Working capital turnover ratio is the ratio between the total revenue or turnover of a business enterprise to the working capital utilised in the business. Working capital (WC) here denotes the total capital needed to run the daily operations of the company.
The working capital formula is used to assess the net capital by subtracting current liabilities from current assets. Current assets include cash, short-term investments, inventory, etc. Whereas, current liabilities include salaries of employees, bills, loans, etc.
Entrepreneurs mostly opt for working capital loans when the present liabilities exceed current assets. WC turnover ratio is a sign of how effectively a business enterprise is managing its funds.
A positive turnover ratio indicates that the company has streamlined its assets and funds well to run the production efficiently.
On the other hand, a poor turnover ratio signifies that the company has invested more in inventory and has too many debts to clear.
Factors affecting the working capital turnover ratio
The capital requirements of a business vary from one company to another. Thus, it is important for an entrepreneur to identify the various factors affecting the capital requirements to ensure the business never runs out of working capital. Here is the list of such factors-
- Nature and size of the business – Companies involved in manufacturing or trading mostly require a greater amount of capital. Labour-intensive industries also need a huge capital.
- Manufacturing costs – If the manufacturing or production cost of an item is high, the required capital will also be proportionately higher.
- Market Conditions – Market conditions determine how much a company has to spend on advertising, sales promotion, renewing stocks, etc.
- The business cycle – Working capital needs of a company, fluctuates according to the boom and recession period. A business requires much more capital during a boom period as compared to a recession.
- Cash needs – If the present liabilities to pay salaries, rents, bills, etc. are high, the company will require an ample amount of cash to get them paid. This would mean a greater WC requirement.
- Plans of growth and expansion – An entrepreneur eyeing to expand his business will need to maintain a healthy amount of capital to get started with the venture.
Thus, a business owner has to keep a check on inflow and outflow of capital to ensure the company runs successfully. There are also several types of working capital he/she has to be aware of, to manage the capital requirements of the company better.
Working capital formula and example
The turnover ratio is also referred to as the ratio between net sales and working capital. The working capital formula gives a figure to determine how well the company is running its daily business operations.
The turnover ratio is calculated by dividing the total sales of a company by the total capital utilised.
For example, if a company’s annual sales stand at Rs. 6 Crore and the average capital utilised was Rs. 3 Crore, the turnover ratio of the company for that particular year, will be –
WC turnover ratio= 6,00,00,000 / 3,00,00,000
This turnover ratio is likely to vary each year as per the changes in capital employed. An entrepreneur has to be well aware of the turnover ratio of his company to understand the loopholes and requirements of the capital inflow.
If the ratio is on a negative side, the entrepreneur has to ensure he utilises the available funds more efficiently to increase the annual sales.
If he still fails to suffice the capital requirements with the available funds, he can opt for a working capital finance from a reputed financial institution.
The working capital formula helps to determine the liquidity and cash flow status of a company. It is the primary role of an entrepreneur to maintain a proper liquidity ratio for his company to function successfully.