In order to run a business, it’s essential to add the secret ingredient, working capital.
Today, numbers and ratios are used to indicate whether a company is profitable, efficient and well-performing.
Accountants have uncountable tools in their arsenal, but one of the most widely used and effective one is working capital turnover.
The working capital turnover shows how effectively is an organization using its working capital.
Furthermore, the main focus of working capital turnover is efficiency, so higher the ratio is, the more efficient it is.
On the whole, a high ratio grants the ability to run your firm’s operations without difficulties and extra funding.
Working Capital Turnover Definition, Formula, Indication, Benefits & Example
Definition – Working capital turnover ratio illustrates the results of how many times did the working capital turned into revenue.
Furthermore, working capital turnover ratio can be compared to your previous records or with your competitors to find out whether your working capital is well-organized or not.
Also, one of the greatest advantages of working capital is being capable of predicting the financial difficulties your company might face in the near future, that may be caused by temporary cash flow or other unexpected factors.
As for the formula, it looks like this: Working Capital Turnover = Net Annual Sales / Working Capital
Indication – Your effectiveness in utilizing working capital to generate sales is regulated by your turnover ratio and the higher it is, the better.
Though, sometimes high working capital turnover ratio can be misleading. Apparently, it may seem as you’re operating at a high efficiency, yet your working capital is vulnerable due to being low.
In this case, it’s highly possible for your company to run out of money and stop funding. So, being cautious is essential while taking important decisions.
Benefits of a High Ratio – In order to gain the edge over your competitors, fully understanding and using working capital turnover is essential, because it gives a precise idea about your company money flow. And this information grants the ability to avoid financial problems.
Example – If a firm’s net sale for 2009 was 200,000$ and the monthly working capital was 20,000$, then 200,000 divided by 20,000 equals 10, so the working capital turnover ratio is 10. This means that the firm’s sales numbers are ten times bigger than the working capital.
Determining a High Turnover Ratio – In most cases, turnover ratio is thought to be high when it exceeds the similar businesses in your marketplace. And to not overdo it, setting a benchmark on turnover ratios is a wise thing to do.
Furthermore, the benchmark mustn’t set by us, but after thoroughly analysing our competitors, because they sell almost identical products and are more likely to have the same business structure.
For instance, if four of your competitors turnover ratios are 4, 4.6, 5 and 3,6, your ratio is 7,5 it’s considered as high because it exceeds theirs.
Working capital turnover is an effective tool in order to determine whether your company is profitable, efficient and well structured.
Keeping your turnover ratio high is important to gain and maintain the edge over your competitors, but it’s vital to not overdo it because it has the potential to severely damage your business.