Working Capital Turnover Ratio

Introduction to Working Capital Turnover Ratio

The working capital turnover ratio (WCTR) gives the number of times the working capital is turned over in a year. The number indicates effectiveness in the utilization of working capital such that a higher ratio indicates efficient utilization of working capital and vice versa. The ratio is used to determine the relationship between the funds and the sales of the Company.

Formula

where,

Working Capital = Current Assets − Current Liabilities

Average Working Capital = (Beginning Working Capital + Ending Working Capital) / 2

Examples of Working Capital Turnover Ratio (With Excel Template)

Let’s take an example to understand the calculation of the Working Capital Turnover Ratio in a better manner.

Example #1

Calculate the working capital turnover ratio of a Company ABC Inc. which has a net sales of $ 100,000 over the past twelve months and the average working capital of the Company is $ 25,000.

Solution:

Working Capital Turnover Ratio is calculated using the formula given below

Working Capital Turnover Ratio = Net Sales / Average Working Capital

• WCTR = $100,000 / $25,000
• WCTR = 4

Example #2

Calculate and analyze the working capital turnover ratios of the three companies A, B, and C for the financial year 2019. The numbers are in $ Millions.

Solution:

The following schedule contains the required calculations:

Working Capital Turnover Ratio is calculated using the formula given below

Working Capital = Current Assets − Current Liabilities

Working Capital Turnover Ratio is calculated using the formula given below

Working Capital Turnover Ratio = Net Sales / Average Working Capital

Company A is using its working capital funds most efficiently followed by Company B and then C.

Example #3

Consider the balance sheet and Income statement for Apple Inc.

Source Link: Apple Inc. Balance Sheet 

Solution:

Beginning Working Capital (2018)  is Calculated as

Beginning Working Capital = Total Current Assets − Total Current Liabilities

• Beginning Working Capital = $131,339 – $116,866
• Beginning Working Capital = $14,473

Ending Working Capital (2017) is calculated as

Ending Working Capital = Total Current Assets − Total Current Liabilities

• Ending Working Capital = $128,645 – $100,814
• Ending Working Capital = $27,831

Average Working Capital of Apple Inc.is calculated using the formula given below

Average Working Capital = (Beginning Working Capital + Ending Working Capital) / 2

• Average Working Capital = ($14,473 + $27,831) / 2
• Average Working Capital = $21,152

WCTR is calculated using the formula given below

 WCTR= Net Revenue from Operation (Sales) ÷ Average Working Capital

• WCTR = $59,531/ $21,152
• WCTR = 2.81

Advantages

• The ratio gives an indication of the operations of the Company
• The ratio helps the management to make an informed decision on raising of funds and utilization of the Company’s resources
• The management can decide on business expansion if it feels they have enough funds to continue its operations and build new resources.

Important Points

• WCTR measures the revenue of the Company from the working capital funds available with it.
• its helps the company to understand the relationship between working capital investment and revenue generation.
• The ratio provides an efficiency number on how the Company is run and the funds are managed by the management.
• A higher ratio indicates that the Company is efficiently managed and it provides a competitive edge to the Company against its promoters.
• However, a very high ratio of ~80% may indicate that the Company does not have enough funds to support the growth in its sales further indicating the prospects of the Company being insolvent in the near future due to higher account payables.
• A lower ratio may indicate Company having higher account receivables or inventory assets. High account receivables have credit risk and higher inventory has a risk of going stale which is not good for sales. 

Conclusion

The (WCTR) is a significant indicator of the efficiency of the Company and how well it is doing compared to the competitors. The (WCTR) gives an indication of efficiency in the utilization of the working capital. The analysts and the Company’s management often look at this ratio while doing business analysis. If the ratio is too high or too low than the average ratio of the industry, they should look for outliers in the financials of the Company so to make informed decisions.

1. Stock Turnover Ratio
2. Capital Adequacy Ratio
3. Operating Ratio
4. Cash Flow From Operations Ratio