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

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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