Home Blog Working Capital Turnover (What It Is And How It Works: Overview)

Working Capital Turnover (What It Is And How It Works: Overview)

What is Working Capital Turnover?

How do you calculate capital turnover?

How does it work?

Keep reading as I have gathered exactly the information that you need!

Let’s see what working capital turnover means and why it’s important!

Are you ready?

Let’s get started!

What Is Working Capital Turnover

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.

In principle, the working capital turnover (or net working capital turnover) measures how much money a company required to run the business compared to its ability to generate revenues from operations.

In other words, if a company is able to generate more revenues and profits from every dollar of money available in working capital means that the company is more efficient at using its working capital.

According to Investopedia, working capital turnover is defined as follows:

Working capital turnover is a ratio that measures how efficiently a company is using its working capital to support sales and growth.
Author

As you can see from this definition, a company’s operating working capital turnover can be summed up as:

  • A measure of efficiency 
  • Between a company’s working capital 
  • And how much revenue it generates 

In essence, when a company has higher capital turnover ratios than compared to its peers and competitors, it is more efficient at generating sales for every dollar of working capital spent.

Working Capital

To understand working capital turnover, we must first understand the meaning of “working capital”.

Working capital is a company’s total assets less total liabilities. 

When a business is able to generate sales, collect the funds, produce goods and services, generate new sales, and so on, it needs to have a good handle on its cash management, working capital, and cash conversion cycle.

Working capital allows a company to pay business operations, expenses, costs, bills, invoices, and support the company in generating revenues.

By keeping a sufficient amount of money in its working capital, a company is able to fund its business needs for a certain period of time without running the risk of having operational liquidity issues.

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.

Factors Affecting Working Capital

There are several factors that will have a direct impact on a company’s working capital:

  • How much money a company has in its bank accounts
  • How well it collects its account receivables 
  • How well it is able to sell goods kept in inventory 
  • The availability of lines of credit of other sources of funding

Money in the bank account will serve as an immediate source of funds to pay for any short-term financial obligations or business operational expenses.

If the company does not have the money sitting in the bank account, the next source of funding is from customers paying their invoices and how well a company is able to collect on outstanding accounts.

Then, a company can generate more working capital by selling goods and merchandise it has in its inventory to customers (leading to the company invoicing for the goods sold and then collecting).

Many companies also have a line of credit that they can use to manage ups and downs in their cash needs if they do not have enough cash in their bank accounts or money coming in from the collection from their account receivables.

Why Working Capital Turnover Is Important

Companies and business organizations want to use their capital as efficiently as possible to run their business.

In this process, a company will want to calculate its net working capital turnover to see how efficiently it is using its available capital to fund its business operations in relation to how much sales it is able to generate. 

For this reason, a company will want to measure its working capital turnover to assess how well it is able to use its current assets and liabilities to support business sales and the growth of the business.

The higher the NWC ratio, the more a company is efficient in using its working capital to support sales.

On the other hand, when the capital turnover ratio formula provides a lower figure, it means that the company’s current assets are more tied up in accounts receivable or inventory which may not support sales as much.

Capital Turnover Formula

How to calculate capital turnover?

The working capital turnover equation is as follows:

WCT = NAS / AWC
Author
  • WCT = Working Capital Turnover
  • NAS = Net Annual Sales
  • AWC = Average Working Capital 

The Net Annual Sales represents the company’s gross sales less any discounts or allowances.

The Average Working Capital is the company’s average current assets less its average current liabilities.

Another way of presenting the capital turnover formula is as follows:

WCT = NS / ](BWC + EWC) / 2]
Author
  • WCT = Working Capital Turnover
  • NS = Net Sales
  • BWC = Beginning Working Capital (for the period)
  • EWC = Ending Working Capital (for the period)

This formula is used to calculate the WCT over a one-year period or a trailing 12-month period.

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.

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.

You can find a capital turnover calculator online if you want to do a quick calculation and there is finance and accounting software that you can get to provide you further insights into your working capital management and utilization.

Working Capital Turnover Ratio

What does the capital turnover ratio provide as information?

The information provided by the working capital turnover ratio is important in the overall process of working capital management operations.

Having a good handle of your company’s cash flow is crucial to be able to manage the current business operations and execute intended business projects.

There are a few ratios that are crucial in providing a company with information about its financial positions and how working capital is impacted, namely:

  • Working capital turnover
  • Collection ratio or receivable turnover ratio 
  • Inventory turnover ratio

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.

In this context, companies are interested to know how quickly they can convert their current assets and liabilities into cash so they can internally continue funding the business.

To the extent a company is able to convert its accounts receivables, inventory, and short-term assets into cash in a timeframe allowing it to satisfy its financial obligations, then the company is in a good cash posture.

However, if a company is unable to convert its short-term assets into cash to replenish its working capital, then it may face cash shortages leading it to financial troubles.

Working Capital Turnover Example

Let’s look at an example of working capital turnover to better illustrate the concept.

Imagine that a company has:

  • Net sales in the past 12 months: $10,000,000
  • Working Capital at beginning of period: $6,000,000
  • Working Capital at the end of the period: $2,000,000

In this case, the working capital turnover ratio will be $10,000,000 / [($6,000,000 – $2,000,000) / 2].

As a result, the working capital turnover ratio will be 5.

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.

On the other hand, if the ratio is too high, it may suggest that the company will not have enough capital to support sales growth or the company may potentially become insolvent.

Capital Turnover Takeaways 

So there you have it folks!

What is capital turnover?

How do you calculate working capital turnover?

What is a good working capital turnover ratio?

The working capital turnover refers to a company’s ability to convert its short term assets into cash to fund business operations.

The “working capital turnover ratio” is a measure of how efficiently a company is utilizing its working capital to support sales.

By definition, working capital is the company’s current assets less its current liabilities.

When a company has a high capital turnover ratio, it means that it is good at converting its short term assets and liabilities to support business operations leading to sales.

A low ratio can suggest that the company’s capital is getting stuck in inventory or account receivables and the company is not converting them to cash as quickly as they should.

Not managing inventory properly can lead to obsolete inventory assets.

Similarly, the lack of account receivable management can lead to bad debt and account write-offs.

In the end, working capital turnover and calculating the working capital turnover ratio is an important process of properly managing a company and ensuring that it can meet its business operational needs and handle its current liabilities.

My Investing, Business, and Law Blog

By the way, on this blog, I focus on topics related to starting a business, business contracts, and investing, making money geared to beginners, entrepreneurs, business owners, or anyone eager to learn. 

Just so you know who I am and where I come from, a little about me…

I have a university degree in finance and law. 

I have worked in an international financial institution dealing with the stock market, stock, bonds, corporate financing, and securities.

I practiced law in private practice where I advised and consulted entrepreneurs and business owners on many aspects of their business, such as how to start new business ventures, how to scale their business, how to navigate commercial contracts, and how to set themselves up for success. 

I also acted as an in-house counsel and eventually as the General Counsel in a rapidly growing technology company going through hypergrowth, dealing with international Fortune 500 clients, and operating internationally. 

Let me tell you, in my career, I’ve learned a lot about business, investing, investment decisions, business decisions, and law. 

I started this blog out of my passion to share my knowledge with you in the areas of finance, investing, business, and law, topics that I truly love and have spent decades perfecting.

You may find useful nuggets of wisdom to help you in your entrepreneurship journey and as an investor.

Hey You!
Looking For Real Actionable Tips To Reach Your Financial And Business Goals?

If you’re interested in my actionable tips, guides, and knowledge on how to achieve your financial and business goals, subscribe to my blog and I’ll share with you my premium and exclusive content that will blow you away!

I’d love to share the insider knowledge that I’ve acquired over the years helping you achieve your business and financial goals.

Now, let’s look at a summary of our findings.

Working Capital Turnover Overview

  • The working capital turnover ratio is the result of an analysis measuring the relationship of net sales to the company’s average working capital 
  • It’s a measure of how money is used to finance a company’s business operations and how much revenue a company was able to generate during the same period of time
  • To calculate the capital turnover, you need to divide your net sales by your average working capital for the period 
  • The higher your working capital turnover and ratio, the better a company is deploying its cash resources to fund the business (money is easily coming in and going out of the business)
Accounting software 
Cash conversion cycle 
Cash ratio
Current ratio
Financial management software 
Financial ratios 
Inventory turnover 
Invested capital 
Liquidity ratios 
Merchandise turnover 
Net sales to working capital 
Operating cash flow margin
Operating cash flow ratio
Profitability ratios
Quick ratio
Receivable turnover ratio
Retention ratio
Revolving line of credit 
Solvency ratios
Turnover period 
Turnover rate 
Valuation ratios 
What are accounts payable 
What are accounts receivable
What is working capital
Author
Accounting system 
Accounts receivable 
Balance sheet
Cash flow forecast
Cash flow statement 
Company liquidity 
Corporate finance 
Cost of goods sold
Current assets
Current liabilities
Current ratio
Deferred revenues 
Deferred taxes 
Financial analyst 
Financial modeling 
Gross working capital 
Income statement
Net operating working capital 
Net working capital
Offset definition 
Operating cash flow 
Operating income
Operational efficiency
Weighted Average Cost of Capital (WACC)
Venture debt
Author
Editorial Staff
Hello Nation! I'm a lawyer by trade and an entrepreneur by spirit. I specialize in law, business, marketing, and technology (and love it!). I'm an expert SEO and content marketer where I deeply enjoy writing content in highly competitive fields. On this blog, I share my experiences, knowledge, and provide you with golden nuggets of useful information. Enjoy!

Most Popular

Form LLC-12 (What It Is And How It Works: All You Need To Know)

Form LLC-12 (What It Is And How It Works: All You Need To Know)

Form SI-550 (What It Is And How It Works: All You Need To Know)

Form SI-550 (What It Is And How It Works: All You Need To Know)

Biennial Statement (New York: What It Is And How It Works)

Biennial Statement (New York: What It Is And How It Works)

Tender of Delivery (Legal Definition: All You Need To Know)

Tender of Delivery (Legal Definition: All You Need To Know)

UCC 2 601 (Explained: Buyer’s Rights on Improper Delivery)

UCC 2 601 (Explained: Buyer’s Rights on Improper Delivery)

UCC 2 508 (Explained: Cure By Seller of Improper Tender)

UCC 2 508 (Explained: Cure By Seller of Improper Tender)

UCC 2 612 (Explained: Installment Contracts And Its Breach)

UCC 2 612 (Explained: Installment Contracts And Its Breach)

Substantial Performance (Contract Law: All You Need To Know)

Substantial Performance (Contract Law: All You Need To Know)

Editor's Picks

Night Depositories (What Are They And How They Work: Overview)

Night Depositories (What Are They And How They Work: Overview)

How To Start A Business In New Hampshire [Step-By-Step Ultimate Guide]

How To Start A Business In New Hampshire [Step-By-Step Ultimate Guide]

Letter of Good Standing (What Is It And How To Get It?)

Letter of Good Standing (What Is It And How To Get It?)

Capital Outlay (Definition, Examples And Why It’s Important)

Capital Outlay (Definition, Examples And Why It’s Important)

System Audit Basics (Understand The System Auditing Process)

System Audit Basics (Understand The System Auditing Process)

Coterminous (Legal Definition And Contracts: All You Need To Know)

Coterminous (Legal Definition And Contracts: All You Need To Know)