Working Capital Turnover Ratio: Meaning, Formula, Significance and Examples

working capital ratio

Working capital management is a discipline in managerial accounting that involves tracking working capital and optimizing it by adjusting current assets and liabilities. For example, a company can try to speed up debt collection to raise cash (an asset) while refinancing a loan to reduce monthly payments (a liability). Another financial metric, the collection ratio, indicates how quickly sales are being converted into cash, while the inventory turnover ratio compares the cost of inventory against revenue. If a company’s working capital ratio falls below one, it has a negative cash flow, meaning its current assets are less than its liabilities. In this situation, a company is likely to have difficulty paying back its creditors. If a company continues to have low working capital, or if cash flow continues to decline, it may have serious financial trouble.

It all depends on your industry, growth phase, or even the impact of seasonality. For example, if you just made some big purchases or hires to service a contract with a big new client, then your ratio will fluctuate as your assets increase. Although many factors may affect the size of your working capital line of credit, a rule of thumb is that it shouldn’t exceed 10% of your company’s revenues. These projections working capital ratio can help you identify months when you have more money going out than coming in, and when that cash flow gap is widest. Your net working capital tells you how much money you have readily available to meet current expenses. To make sure your working capital works for you, you’ll need to calculate your current levels, project your future needs and consider ways to make sure you always have enough cash.

Current liabilities

Working capital is calculated by subtracting current liabilities from current assets. This is represented by combining the accounts receivable and inventories, less accounts payable. This way, it gives a more realistic picture of the company’s liquidity position. Cash to working capital ratio measures exactly what percentage of company working capital is made up of cash and cash equivalents. It shows the company’s ability to pay its short-term obligations using its most liquid assets such as cash and cash equivalents and marketable securities.

  • If a company has enough working capital, it can continue to pay its employees and suppliers and meet other obligations, such as interest payments and taxes, even if it runs into cash flow challenges.
  • The current ratio allows for a comparison between companies of different sizes.
  • Inventory to working capital measures exactly what portion of the company’s net working capital is funded by its inventories.

Company B sells slow-moving products to business customers who pay 30 days after receiving the products. Unfortunately, Company B must pay its suppliers within 10 days of receiving the products it had ordered. Company A sells fast-selling products online and requires customers to pay with a credit card when ordering. Hence, within a few days after an online sale takes place, Company A receives a bank deposit from the credit card processor.

List of Working Capital Formulas

Many large companies often report negative working capital and are doing fine, like Wal-Mart. Anything above 2.0 could suggest that the business isn’t using its assets to its full advantage. An unsecured, revolving line of credit can be an effective tool for augmenting your working capital.

  • It isn’t particularly helpful as a single metric viewed in a vacuum but is an important part of measuring financial health alongside other metrics.
  • Data is power, so use it as a tool—alongside your cash flow forecast—to see how you’re managing your assets and liabilities.
  • A low ratio might be the result of poor inventory management or inefficient debt collection.
  • For example, if you just made some big purchases or hires to service a contract with a big new client, then your ratio will fluctuate as your assets increase.
  • Businesses that are growing fast and investing big by extending credit lines might have a low working capital ratio, but when the growth pays off, they will be in a much stronger position.