Formula for Working Capital Turnover Ratio
“Working Capital” and “Turnover” are two terms in the Working Capital Turnover Ratio Formula. Before we can comprehend the Working Capital Turnover Ratio, we must first comprehend what Working Capital is and what business turnover entails.
Working Capital
Working capital is capital that a company needs to run its day-to-day operations. Working cash is critical for a company’s success. A business can become trapped in the middle if it does not manage its working capital properly.
Working capital is a type of short-term financing. A company’s Working Capital must be regularly monitored and remedial actions taken as needed. Positive working capital is good for business since it signifies a company has enough short-term funds to pay off its short-term liabilities.
The difference between current assets and current liabilities is known as working capital. Working Capital can be stated as follows in equation form.
Working Capital = Current Assets – Current Liabilities
Cash and bank balances, various debts, short-term loans and advances, short-term deposits, and inventory are all examples of current assets.
Bank OD, CC, and Sundry Creditors for Purchases, Expenses, Taxes Payables, and other payables during a year are included in Current Liabilities.
Turnover
The term “turnover of business” refers to the company’s net sales. Gross sales minus all discounts, credit notes, and taxes equals net sales. Many ratios employ turnover in their calculations. Turnover can be represented as follows in equation form:
Turnover = Sales – Discounts – Credit Note – Taxes
We can grasp the Working Capital Turnover Ratio now that we know the definitions of both terms, Working Capital and Turnover.
Ratio of Working Capital Turnover
The Working Capital Turnover Ratio is used to assess how well short-term resources are being utilised for sales. The ratio of net sales to working capital is known as the working capital turnover ratio.
Working Capital Turnover Ratio Formula
Working Capital Turnover Ratio = Turnover (Net Sales) / Working Capital
Explanation
The Working Capital Turnover Ratio Formula can be defined as the amount of Working Capital used per unit of Sales. In other words, this ratio indicates the amount of Working Capital required per unit of sales made.
A higher Working Capital Ratio indicates that the company has enough working capital to complete its sales. It should be highlighted that extremely high working capital has a negative impact, implying that there is room to grow sales with current working capital. The ratio should be compared to other peer companies in the same industry for competitive analysis.
The lower the working capital turnover ratio, the worse the company’s working capital management for completed sales is, or the company’s failure to use working capital efficiently. This has an impact on the company’s ability to survive in the long run.
Working Capital Turnover Ratio’s Importance and Applications
The Working Capital Turnover Ratio Formula is used to calculate the working capital use per unit. This is particularly useful since it allows the company to determine whether or not working capital usage is being done properly, which helps a business survive and expand in the long run.
FAQs
Is it possible for the working capital turnover to be negative?
The working capital turnover might be negative mathematically. When the average current assets are less than the average current liabilities, this can happen.
A company with negative working capital is unlikely to endure long, as working capital is the money it uses to perform its everyday operations.
What is the definition of working capital?
Working capital is the money that a company uses to run its day-to-day operations. It can alternatively be described as the difference between the average current assets and liabilities.
What does a healthy working capital turnover ratio look like?
Different industries have different working capital turnover characteristics. As a result, rather than comparing working capital turnover to the market average, it is crucial to compare it to the average of its peers.
Is it beneficial to have a large working capital turnover?
A high working capital turnover is usually a favorable indicator for a corporation because it indicates that its operations are efficient.
When a company’s working capital turnover is much higher than its peers, however, there is a risk that the company may not be able to support its expansion.