Working Capital Turnover Ratio

Updated on May 15, 2024
Article byWallstreetmojo Team
Edited byAaron Crowe
Reviewed byDheeraj Vaidya, CFA, FRM

What is the Working Capital Turnover Ratio?

Working Capital Turnover Ratio helps determine how efficiently the company is using its working capital (current assets – current liabilities) in the business and is calculated by dividing the company’s net sales during the period by the average working capital during the same period.

Key Takeaways

  • The working capital turnover ratio assesses a company’s efficiency in utilizing working capital during operations, calculated by dividing net sales by average working capital.
  • A higher ratio indicates that the company generates more revenue per unit of working capital. Positive working capital occurs when current assets exceed current liabilities.
  • To enhance a low ratio, a company should concentrate on managing inventory levels and debtor/credit management to increase revenue and gain insights for future purchasing and sales strategies. Improving this ratio can lead to better financial performance and resource utilization.

Working Capital Turnover Ratio Formula

It signifies how well a company is generating its sales concerning the working capital. The company’s working capital is the difference between the current assets and current liabilities of a company.

The formula for calculating this ratio is by dividing the company’s sales by the company’s working capital.

Working Capital Turnover Ratio Formula = Sales/ Working Capital
Working-Capital-Turnover-Ratio-Formula

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Working Capital Ratio Explanation Video

 

Interpretation

It signifies how well a company is generating its sales concerning the working capital. The two variables to calculate this ratio are sales or turnover and a company’s working capital. The company’s working capital is the difference between the current assets and current liabilities of a company.

Examples

Let’s see some simple examples for the calculation of the working capital turnover ratio formula to understand it better.

Example#1

Let us try to understand how to calculate the working capital of an arbitrary company by assuming the variables used to calculate working capital turnover.

Suppose for company A, the sales for a particular company are $4000.

Working capital turnover eg 1

Working capital, which is current assets minus current liabilities, is a balance sheet item that is why it is important to take the average of working capital. For the calculation of working capital, the denominator is the working capital. Let’s assume that the working capital for the two respective periods is 305 and 295.

So, the following is the calculation of the Working Capital Turnover Ratio.

Working capital turnover eg 4.1png

The result will be –

Working capital turnover eg 4.2png

Example#2

Let us try to understand how to calculate this ratio of Tata Steel.

Working capital turnover eg 2

For the calculation of working capital, the denominator is the working capital. Working capital, which is current assets minus current liabilities, is a balance sheet item that is why it is important to take the average of working capital. The working capital for Tata steel for the two respective periods is -2946 and 9036

So, the following is the calculation of the Working Capital Turnover Ratio of Tata Steel.

Working capital turnover eg 5.1png

The result will be –

Working capital turnover eg 5.2png

The working capital ratio for Tata steel is 19.83

It is important to look at the working capital ratio across ratios and compare it to the industry to analyze the working capital. A higher ratio generally signals that the company generates more revenue with its working capital. When the current assets are higher than the current liabilities, the working capital will be a positive number. If the inventory level is lesser than the payables, then the working capital is low, which is in this case. That makes the working capital ratio very high.

Example#3

Let us try to understand how to calculate the working capital turnover of Hindalco.

Example 3

Working capital, which is current assets minus current liabilities, is a balance sheet item that is why it is important to take the average of working capital. The working capital for Hindalco for the two respective periods is 9634 and 9006. The below snapshot depicts the variables used to calculate this ratio.

Example 3.1

The result will be –

Example 3.2

The working capital ratio for Hindalco is 1.28.

A lower ratio generally signals that the company is not generating more revenue with its working capital. When the current assets are higher than the current liabilities, the working capital will be a positive number. If the inventory level is lower than the payables, then the working capital is high, which is in this case. That makes the working capital very low. It is important to look at working capital ratio across ratios and compare it to the industry to analyze the formula well.

Working Capital Turnover Ratio Calculator

You can use this calculator

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Working Capital Turnover Ratio Formula
 

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Relevance and Use

A higher working capital generally signals that the company generates more revenue with its working capital. When the current assets are higher than the current liabilities, the working capital will be positive. It is important to look at all the parts that go into the formula. It’s important to analyze whether the ratio is higher or lower due to a high level of inventory or the management of debtors or credits from whom the company buys raw materials or sells their finished goods. It is important to look at the working capital ratio across ratios and also in comparison to the industry to make a good

You can download this Excel Template here – Working Capital Turnover Ratio Formula Excel Template

Frequently Asked Questions (FAQs)

1. Can the working capital turnover ratio be negative?

Yes, the working capital turnover ratio can be negative. A negative working capital turnover ratio occurs when a company’s sales revenue is lower than its average working capital during a specific period. This situation may indicate inefficient use of working capital or potential liquidity issues, as the company is generating less revenue than the funds tied up in its current assets.

2. Is the working capital turnover ratio a profitability ratio?

No, the working capital turnover ratio is not a profitability ratio. An activity or efficiency ratio measures how effectively a company utilizes its working capital to generate sales revenue. Profitability ratios, on the other hand, assess a company’s overall profitability by comparing its earnings with sales, assets, or equity.

3. What are the limitations of working capital turnover?

The working capital turnover ratio doesn’t consider profitability directly, focusing solely on the relationship between sales and working capital. Also, it may not reflect the company’s performance accurately if the sales and working capital levels fluctuate significantly during the measurement period.

This article has been a guide to what is Working Capital Turnover Ratio? Here we discuss how to calculate Working Capital Turnover Ratio and its formula, along with practical examples and downloadable excel sheets. You can learn more about accounting from the following articles –

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