What is the Working Capital Turnover Ratio?

The working capital turnover ratio measures how well a company is utilizing its working capital to support a given level of sales. A high turnover ratio indicates that management is being extremely efficient in using a firm's short-term assets and liabilities to support sales. A business that consistently operates with a high working capital turnover ratio needs a smaller ongoing cash investment than its competitors to produce the same level of sales that they are generating.

Conversely, a low ratio indicates that a business is investing in too many accounts receivable and inventory assets to support its sales, which could eventually lead to an excessive amount of bad debts and obsolete inventory write-offs.

Working Capital Turnover Formula

To calculate the ratio, divide net sales by working capital (which is current assets minus current liabilities). The calculation is usually made on an annual or trailing 12-month basis, and uses the average working capital during that period. The calculation is:

Net sales ÷ ((Beginning working capital + Ending working capital) / 2)

Example of the Working Capital Turnover Ratio

ABC Company has $12,000,000 of net sales over the past twelve months, and average working capital during that period of $2,000,000. The calculation of its working capital turnover ratio is:

$12,000,000 Net sales ÷ $2,000,000 Average working capital

= 6.0 Working capital turnover ratio

Related AccountingTools Courses

Business Ratios Guidebook

Working Capital Management

Problems with the Working Capital Turnover Ratio

Though the working capital turnover ratio can provide useful information under certain circumstances, there are also several problems with it, which are as follows:

Volatility of the components. The components of this measurement can vary a great deal over time, especially if the products being sold are seasonal in nature. If so, the reported amount of this ratio could vary substantially over time.
Impact of near-zero working capital. In cases where a business has very low or even negative working capital, the ratio can be so high as to be rendered essentially meaningless. This situation arises when a business routinely operates with very low inventory levels.
Does not match cash flows. The working capital turnover ratio is usually created under the accrual basis of accounting, where the sales included in the measurement do not necessarily match the cash flows that will eventually be derived from those sales. This can render the outcome of the measurement less useful.
Ignores long-term liabilities. A business might be burdened with quite substantial long-term liabilities, which do not appear in this measurement at all, and which might have a massive impact on its ability to pay its short-term liabilities.