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.) |
