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Working Capital Turnover Ratio:

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Definition and Explanation:

Working capital turnover ratio establishes relationship between cost of sales and net working capital. As working capital has direct and close relationship with cost of goods sold, therefore, the ratio provides useful idea of how efficiently or actively working capital is being used.

Interpretation of this ratio should be done when inter-firm or inter-period comparison is being done. Increasing ratio indicates that working capital is more active; it is supporting, comparatively, higher level of production and sales; it is being used more intensively.

Formula:

Working capital turnover ratio =  Cost of sales / Average net working capital

Where,

cost of sales = Opening stock + Net purchases + Direct expends - Closing stock

Net working capital = Current assets - Current liabilities

Average of networking capital is calculated, as usual, opening + closing dividing by 2. However, if the information regarding cost of sales and opening balance of networking capital is not available then the formulae should be substituted as:

Net sales / Net working capital


Example:

From the summarized balance sheet given below of a company calculate working capital turnover ratio.

  2000 2001
  $ $
Equity 1,24,000 1,22,000
Long term loans 1,10,000 80,000
Current liabilities 74,000 1,38,000
 

  3,08,000 3,40,000
 

Fixed assets 2,08,000 1,98,000
Current assets 1,00,000 1,42,000
 

  3,08,000 3,40,000
 

Your are informed that sales (net) during 2000 and 2001 amounted to $6,00,000 and $5,00,000 respectively and Gross profit for the two years was $80,400 and $60,801 respectively.

Working Notes:

 Ascertaining cost of sales: 2000 2001
  $ $
  6,00,000 5,500,000
Loss gross profit 80,4000 60,8000
Cost of sales

  5,19,600 4,39,200
 

Ascertaining networking capital: 2000 2001
  $ $
  1,00,000 1,42,000
Current assets 1,00,000 1,42,000
Less current liabilities 74,000 1,38,000
 

Net working capital 26,000 4,000
 

Average networking capital cannot be calculated for the year 2000 because opening figure is not available. Hence we shall use closing balance.

Average networking capital for the year (2001)

(Opening + Closing) / 2

= (26,000 + 4,000) / 2

= 30,000 / 2

= $15,000

Working capital turnover ratio (2000)

= Cost of sales / Net working capital

= 5,19,000 / 26,000

20 times (app.)

Working capital turnover ratio (2001)

= Cost of sales / Average networking capital

= 4,39,200 / 15,000

= 29 times (approx.)

More study material from this to
 

More study material from this topic:

Meanings, Nature and Usefulness of Ratios Analysis
Interpretation of Ratios
Important Factors for Understanding Ratios Analysis
Significance and Usefulness Ratios Analysis
Classification of Ratios
Analysis of Short Term Financial Position or Test of Liquidity
Current Ratio
Quick/Acid Test/Liquid Ratio
Absolute Liquid Ratio
Inventory/Stock Turnover Ratio
Debtors / Receivable Turnover Ratio
Creditors / Payables Turnover Ratio
Working Capital Turnover Ratio
Profitability Ratios
Gross Profit Ratio (GP Ratio)
Operating Profit Ratio
Net profit ratio (NP ratio)
Earnings Per Share Ratio
Operating ratio
Expense ratio
Solvency ratios - Test of Long Term Solvency
Debt-equity Ratio
Debt Service Ratio or Interest Coverage Ratio
Fixed Assets Ratio
Debts to Total Funds or Solvency Ratio
Reserves to Capital Ratio
Capital Gearing Ratio
Proprietary Ratio
Accounting Ratios Formulas
Limitations of Ratios Analysis

 

A D V E R T I S E M E N T

 

Financial Accounting Topics


  Introduction to Accounting
 ----------------------------------------------------------------------------
  Transactions and Accounting Equation
----------------------------------------------------------------------------
  Analysis of Business Transactions
----------------------------------------------------------------------------
  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
----------------------------------------------------------------------------
  Special Journals
----------------------------------------------------------------------------
  Cash Book
----------------------------------------------------------------------------
Bank Reconciliation Statement
----------------------------------------------------------------------------
  Final Accounts
----------------------------------------------------------------------------
  Work Sheet
----------------------------------------------------------------------------
  Capital and Revenue Items
----------------------------------------------------------------------------
  Valuation of Inventories
----------------------------------------------------------------------------
  Accounts of Non-profit Making Organizations
----------------------------------------------------------------------------
  Statement of Cash Flows
----------------------------------------------------------------------------
  Accounting Ratios Analysis
----------------------------------------------------------------------------
  Depreciation, Provisions and Reserves
----------------------------------------------------------------------------
  Accounting Dictionary
----------------------------------------------------------------------------
  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
----------------------------------------------------------------------------
  Materials and Inventory Cost Control
----------------------------------------------------------------------------
  Activity Based Costing System
----------------------------------------------------------------------------
  Standard Costing and Variance Analysis
----------------------------------------------------------------------------
  Balanced Scorecard
----------------------------------------------------------------------------
  Capital Investment Analysis/Capital Budgeting
 

 

 

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