Working capital turnover ratio (WCTR) is the ratio between the total sales and working capital of a business.
The ratio determines how well a company is generating revenue by utilising the assets at disposal. Companies may perform various analytical techniques to calculate Working capital turnover ratio. It is of utmost importance to check the ratio from time to time to ensure the company maintain liquidity.
Significance of WCTR
A high turnover ratio indicates demonstrates that a company is using the available capital in an effective manner for continuous production. It also means that it is managing its resources effectively to generate optimum output. Slight changes in the sales or demand will not create any issue to manage inventory.
On the other hand, a negative turnover ratio may indicate that a firm currently has too many liabilities. It also suggests that it is investing more than required in the inventory. Such incidents can create a huge debt or inventory shortage.
Calculation using formulae
The formulae to calculate WCTR is:
WCTR= Net sales/Working capital (WC).
Here, net sales are the difference between sales and returns while WC is the difference between current assets and current liabilities.
Suppose a company has net sales of Rs. 60, 000 and a capital of Rs. 20,000. Therefore, the WCTR will be Rs. 60,000/Rs. 20,000 = 3. It indicates that 3 units of business are generated for every 1 unit of capital utilised.
Benefits of a high ratio
A high WCTR may provide a competitive edge to a company in the market. It indicates that the money is smoothly flowing in and out of business. Also, it provides flexibility to the companies and allows them to use up the funds if required. Companies with a high WCTR ratio is more likely to adapt to inventory shortages if there is a sudden rise in demand.
However, a high ratio may not be indicating the efficiency of a firm every time. In reality, a company with extremely low capital can have a high ratio as well. It could mean that it is likely to run out of funds to meet its operational expenses. In such cases, it should ensure that they maintain considerable WC to support smooth operations. Here are a few techniques by which a company can ensure that they never run out of working capital.
- Ensure regular payments
Regular payments from the clients ensure that the current assets are greater than current liabilities all the time. Companies should take the necessary steps to receive all the payments. They should keep a record of every transaction so that no payment is missed. High working capital helps your business to stay agile.
- Manage the date of payments
Companies should ensure that they pay their suppliers after they receive the funds from the clients. Managing the timeline properly will ensure that they do not face a shortage of capital at any point of time.
- Avail a credit
Companies can avail a working capital loan from any leading financial institution to increase the amount of funds available to them to perform day to day operations. It comes with a high loan amount to ensure that it caters to every need.
With this information on working capital turnover ratio, you will be able to ensure the smooth operation of your company. Also, ensure that you develop a unique marketing plan to boost your sales and subsequently increase the amount of capital that you can work with.