What is the working capital turnover ratio and how it is calculated

A company’s working capital turnover ratio is used to determine how the company generates sales relative to its working capital. This means the number of net sales generated for each unit of working capital involved in the business.

A large amount of working capital indicates that a company’s current assets are considerably higher than its liabilities. Companies perform different types of analysis to determine if working capital is being used correctly.

Working capital

Working capital is the difference between the current assets and the liabilities of a business. It is the measure of the short-term financial health of a business. If a business’s accounts receivable do not exceed accounts payable, it can have problems paying off creditors and can lead to bankruptcy.

How to calculate the working capital turnover ratio

The working capital turnover can be determined using the simple formulas:

Working capital turnover = Annual net sales / Average working capital.

Suppose a company has a net turnover of Rs. 10 lakhs in the past 12 months, and the average working capital is Rs. 2 lakh. The ratio will then be Rs. 10,000,000 / Rs. 2, 00000 = 5.

A high turnover rate indicates that the business is effectively using its current assets and liabilities to support sales. On the other hand, a low turnover rate indicates that the business has too many liabilities, which can eventually increase the number of bad debts and obsolete inventory.

High turnover of working capital

High turnover in working capital indicates that a business is performing well and does not need additional financing. This involves funds coming in and going out regularly, giving the company the opportunity to expand its business and inventory with capital.

A very high ratio typically above 80% may indicate that a company does not have enough capital to support sales growth. Businesses can take out a working capital loan from different financial institutions to expand their business and support sales growth.

Improve the turnover rate by managing your working capital

A top working capital turnover ratio can be achieved by implementing the following steps to manage working capital –

  • Offer debt incentives

Providing incentives to customers who pay on time will help increase working capital. Customers are more likely to make payments on time if prompted to do so. It will maintain the continuous flow of funds and provide sufficient working capital for expansion.

  • Good stock management

Excessive stock in inventory can clog excess funds. Excessive purchases can affect working capital and therefore reduce the turnover rate. It is very important to have a monthly or quarterly inventory check so that the inventory is not overstocked.

Working capital can be managed by paying off debts on time. Timely payments will reduce such scenarios which can lead to penalties and reduce working capital.

  • Use loans for a short term solution.

Knowing all about several working capital loan FAQs can be a great way to overcome shortage of funds. A business can take out such a loan to expand its business, which can increase sales and increase turnover.

Now let’s see what is the importance of good working capital management and what is its objective:

Here are some important points to highlight why working capital management is important to businesses:

  • Increase in profitability
  • Better liquidity
  • Ensuring a higher return on capital
  • Improve solvency and credit profile
  • Appreciation of commercial value
  • Gain the advantage over competitors
  • Uninterrupted productivity
  • Prepare a business for peak demands

What are the objectives of working capital management

According to a research report on working capital management, its main objectives are:

  • Effortless duty cycle: The primary goal of working capital management is to ensure the effortless operating cycle of the business. This means that the work cycle should never stop due to a lack of liquidity, whether it is for wages, the purchase of raw materials, the payment of taxes or other finances.
  • Minimize the cost of capital or the interest rate: It is essential to understand that the cost of interest on capital is one of the major costs in any business. The management of a company must negotiate well with its financial institutions to choose the right mode of financing while maintaining its optimal capital structure.
  • Optimal rate of return when you invest in current assets: When you run a business, you have to have a liquidity crisis on the one hand and excess liquidity on the other. During the period of excess liquidity, working capital management must have better short-term investments to take advantage of unused funds.
  • Keep working capital low: To keep the working capital turnover ratio as low as possible, it is necessary to acquire favorable credit terms through accounts payable and receivable, efficient inventory management, a faster production cycle, etc.

Increasing working capital by implementing the above-mentioned methods can help achieve high working capital turnover rate. It is very important to maintain a high ratio to keep any business running smoothly. Learn more here

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