![]() The working capital turnover is the ratio that helps to measure a company's efficiency in using its working capital to support sales. If your working capital ratio is high, it is not necessarily a good thing because it indicates that your business isn't investing excess cash or has too much inventory. However, if payment is being collected slowly, or there is a decrease in sales volume leading to reduced account receivables, the resultant effect is reduced cash flow.īusinesses that inefficiently use their working capital can increase cash flow by squeezing customers and suppliers or selling off assets. Although this reduces cash flow, it should be balanced out by money coming in via account receivables. Most business undertakings require a working capital investment. Alternatively, they may consider the quick ratio which is used to indicate short-term liquidity because it includes account receivables, cash, cash equivalents, and marketable investments. A ratio above 2.0 may indicate that the company is not effectively using its assets to generate the maximum level of revenue possible.Ī working capital ratio that continues to decline is a major cause of concern and a red flag for financial analysts. If the ratio is less than 1.0, it is known as negative working capital and indicates liquidity problems. Understanding the Working Capital RatioĪny point between 1.2 and 2.0 is considered a good working capital ratio. This indicates whether a company possesses enough short-term assets to cover short-term debt. (Working capital of the current year + Working capital of the prior year) ÷ 2 To calculate a company's average working capital, the following formula is used: Inventories of finished good and raw materials.Ĭurrent assets divided by current liabilities is known as a working capital ratio.Calculating Average Working CapitalĪ good example of a liability is accounts payable. It is calculated by subtracting current liabilities from current assets. Impact of a High Working Capital Turnover RatioĪverage working capital is a measure of a company's short-term financial health and its operational efficiency. Effects of Low Working Capital Turnover 6. ![]() ![]() Understanding the Working Capital Ratio 3. ![]()
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