How to Calculate Working Capital Turnover Ratio
What is the Working Capital Turnover Ratio?
The Working Capital Turnover Ratio indicates how effective a company is at using its working capital. In other words, it displays the relationship between the funds used to finance the company’s operations and the revenues the company generates as a result.
How to Calculate the Working Capital Turnover Ratio?
The Working Capital Turnover Ratio is calculated by dividing the company’s net annual sales by its average working capital.
Working Capital is calculated by subtracting total liabilities for total assets.
What Does It Tell You?
Calculating Working Capital Turnover Ratio provides a clear indication of how hard you are putting your available capital to work in order to help your company succeed. The more sales you bring in per dollar of working capital deployed, the better. Therefore, a high turnover ratio indicates management is being very efficient in using its short-term assets and liabilities to support sales.
A low ratio indicates your business may be investing in too many accounts receivable and inventory to support its sales. This could lead to an excessive amount of bad debts or obsolete inventory.
The best way to use Working Capital Turnover Ratio is to track how the ratio has been changing over time and to compare it to other companies in the same industry. Doing so shows how you compare against your competitors and will push you to design more efficient uses for your working capital.
Pros & Cons of High Working Capital Turnover
- Shows your company is running smoothly.
- Indicates there is limited need for additional funding.
- May give your company a competitive edge over thee competition.
- An extremely high ratio (80%+) indicates your company does not have enough capital to support its sales growth.
- The company could become insolvent in the near future.
Acquiring Working Capital with Alternative Financing
Many growing companies are looking to alternative financing structures as a more flexible way to access the working capital they need while minimizing equity dilution.
Revenue-Based Financing provides company with working capital in exchange for a percentage of future monthly revenue. You can monitor the Working Capital Turnover Ratio to make sure you are optimizing use of the working capital.
Venture Debt is a financing structure similar to that of a traditional bank loan. It requires fixed monthly interest payments and is used by companies experiencing rapid growth.