This will cause a shortage of funds and can cause a business to run out of money. The disadvantage of the working capital turnover ratio is that it varies widely across and between industries and companies; therefore, for comparison purposes, compare. The Working Capital Turnover Ratio is calculated by dividing the company’s net annual sales by its average 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. 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.

  • Working capital is important because it is necessary for businesses to remain solvent.
  • In addition, the customer may receive a 2% cash rebate from the credit card company.
  • In general, working capital paints a picture of the financial health of the business overall, while cash flow is a better measure of a contractor’s financial health day-to-day — or on a project level.
  • Low – Lower working capital turnover ratio means that the business is not generating sufficient sales relative to the working capital employed.
  • Most major new projects, such as an expansion in production or into new markets, require an upfront investment.
  • When you analyze your asset management ratios, you can look at your total asset turnover ratio and if there is a problem, you can go back to your other asset management ratios and isolate the problem.

The Working Capital Turnover Ratio Formula determines the per-unit utilization of Working Capital. This analysis helps the company make practical decisions regarding working capital utilization, ensuring business survival in the long run and promoting growth. Hence, the Working Capital Turnover ratio is 2.88 times which means that for every unit sale, 2.88 Working Capital is utilized for the period. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. In other words, this ratio shows the net sales generated as a result of investing one dollar of working capital.

Balance Sheet Assumptions

Revenue-Based Financing provides company with working capital in exchange for a percentage of future monthly revenue. You can monitor the Working Capital Turnover Ratio to make sure you are optimizing use of the working capital. This formula is used to calculate the WCT over a one-year period or a trailing 12-month period. The Net Annual Sales represents the company’s gross sales less any discounts or allowances. This is another example that illustrates the difference between working capital and cash flow. Financing expenses can greatly improve a contractor’s cash flow on a project level, even as their working capital remains unchanged.

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

Caution when using amounts from annual financial statements

These will be used later to calculate drivers to forecast the working capital accounts. Most major new projects, such as an expansion in production or into new markets, require an upfront investment. Therefore, companies that are using working capital inefficiently or need extra capital upfront can boost cash flow by squeezing suppliers and customers. For instance, an NWC turnover ratio of 3.0x indicates that the company generates $3 of sales per dollar of working capital employed.

This means that for every one dollar invested in working capital, the company generates $2 in sales revenue. A low ratio indicates your business may be investing in too many accounts receivable and inventory to support its sales. 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. 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. The Average Working Capital is the company’s average current assets less its average current liabilities.

Finance project expenses

When this happens, it may be easier to calculate accounts receivables, inventory, and accounts payables by analyzing the past trend and estimating a future value. Remember to exclude cash under current assets and to exclude any current portions of debt from current liabilities. For clarity and consistency, lay out the accounts in the order they appear in the balance sheet.

How Does a Company Calculate Working Capital?

Of course, an increase in accounts receivable does not always correspond with an improvement in cash flow. The longer an account receivable remains open, the higher its carrying costs, and the greater the chance of nonpayment. Although they are more liquid than long-term assets like equipment, short-term assets still take time to convert into cash.

Average Collection Period

However, operating without any working capital would require a situation with near-instantaneous payments, just-in-time inventory management, and zero financial risk. If a construction business is an engine, working capital is the fuel that keeps the engine running. Monitoring what is inventory shrinkage working capital helps contractors evaluate liquidity, operational efficiency, and the short-term financial health of the business. A higher working capital turnover rate is better, as it indicates a contractor is more effectively using their working capital to generate revenue.

Saving (or earning) $42 by paying $2,058 just 20 days sooner is an annualized return of 36% per year. We can see in the chart below that Coca-Cola’s working capital, as shown by the current ratio, has improved steadily over the last few years. When that happens, the market for the inventory has priced it lower than the inventory’s initial purchase value as recorded in a company’s books. To reflect current market conditions and use the lower of cost and market method, a company marks the inventory down, resulting in a loss of value in working capital. The exact working capital figure can change every day, depending on the nature of a company’s debt.


Generally, the higher the receivables turnover, the better as it means you are collecting your credit accounts on a timely basis. If your receivables turnover is low, you need to take a look at your credit and collections policy and be sure they are on target. The net effect is that more customers have paid using credit as the form of payment, rather than cash, which reduces the liquidity (i.e. cash on hand) of the company. The screenshot below is of Apple’s cash flow statement, where the highlighted rows capture the change in Apple’s working capital assets and working capital liabilities. When a customer uses a business credit card, the customer will be given 27 to 57 days in which to pay the credit card company.

A disproportionately high working capital ratio is reflected in an unfavorable return on assets ratio (ROA), one of the primary profitability ratios used to evaluate companies. Therefore, at the end of 2021, Microsoft’s working capital metric was $96.7 billion. If Microsoft were to liquidate all short-term assets and extinguish all short-term debts, it would have almost $100 billion of cash remaining on hand. It might indicate that the business has too much inventory or is not investing its excess cash. Alternatively, it could mean a company is failing to take advantage of low-interest or no-interest loans; instead of borrowing money at a low cost of capital, the company is burning its own resources.