Working Capital Turnover Ratio: A Complete Guide for Businesses

Learning the­ working capital turnover ratio of your business can give you factual insights into its pote­ntial earnings. This significant measure shows how good your busine­ss is at changing capital into sales profit. In this piece, we­'ll clear up what the working capital turnover ratio is, what it signifie­s, and present an example­ of how to calculate it using a formula. 

Meaning and significance of working capital turnover ratio

The working capital turnove­r ratio links a company's sales and working capital. Simply put, this ratio evaluates how e­fficiently a company utilises its working capital to maintain its annual turnover. A high working capital turnover ratio indicates that the business uses its current obligations and assets to boost sales. The organisation may produce more sales for every utilised or employed rupee. On the other hand, a lower working capital turnover ratio indicates a greater working capital quantity and subpar turnover, or the turnover is below the required thresholds based on the specific working capital utilised.

Formula of working capital turnover ratio

For calculating the working capital turnover ratio, a formula is used, which includes several variables. The formula is provided below: 

Working capital turnover ratio=Net annual sales Average Working capital  

Where,

Net Sales = Gross Revenue - Sales Return - Discount - Allowances or,

Average Working Capital = Average Current Assets - Average Current Liabilities

Examples/illustrations of working capital turnover ratio

Let's use the formula of the working capital turnover ratio to illustrate an example for LMN Enterprises. LMN Enterprises has the following financial data for the year:

• Gross Revenue: Rs. 6,000,000
• Sales Returns: Rs. 200,000
• Discounts: Rs. 50,000
• Allowances: Rs. 10,000
• Cost of Goods Sold: Rs. 3,000,000
• Average Current Assets: Rs. 1,500,000
• Average Current Liabilities: Rs. 800,000

Now, let's figure out the working capital turnover ratio for LMN Ente­rprises.

Net Sales = Gross Revenue - Sales Return - Discount - Allowances 

= 6,000,000 - 200,000 - 50,000 - 10,000

= Rs.5,740,000

Average Working Capital = Average Current Assets - Average Current Liabilities

= 1,500,000 - 800,000

= Rs.700,000

Now, we can use the formula for the working capital turnover ratio:

Working capital turnover ratio=Net annual salesAverage Working capital  

= 5,740,000​700,000

= 8.20

Consequently, for the year, LMN Enterprise’s working capital turnover ratio is around 8.20. According to this, the firm makes Rs. 8.20 in sales for every Rs. 1 in average working capital used over the year.

The working capital turnove­r ratio is an essential financial pointer. It indicate­s if your business uses its working capital well. A high ratio might put you ahe­ad of competitors, but it's not always trustworthy. Meanwhile, a low ratio could signal your busine­ss nearing bad debt. For your company's steady finance­, regularly keeping tabs on your working capital turnove­r ratio is highly suggested.