Working Capital Turnover Ratio Definition & Calculation

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. 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. It’s important for a business to have sufficient funds in the short term to pay for its business and provide funding to all areas of the business driving sales and revenues. The metric is meant to help you compare how efficient your operations are to your competitors or others in your industry.

  • When the ratio is high, it indicates that the company is running smoothly and is able to fund its operations without additional sources of funding.
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  • The higher the ratio, the more efficient your business is at meeting short-term debts.
  • Working capital turnover, also known as net sales to working capital, is an efficiency ratio used to measure how the company is using its working capital to support a given level of sales.
  • Monitoring and analyzing working capital turnover ratio is crucial to staying ahead of competitors, securing credit lines, and making informed business decisions.

The higher the ratio, the more efficient your business is at meeting short-term debts. A high ratio helps your company’s operations run smoothly and limits the need to secure additional funding. The working capital turnover ratio is calculated by dividing net sales by the average working capital during a specific period. Effective working capital management requires the use of ratios, such as working capital turnover and inventory ratios, among others.


Working capital turnover refers to a ratio providing insights as to the efficiency of a company’s use of its working capital to run the business and scale. If three of your closest competitors have working capital turnover ratios of 5, 4, and 6, and you have a ratio of 7, your ratio is high because it exceeds that of your competition. Looking at the surface, both companies have generated the same amount of sales. Blue Company, on the other hand, had $500,000 in sales and $125,000 in working capital. Blue Company spent its working capital only four times throughout the year to generate the same level of sales as Red Company. Another important factor to consider when interpreting the working capital turnover ratio is the seasonality of the business.

It’s also meant to shed light on whether your operations are making progress every year. The inventory turnover rate indicates how many times the company has sold and replaced its entire inventory during an accounting period. The receivable turnover rate shows how effectively it extends credit and collects debt on that credit. Let’s say that the Yellow Company finishes the year with $2.1 million dollars in sales and $200,000 and $400,000 in working capital at the beginning and the end of the year. That said, if your working capital turnover ratio is too high, it may be misleading.

  • To bring context and to see why this metric is so important for measuring business efficiency, let’s take a look at a few examples.
  • The formula measures how funds go into operations and generate profits for your organization.
  • The turnover ratio portrays the efficiency at which a company’s operations can create sales, which supports the statement from earlier about net working capital (NWC) being preferable over working capital.
  • It’s important for a business to have sufficient funds in the short term to pay for its business and provide funding to all areas of the business driving sales and revenues.

For example, a retail business may have a higher ratio during the holiday season due to increased sales, but a lower ratio during slower months. It is important to take into account the timing of sales and the impact it may have on the ratio. Experts say that a capital turnover ratio calculation of 1.5 to 2.0 is good. If the number is too high, it’s a working capital indicator that your available funds are too low. It tells you whether or not your leadership is good at managing cash flow within the organization.

What does a negative working capital turnover ratio mean?

The working capital turnover ratio measures how well a company is utilizing its working capital to support a given level of sales. A high turnover ratio indicates that management is being extremely efficient in using a firm’s short-term assets and liabilities to support sales. The working capital turnover ratio and inventory turnover ratio are two different but related metrics. In essence, it is an efficiency ratio that shows how well a company manages its inventory levels. Both ratios are essential for understanding a company’s financial health, but working capital turnover ratio analyzes the broader set of assets, whereas inventory ratio is more focused on inventory management alone. As a key financial ratio, the working capital turnover ratio measures a company’s efficiency in managing its working capital (i.e., current assets and current liabilities).

Working Capital: Formula, Components, and Limitations

In particular, comparisons among different companies can be less meaningful if the effects of discretionary financing choices by management are included. Carbon Collective is the first online investment advisor 100% focused on solving climate change. We believe that sustainable investing is not just an important climate solution, but a smart way to invest.

Hence, as a business person, understanding your company’s working capital turnover ratio is essential for long-term financial success. Working capital is also a measure of a company’s operational efficiency and short-term financial health. If a company has substantial positive NWC, then it could have the potential to invest in expansion and grow the company. If a company’s current assets do not exceed its current liabilities, then it may have trouble growing or paying back creditors. The working capital turnover ratio is one of the key ratios that investors and businesses use to measure a company’s financial health. This ratio is especially important for small businesses that often have limited financial resources.

Understanding the Concept of Working Capital Turnover Ratio

However, a lower working capital ratio means that the amount employed in working capital is higher and that the turnover is not up to the mark. In other words, the turnover is lower than the minimum levels as per the given amount of working capital employed. A low ratio can indicate over investment in current assets that are not supported by current sales. This can result in inventory obsolescence or accounts receivable bad debt writeoffs.

What Does Working Capital Turnover Mean for Your Business?

The information provided by the working capital turnover ratio is important in the overall process of working capital management operations. Keeping track of how well a company is using its working capital to support sales can give a good indication of a company’s ability to effectively use its short-term assets to help grow the business. To see how a company is progressing in time, many organizations will measure use the capital turnover equation to measure their ratio and compare their current results to past ones. The better a company is able to produce, sell, invoice, and collect its invoices, the more efficient it can get in managing its cash flows and business cash needs.

However, unless the company’s NWC has changed drastically over time, the difference between using the average NWC value and the ending balance value is rarely significant. To calculate the turnover ratio, a company’s net sales (i.e. “turnover”) must be divided by its net working capital (NWC). In practice, the working capital turnover metric is a useful tool for evaluating how efficiently a company uses its working capital to produce more revenue. The Working Capital Turnover is a ratio that compares the net sales generated by a company to its net working capital (NWC). The disadvantage of the working capital turnover ratio is that it varies widely across and between industries and companies; therefore, for comparison purposes, compare. In other words, this ratio shows the net sales generated as a result of investing one dollar of working capital.

Without proper management of Working Capital, a business can be stuck in between. A company must continuously monitor its Working Capital and immediately take corrective actions when required. Positive Working Capital means that a business has sufficient short-term funds to pay off its short-term liabilities and is suitable for business. 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.

By understanding the working capital turnover ratio, companies can identify opportunities for improvement in managing their working capital and use this knowledge to make better business decisions. A higher working capital turnover ratio indicates a company efficiently uses its resources to generate sales and that it is more likely to meet its short-term financial obligations. On the other hand, a low ratio could indicate poor management of working capital that could lead to financial difficulties in the long run. The working capital turnover ratio is a financial ratio that measures the efficiency of a company in utilizing its working capital to generate sales revenue.

To match the time period of the numerator with the denominator, using the average NWC balances between the beginning and ending periods is recommended. The sales of a business are reported on its income statement, which tracks activity over a period of time. The working capital turnover ratio is also known as net sales to working capital.