The ratio, which shows how efficiently a company is utilising its working capital in relation to a specific amount of sales, is known as the working capital turnover ratio (WCTR).
You have to learn what working capital is and its importance before knowing the impact of a higher WCTR.
Working Capital (WC)
Every business needs funds to finance its short-term assets after paying off its short term liabilities. This fund is termed as working capital of a business. It helps in smooth functioning of the business while maintaining a uniform cash flow.
Importance of WC
Working capital turnover ratio
WCTR is the ratio of net sales to average working capital. It is an accounting tool that helps to measure how well a company is utilising its working capital to support its annual sales. The formula can be represented in the following terms:
Working capital turnover ratio (WCTR) = Net sales / Average WC
Where,
Average WC = {(opening WC + Closing WC)/2}
Where,
Opening and Closing Working Capital (WC) = Current asset– Current liabilities
WCTR is measured for a specific period. This is because it signifies how many times a business has converted working capital into revenue.
Example:
Let there be a firm called X Co. The firm has net annual sales of Rs. 12,00,000 and an average WC of Rs. 2,00,000.
By formula,
WCTR = Net annual sales / Average WC
= 12,00,000/2,00,000
= 6 times
Therefore, from the above workings, we can tell X Co. has converted its working capital into sales 6 times.
Working capital meaning and implications can be best understood when compared with industry standards. However, there are a few inferences that can be drawn from a high WCTR.
Implications of a high WCTR
Therefore, we can conclude that the management of working capital has significant impact on the performance of the business and a high working capital turnover ratio does not always mean a well-performing firm.