Working Capital Turnover Ratio
Working Capital Turnover Ratio is an efficiency ratio that measures the efficiency with which a company is using its working capital in order to support the sales and help in the growth of the business.
Working capital is very essential for the business. It is defined as the difference between the current assets and current liabilities and working capital turnover ratio establishes a relationship between the working capital and net sales generated by the business.
In other words, working capital turnover ratio deals with the relationship between the funds that are used for financing the business operations and the revenue generated from the business.
If a business is accounting for accounts receivable that is lower than the accounts payable, there is a high chance that the business will not be able to pay off its creditors and that can lead to bankruptcy.
Higher levels of working capital turnover ratio shows that a business is managing the short term assets and liabilities very efficiently.
t is advisable not to have a very high level of working capital as it indicates that the company or the business is undergoing low capital situation which is bad for the business growth.
Whereas, in the case of low levels of capital turnover ratio it shows that there is insufficient sales generated by the business with respect to the working capital employed.
In practical situations, it might be difficult to provide the net sales by a company, in such cases the cost of goods sold or the cost of revenue from operations are considered for calculating the working capital turnover ratio.
Calculating Working Capital Turnover Ratio
Working capital turnover ratio can be calculated by dividing the net sales done by a business during an accounting period by the working capital.
It can be represented in the form of a formula as follows
Working capital Turnover ratio = Net Sales / Working Capital
Where,
Net Sales = Total Sales – Sales Return
and , Working capital = Current assets – Current Liabilities
Or
Working Capital Turnover Ratio = COGS / Working Capital
Where, COGS = Net Sales – Gross Profit
And, COGS = Opening Stock + Purchases – Closing Stock
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Let us understand the application of working capital turnover ratio by a solved example
Solved Example
Q. Eastern Company has the following information provided from its operations.
Sales = ₹500,000
Sales return = ₹80,000
Current assets = ₹100,000
Current Liabilities = ₹40,000
Calculate the working capital turnover ratio based on the above information
Answer:
We know that,
Working capital Turnover ratio = Net Sales / Working Capital
And Net Sales = Total Sales – Sales Return
Here, Total Sales = 500,000
Sales Return = 80,000
Therefore, Net Sales = 500,000 – 80,000
= 420,000
Now, working capital = Current assets – Current liabilities
= 100,000 – 40,000
= 60,000
Putting the values in the formula of working capital turnover ratio, we get
Working capital Turnover ratio = Net Sales / Working Capital
= 420,000 / 60,000
= 7
This means that for every ₹1 spent on the business it is providing net sales of ₹7.
This concludes our article on the topic of Working Capital Turnover Ratio, which is an important topic in Class 12 Accountancy for Commerce students. For more such interesting articles, stay tuned to BYJU’S.
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