What is the Working Capital Turnover Ratio?

To operate one’s business smoothly, a smooth influx of working capital is necessary. Working capital turnover ratio is a numerical representation of the financial situation of a business. It is the difference between an enterprise’s current assets like cash, receivables, inventories and its current liabilities like the payable accounts. It measures your company’s operational efficiency, liquidity and its short-term financial condition.

Now working capital turnover ratio determines how efficiently this enterprise uses its working capital to fund its business operations and the sales generated in the process. It's only if a business has substantial working capital at hand, it holds the potential to invest and expand.

How to calculate this turnover ratio?

If you run a business, here’s how to calculate the turnover ratio –

Working capital turnover ratio = Net sales divided by your working capital

Why is it used?

If the ratio is high for a company, it indicates that the company can utilise its short-term assets and liabilities efficiently to support the sales. A higher rate means that business operations are operating smoothly, and there's no need for any additional capital in the business.

On the other hand, if the turnover ratio is low, it shows that a company has higher receivables and inventories than assets to support the sales. It's a negative sign as it denotes that there's a substantial amount of out-of-date stocks and mounting bad debts.

Benefits of working capital turnover ratio

• It ensures the smooth functioning of business operations.

• It eliminates any requirement of additional funds.

• Better capital management helps in streamlining business operations.

These, in turn, provide a company's competitive edge over its peers. Thus, you can avail Working Capital Loan from lenders of your choice to fuel your business’s growth and operate it without hitting financial roadblocks.

Net capital turnover indications

Turnover ratio indicates a firm's financial health by determining its ability to meet all its short-term monetary obligations. Although the numbers vary between industries, a ratio below 1 shows a company's shortfall in meeting its immediate liabilities. A ratio of 1.2 to 2 is considered optimum. A ratio above 2 means that the business is not using its assets efficiently to increase its revenues.

The collection ratio also determines how effectively a company manages its receivable accounts. It is calculated as the product of average outstanding amounts within a specific accounting period. Collection ratio shows the average number of days an enterprise takes to receive payments. The lower is a business’s collection ratio; more efficient will be its cash flow.

Effect on inventories

A crucial element of net capital turnover is its inventory management. To operate a business with maximum efficiency, the right proportion of working capital is needed to help your business stays agile. Simultaneously, an enterprise also must balance its inventories in hand to meet its customers’ requirements. Here, companies use the inventory turnover ratio to calculate how effectively the net capital balance is maintained.

Additionally, this ratio also calculates the inventory cost and reveals how swiftly the inventories are replenishing from a company. A low ratio compared to your industry peers shows your inventory levels are substantially high. On the other hand, a higher ratio indicates that the efficiency of inventory ordering needs to be improved.

Be it venturing into new markets or expanding the production; you must ensure your business never runs out of capital finance with right sources of working capital. The working capital turnover ratio is essential for business organisations to compare their overall performance and productivity. It imparts a meaningful outlook to an enterprise in determining its efficiency in utilising its working capital.

Aditya Sehgal is a blogger and loves to write on various niches. He is known for his in-depth knowledge on topics such as technology, finance, lifestyle, current trends etc. Being a passionate writer he also contributes his knowledge on various blogs