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.
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.
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
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:
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
= 5,740,000700,000
= 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.