Working Capital Turnover Ratio: Definition & Formula

Lending institutions and investors often use financial analysis to evaluate the performance and financial health of a business. One of the many financial ratios often used in corporate finance to determine a company’s short-term liquidity situation is the operational capital turnover ratio. It offers insights into how efficient a business is in managing its working liquidity. 

Understanding what this ratio means, how it is calculated and its various implications are vital. In this comprehensive guide, we’re going to delve deep into the concept of the operational capital turnover ratio.

What is the Working Capital Turnover Ratio?

The working liquidity turnover ratio is a metric that’s used to evaluate a company’s ability to generate revenue using its working capital. The working liquidity is the difference between a company’s current assets and its current liabilities. It is a measure of liquidity and indicates whether a company is capable of meeting all of its short-term obligations or not. 

The working liquidity turnover ratio provides the user with insights into just how efficiently a company utilizes its working capital to support sales and operations during a specific period. Lenders and investors often prefer businesses with a good working capital turnover ratio since it essentially signifies that the company is efficient at managing its financial position. 

How to Calculate the working liquidity Turnover Ratio?

Now that you know what the working capital turnover ratio is, let’s look at how it is calculated. Financial experts use a simple mathematical formula to find out the metric for any given company. Here’s a quick look at what it is. 

Here, net sales refer to the total sales made by the company for the given period after subtracting any sales discounts offered and sales returns made by the customers. The mathematical formula for calculating net sales is as follows.

The average working capital, on the other hand, refers to the difference between the working capital at the beginning of the period and the working capital at the end of the period, divided by

Here’s the mathematical formula used to calculate the average working capital

As you know already, the working capital is calculated by subtracting the current liabilities from the current assets of a company for a specific period.

Also Read: Understanding Working Capital Ratio

What Does the Working Capital Turnover Ratio Tell You?

The operational liquidity turnover ratio is a very important metric that provides key insights into how well a company is managing its operations and its liquidity. Here’s a brief overview of what this ratio signifies. 

1. High Working Capital Turnover Ratio

A company with a high turnover ratio essentially means that it effectively utilizes its operational liquidity to generate sales. For instance, if the turnover ratio is 5, it means that for every rupee of operational liquidity employed, the company generates 5 rupees worth of sales. This reflects strong operational efficiency and swift inventory turnover. 

That said, an extremely high working capital turnover ratio may not always be a positive sign. It could mean that the company doesn’t possess the capital required to support the growth in its sales. To work around such a situation, it could pump in additional funds, obtained either through a business loan online or by selling its equity, to maintain the growth rate.   

2. Low working liquidity Turnover Ratio

A company with a low turnover ratio, on the other hand, essentially means that it doesn’t use its operational liquidity effectively to generate sales. For instance, if the turnover ratio is 0.5, it means that for every rupee of working capital employed, the company generates only 0.5 rupees worth of sales. 

Such a low ratio suggests severe inefficiencies in working capital management and could potentially lead to excess build-up of inventory or inadequate liquidity to meet its short-term obligations. Having a low ratio for an extended period could increase the debt burden and stagnant inventory unless the company takes remedial measures. 

Meanwhile, if the working capital turnover ratio is negative, it could potentially point towards the brink of bankruptcy since the company is spending more operational liquidity and not generating enough sales to even cover the amount it spends. 

It’s worth noting that there isn’t a universally optimal working liquidity turnover ratio for every company. The ideal ratio varies based on factors such as the company’s business model and the specific sector and industry it belongs to. For instance, a turnover ratio of 5 could be considered favorable for a company operating in the automobile sector, especially when considering aspects like managing cash flow and acquiring loan for automobile service. However, the same ratio might appear comparatively low for a company within the FMCG sector due to differences in operational dynamics and capital requirements.

Therefore, it is essential to restrict the operational liquidity turnover ratio comparisons to companies with similar business models operating within the same sector or industry. This way, you can get more accurate information on the company’s real financial standing. Comparing the ratios of companies across different sectors may lead you to make inaccurate financial decisions.

Example of the Working Capital Turnover Ratio

Now let’s look at a hypothetical scenario to understand how the operational liquidity turnover calculation is done. 

Assume you have a business and are involved in the manufacture and sale of automotive components. You wish to find out the operational liquidity turnover ratio of your company for the financial year (FY 2022 – 2023). The key financial details of your company, required for the working liquidity turnover calculation, are as follows.

• The current assets as of April 01, 2022, were ₹72 lakhs
• The current liabilities as of April 01, 2022, were ₹39 lakhs
• The current assets as of March 31, 2023, were ₹82 lakhs
• The current liabilities as of March 31, 2023 were ₹47 lakhs
• The total sales made during the financial year of 2022 – 2023 were ₹9 crores
• The sales discounts provided to your customers during the financial year of 2022 – 2023 were ₹21 lakhs
• The sales returns from your customers during the financial year of 2022 – 2023 were ₹8 lakhs

Now, before you proceed towards the working liquidity turnover calculation, you need to first find out the net sales and the average working liquidity of your business during the financial year of 2022 – 2023.

Now that you have all the required figures, all you need to do is substitute them in the working capital turnover ratio formula. 

Working liquidity Turnover Ratio = 25.61 (₹8.71 crores ÷ ₹34 lakhs)

A ratio of 25.61 basically means that your business generates 25.61 rupees for every rupee of working liquidity employed. It signifies high operational efficiency and a quick turnover of inventory, which is often a positive sign for a business.  

Also Read: How to Calculate the Working Capital Requirement

Conclusion

The working liquidity turnover ratio is a crucial financial metric for evaluating a company’s operational efficiency and liquidity management. However, looking into this particular ratio alone may not always provide you with enough information about a business. Instead, it is advisable to use this ratio along with other financial ratios to get a holistic and comprehensive overview of a company’s financial position and stability.  Lendingkart’s working capital loans are an efficient financial tool for businesses in need, offering loans from 50 thousand to 2 crores with a tenure of 1 to 36 months. The process is quick, entirely online, and does not require collateral. With competitive interest rates, a transparent fee structure, and flexible repayment options, these loans provide a streamlined and accessible way for businesses to secure short-term funding.

This is a fast, fully digital, and hassle-free loan application process without any collateral requirement. The interest rates are attractive and competitive, the fees are clear and transparent, and the repayment options are also flexible. It is a convenient and efficient solution for businesses seeking short-term funding without the complexity of traditional loans.

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