A Guide to Working Capital Turnover Ratio: Definition and Formula

Introduction

Working capital is the difference between the current assets and current liabilities of a company; it can be cash, accounts receivable, or inventory minus them with accounts payable and short-term debts. The figure is important, as it is the available money for working capital to fulfill its present needs.

This is an important indicator to know the number of times a company can replace its working capital with sales during a given period. The factor points out how efficiently a company utilizes its working capital to raise revenues. A high ratio generally signifies that the concern is raising a great deal of sales relative to its working capital. Such working capital represents good operational efficiency mostly.

It may be a low ratio in case the company is not efficiently employing its working capital. A collateral-free business loan can be an option for dealing with such deficiencies.

Working Capital Turnover Ratio Calculation

 The formula is self-explanatory:

• Working Capital Turnover Ratio = Net Sales / Average Working Capital

• It refers to the net sales after subtracting returns, allowances, and also discounts.

• The working capital average is the average between the working capital of a company at the start of a specific period and the working capital at the end of that period.

 

The formula to calculate Working Capital is;

Working Capital = Current Assets – Current Liabilities.

Steps to Calculate:

1. Calculate Net Sales: Derive total sales for the period. Be sure to add back deductions including discounts, allowances, and return.
2. Calculate Average Working Capital:

• Determine the working capital at the beginning of the period (opening balance).
• Determine the working capital at the end of the period (closing balance).
• Average Working Capital= (Beginning Working Capital + Ending Working Capital) / 2.

1. Apply the Formula: Divide net sales by the working capital average to get the working capital turnover ratio, as shown in the below scenario;

Example of the Working Capital Turnover Ratio;

Situation: X Manufacturing company is getting ready to determine its working capital turnover ratio for the year 2024.

The following data is given:

- Net Sales: ₹50 Lakhs.

- Open Working Capital are;

• Current Assets of ₹12 Lakhs
• Current Liabilities of ₹4 Lakhs

So, as per the given example;

= ₹12 Lakhs – ₹4 Lakhs

Hence the Open Working Capital is = ₹8 Lakhs.

- Final Working Capital:

• Current Assets: ₹16 Lakhs.
• Current Liabilities: ₹5 Lakhs.

Working Capital = ₹16 Lakhs – ₹5 Lakhs = ₹11 Lakhs.

Step 1: Calculate Average Working Capital:

Average Working Capital= Initial Working Capital + Final Working Capital/2

Average Working Capital= ₹8 Lakhs + ₹11 Lakhs​/2 =₹9.50 Lakhs.

Step 2: Apply the Working Capital Turnover Ratio Formula:

Working Capital Turnover Ratio= Average Working Capital/Net Sales​

Working Capital Turnover Ratio= ₹50 Lakhs/₹9.50 Lakhs = 5.26

So, here the working capital turnover ratio of X Manufacturing company stands at 5.26. Meaning that for every 1 rupee of working capital, the company generates sales of ₹5.26.

A higher ratio quite obviously shows the effective use of working capital. But a very high ratio will also show an inadequate amount of working capital which can again lead to liquidity issues in the company. So maintaining a balanced working capital turnover ratio is very important.

Conclusion

 As an MSME business owner, it is always important to understand the business status and how to overcome the financial struggle and future risks. Here working capital turnover ratios will work to contribute more to effective operations, financial capability, and finally, long-term success for the MSME business owner. Using the formulas above with examples of calculations, as an MSME owner you can also learn how to maintain and use working capital turnover ratios for your business.

Since the usage of a customer-centric approach to empower the MSME and boost economic growth, NBFCs are one of the best working capital lenders for MSMEs because they provide customized financial solutions that are flexible in nature, easily accessible, and support specifically to the needs of the small business, they become one of the best options for MSMEs.

Additionally, some NBFCs offer free digital workshops for their customers, covering various business-related topics, these sessions provide additional knowledge, and business owners can implement these ideas to drive growth and improve operations, this is something that some of the MSME business owners sometimes seek.