What Is Working Capital Turnover?

Working capital turnover is a ratio that measures how efficiently a company is using its 澳洲幸运5开奖号码历史查询:working capital to support sales ⭕and growth. It's also known as net sales t🍃o working capital.

Working capital turnover measures the relationship between the funds used to finance a company's operations and the revenues a company generates to continue operations and turn a profit.

Working Capital Turnover Formula

$\begin{aligned} &\text{Working Capital Turnover}=\frac{\text{Net Annual Sales}}{\text{Average Working Capital}}\\ \end{aligned}$​Working Capital Turnover=Average Working CapitalNet Annual Sales​​

Where:

• Net annual sales are the sum of a company's 澳洲幸运5开奖号码历史查询:gross sales minus its returns, allowances, and discounts over a year.
• Average working capital is average 澳洲幸运5开奖号码历史查询:current assets less average 澳洲幸运5开奖号码历史查询:current liabilities.

What Does Working Capital Turnover Tell You?

A high turnover ratio shows that management is very efficient at using a company’s short-term assets and liabilities to support sales. It's generating a higher dollar amount of sales for every dollar of working capital used.

A low ratio may indicate that a business is investing in too many 澳洲幸运5开奖号码历史查询:accounts receivable and inventory to support its sales. This could lead to an excessive amount of bad debts or 澳洲幸运5开奖号码历史查询:obsolete inventory.

Analysts also compare working capital ratios to those of other companies in the same industry to gauge 𝔍just how efficient a company is at using its working capital. They look at how the ratio has been changing over time. Such comparisons are meaningless, however, when working capital turns negative because the working capital turnover ratio then also turns negative.

Working Capital Management

Working capital management commonly involves monitoring cash flow, current assets, and current liabilities through 澳洲幸运5开奖号码历史查询:ratio analysis of the key elements of operating expenses. These include working capital turnover, the collection ratio, and the 澳洲幸运5开奖号码历史查询:inventory turnover ratio.

Working capital management helps maintain the smooth operation of the net operating cycle, also known as the 澳洲幸运5开奖号码历史查询:cash conversion cycle (CCC). This is the minimum amount of time required to convert net current assets and liabilities into cash. Financial 澳洲幸运5开奖号码历史查询:insolvency can result and lead to legal tr🌜oubles, liquidation of assets, and potential ba♒nkruptcy when a company doesn't have enough working capital to cover its obligations.

Companies use 澳洲幸运5开奖号码历史查询:inventory management and keep close tabs on accounts receivables and accounts payable to manage how efficiently they use their working capital. Inventory turnover shows how many times a company has sold and replaced inventory during a period and the 澳洲幸运5开奖号码历史查询:receivable turnover ratio ꦬshows how effectively it extends credit and collects debts on that credit.

Special Considerations

A high working capital turnover ratio shows that a company is running smoothly and has a limited need for additional funding. Money is coming in and flowing out regularly, giving the 𓆏business flexibility to spend capital on expansion or inventory. A high ratio may ♋also give the business a competitive edge over similar companies as a measure of profitability.

An extremely high ratio might indicate that a business doesn't have enough capital to support its sales growth, however. The company could therefore soon become insolvent if it doesn't raise additional capital to support that growth.

Important

The working capital turnover indicator may also be misleading when a firm's 澳洲幸运5开奖号码历史查询:accounts payable are very high. This could i🍨ndicate that the company is having difficulty paying its bills as they🐽 come due.

Example of Working Capital Turnover

Say that Company A has $12 million in net sales over the previous 12 months. The average working capitalᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚ during that period was $2 million.

The working capital turnover ratio is therefore $12,000,000 / $2,000,000 = 6.0. Every dollar of working capital produces $6 in revenue.

How Does a Cash Conversion Cycle Work?

A company's cash conversion cycle is an equation that adds its days of outstanding inventory and its days of outstanding sales and then subtracts the days that payables have been outstanding.

Days of outstanding inventory is the average number of days it takes the company to sell its inventory. Days of outstanding sales represent the average number of day𝓡s it takes ꦅthe company to collect on its receivables. Days for payables outstanding equal how many days on average it takes the company to pay what it owes.

The result indicates how long it will theoretically take a company to convert its inventory into cash. It can be used to compare companies but ideally only companies that fall within the same industry.

What Is Working Capital?

Working capital is simply the amount of current assets remaining on the balance sheet after a company's current liabilities are subtracted. It's a measurement of short-term financial health. A positive number typically indicates that the company has sufficient assets to pay off its short-term liabilities within the upcoming year.

What Is Obsolete Inventory?

Obsolete inventory is anything that's held in stock that can no longer be used. It's often the result of plummeting consumer demand for the products in question. Their costs must be either written down or written off the company's books.

The Bottom Line

The working capital turnover ratio measures how well a company uses its working capital to sustain growth and sales. The equation to arrive at the ratio is basic and simple. A high ratio indicates financial efficiency. A low ratio can be a red flag indicating one or more problems. They may include investing in too many inventory-related e🌃xpenses.

Working capital turnover ratios can be efficient and infor💖mative tools when evaluating companies but care should be taken that any companies are in the same industry and share the same inventory models.