
• This ratio shows the relationship between the funds used to finance the company’s operations and the revenues a company generates in return.

Keeping track of how well a company is using its working capital to support sales can give a good indication of a company’s ability to effectively use its short-term assets to help grow the business. By keeping a sufficient amount of money in its working capital, a company is able to fund its business needs for a certain period of time without running the risk of having operational liquidity issues. When a business is able to generate sales, collect the funds, produce goods and services, generate new sales, and so on, it needs to have a good handle on its cash management, working capital, and cash conversion cycle. Our next step is to divide the sales from each period by the corresponding average shareholders’ equity balance to calculate the capital turnover.

Using Industry Benchmarks to Compare Your Business’s Working Capital Turnover Ratio

Therefore, the company would be able to pay every single current debt twice and still have money left over. Working capital turnover ratio is an essential metric managers can use for financial decision-making. The ratio can provide insights into the financial health of a company and help evaluate the effectiveness of investments as well as pricing strategies. The ratio can also offer clues on how to better manage working capital and reduce the company’s operating costs. Furthermore, the working capital turnover ratio can also be used to assess the effectiveness of a company’s inventory management.

• Monitoring and analyzing working capital turnover ratio is crucial to staying ahead of competitors, securing credit lines, and making informed business decisions.
• Working capital is the amount of money the company has to support its daily operations.
• This doesn’t mean delaying payments to the detriment of supplier relationships, but rather, seeking mutual agreements that benefit both parties’ cash flow needs.

This means that the company is majorly depending on its working capital to generate revenues. A high ratio indicates that the company is making sales with very little investment. By analyzing the Cash Conversion Cycle (CCC), we can comprehend the time taken by a company to convert its investments into cash, reflecting working capital management and overall financial health. Operating Cash Flow Ratio is vital for measuring a company’s capacity to generate adequate cash from operations to meet short-term liabilities. Improving your working capital is the most obvious tip to upping your ratio, as doing so is integral to enhancing your company’s financial health and operational efficiency.

Is Negative Working Capital Bad?

The best way to use Working Capital Turnover Ratio is to track how the ratio has been changing over time and to compare it to other companies in the same industry. Doing so shows how you compare against your competitors and will push you to design more efficient uses for your working capital. If a company is fully operating, it’s likely that several—if not most—current asset and current liability accounts will change. Therefore, by the time financial information is accumulated, it’s likely that the working capital position of the company has already changed. Working capital can be very insightful to determine a company’s short-term health. However, there are some downsides to the calculation that make the metric sometimes misleading.

Working Capital Turnover Ratio FAQs

For example, a low ratio might encourage a business owner to lessen costs for a certain product or service as a method to boost sales. A higher ratio indicates efficient use of working capital while a lower ratio may suggest inefficiencies or excessive capital tied up in assets. The interpretation of either working capital or net working capital is nearly identical, as a positive (and higher) value implies the company is financially stable, all else being equal. I started this blog out of my passion to share my knowledge with you in the areas of finance, investing, business, and law, topics that I truly love and have spent decades perfecting. I also acted as an in-house counsel and eventually as the General Counsel in a rapidly growing technology company going through hypergrowth, dealing with international Fortune 500 clients, and operating internationally. When the ratio is high, it indicates that the company is running smoothly and is able to fund its operations without additional sources of funding.

How to Calculate Working Capital Turnover?

For example, say a company has $100,000 of current assets and $30,000 of current liabilities. This means the company has $70,000 at its disposal in the short term if it needs to raise money for a specific reason. Another way to use the working capital turnover ratio is to track its trend over time. By monitoring the ratio over a period of time, businesses can identify if their working capital management is improving or deteriorating. This information can help businesses make informed decisions about their working capital management strategies and take corrective actions if necessary. While the working capital metric can be used – i.e. current assets minus current liabilities – the net working capital (NWC) is a more practical measure, since only operating assets and liabilities are included.

Working Capital Turnover Ratio Calculator

Since we’re measuring the increase (or decrease) in free cash flow, i.e. across two periods, the “Change in Net Working Capital” is the right metric to calculate here. A low ratio can suggest that the company’s capital is getting stuck in inventory or account receivables and the company is not converting them to cash as quickly as they should. To see how a company is progressing in time, many organizations will measure use the capital turnover equation to measure their ratio and compare their current results to past ones.

In practice, the working capital turnover metric is a useful tool for evaluating how efficiently a company uses its working capital to produce more revenue. Below is a short video explaining how the operating activities of a business impact the working capital accounts, which are then used to determine a company’s NWC. Populate the schedule with historical data, either by referencing the corresponding data in the balance sheet or by inputting hardcoded data into the net working capital schedule. If a balance sheet has been prepared with future forecasted periods already available, populate the schedule with forecast data as well by referencing the balance sheet. At the very top of the working capital schedule, reference sales and cost of goods sold from the income statement for all relevant periods.

When this happens, it may be easier to calculate accounts receivables, inventory, and accounts payables by analyzing the past trend and estimating a future value. We have prepared this working capital turnover ratio calculator for you to calculate the working capital turnover ratio of any business what does organization name mean on a job application you like. The working capital turnover ratio formula tells you how much revenue a company can generate given its average working capital. A high working turnover ratio is an indicator of the efficient utilization of the company’s short-term assets and liabilities to support sales.