What is the Working capital turnover ratio?
Among many other turnover ratios, one of the most important ratio is the Working Capital Turnover Ratio.
Similar to other turnover ratios like the Asset turnover ratio or Inventory turnover ratio, this ratio helps in understanding the efficiency of the company.
Working capital turnover ratio meaning
Working capital turnover ratio basically means how efficient is the company in generating the Revenue with its given Working Capital.
But, what is working capital?
Working Capital refers to the money required by the company for its day-to-day operations.
For example, the money required to pay for raw materials, monthly salary/wages etc.
Formula for Working Capital is Current Assets- Current Liabilities
This ratio helps in understanding how many times a company was able to turn over its working capital during the year.
Now, let us look at the formula and understand the ratio better.
Working capital turnover ratio formula
The formula for Working Capital turnover ratio is very simple.
We take Net Sales in the numerator and Average Working Capital in the denominator.
Net Sales value can be obtained from the Income Statement and Average Working Capital can be calculated from the Balance Sheet.
Important considerations while calculating Working Capital turnover ratio.
Net Sales
- Net sales refer to the total sales made by the company after reducing any sales returns from the customer.
- Hence, Net sales have to be considered and not Gross sales.
- Generally, a company may have both credit sales and cash sales as part of its operations.
- Unlike the Receivable turnover ratio, we need to consider Total Sales made by the company and not only Credit sales.
- Any taxes received from the customers towards the government like Goods and Services Tax (GST) etc has to be reduced while arriving at Net Sales value.
Average working capital
- As highlighted above, the formula for Working capital is Current Assets – Current Liabilities.
- Both values can be obtained from the Balance Sheet.
- Also, using only the current period working capital will not give accurate results.
- Hence, we need to consider the average of working capital for the current period and the previous period.
Now, let us understand the working capital turnover ratio using an example.
Working Capital turnover ratio example
As part of our 1st example, let us take Company A and Company B.
Values given in the examples below are in $ millions.
Consider the below-given income statement for both the companies.
To calculate the Working capital turnover ratio, we need
- Net sales
- Average Working Capital
Calculating Net Sales
It is important to note that Net sales need to be considered and not Gross sales.
Net sales value for both the companies can be obtained from the Income Statement.
Company A
- Gross Sales = $2,000
- Sales return = $200
- Net Sales = $2,000 -$ 200 = $1,800
Company B
- Gross Sales = $3,000
- Sales return = $150
- Net Sales = $3,000 -$ 150 = $2,850
Now, take a look at the Balance Sheet extract for both the companies.
Calculating Working Capital
Also Average Working Capital has to be considered and not mere closing working capital.
But, in our example, we are given only a single period data.
Hence, in the absence of complete information, we are safe to use closing working capital instead of Average Working Capital.
As already highlighted, the formula for working capital is Current Assets – Current liabilities
Company A
- Current Assets = $560
- Current Liability = $220
- Working Capital= $560 -$ 220 = $340
- Current Assets = $620
- Current Liability = $800
- Working Capital= $620 -$800 = – $180 (Negative Working Capital)
Now that we know all the values, let us calculate the Working capital turnover ratio for both the companies.
Working capital turnover ratio = Net Sales / Average working capital
- Company A = $1,800/$340 = 20x
- Company B = $2,850/ -$180 = -15.8x
What this means is that Company A was more efficient in generating Revenue by utilizing its working capital.
The company is able to generate Revenue which is as high as 20 times the Average Working Capital.
On the contrary, Company B has a negative working capital which results in a negative working capital turnover ratio.
Now, this indicates that the Company was able to generate Revenue while its working capital is negative. This can be viewed both positively and negatively.
We will understand the interpretation of Negative working capital at a later stage.
Now, let us look at a Practical example using Walmart as an example.
Working capital turnover ratio using excel
In our next example, let us calculate the turnover ratio for Walmart using excel.
You can download the Working capital turnover ratio template from the Marketplace.
Below shown is the Consolidated Income Statement of Walmart.
Net Sales
Net sales for the Walmart can be easily calculated from the Income Statement.
Sales= $514,405
Now let us calculate Average Working Capital for Walmart.
Below given is an extract of Total Assets from Balance Sheet of Walmart.
Also, consider the below-given Liabilities section of the Balance Sheet.
Working Capital = Current Assets – Current Liabilities
Working Capital 2018
Current Assets = $59,664
Current Liabilities = $ 78,521
Working Capital = $59,664 – $ 78,521 = $ -18,857
Working Capital 2019
Current Assets = $61,897
Current Liabilities = $ 77,477
Working Capital = $61,897 – $ 77,4771 = $ -15,580
Now, let us calculate the Average Working Capital.
Average Working Capital = (Working Capital 2018 + Working Capital 2019 ) / 2
= ($ -18,857 + $ -15,580 ) / 2 = $ -17,219
We can clearly see that Working Capital for Walmart is negative (we will understand the meaning and interpretation of Negative working capital soon)
Now that we know all the values, let us calculate the Working Capital turnover ratio for Walmart.
Working capital turnover ratio = Net Sales / Average working capital
= $514,405 / $ -17,219
= -29.9x
As clearly evident, Walmart has a negative Working capital turnover ratio of -29.9 times.
What this means is that Walmart was able to generate Revenue in spite of having negative working capital.
Working capital turnover ratio interpretation
- We have seen that WC turnover ratio helps in understanding how the company generates revenue with its working capital.
- High Working capital turnover ratio is seen as greater efficiency in generating revenue with given Working capital.
Negative working capital turnover ratio
Can working capital be negative?
The answer is, Yes!
Now, let us understand one of the interesting scenarios where working capital can be negative.
If you recall, the formula for Working capital is as below.
Working Capital = Current Assets – Current Liabilities
As seen earlier in our example, Company B has a negative working capital.
- Current Assets = $620
- Current Liability = $800
- Working Capital= $620 -$800 = – $180 (Negative Working Capital)
This happens when the company’s Current Liability exceeds Current Assets.
Negative working capital can be interpreted in two ways.
Negative interpretation of negative working capital
- Since the current liabilities exceed current assets, the company may face liquidity issues.
- This also indicates that the company does not have sufficient current assets to pay off its current liabilities, which may warrant liquidating a few Non-Current Assets.
- Also, the company may be running short of cash to make payments towards its Accounts payables, etc.
Positive interpretation of negative working capital
- If the Company’s sales are growing with negative working capital, this indicates that the company is funding its growth using interest-free capital which ideally belongs to suppliers or other creditors.
- This is similar to raising funds for the operations without interest cost.
- Hence, having a negative working capital is not a bad thing unless managed efficiently.
Trend Analysis
Analyzing any financial metric on a standalone basis will not always give an accurate picture.
One must analyze how the metric has changed historically.
Similarly, even in the case of Financial Ratios, we perform trend analysis.
This helps in understanding how the ratios have moved over the period.
Let us look at the trend analysis of the Working capital turnover ratio for Home Depot.
Home Depot Working capital turnover ratio
Home Depot is a US-based home improvement retailer (supplies tools, construction products, and various similar services).
As shown in the chart above, we can clearly see that the ratio has continuously improved for the past 5 years.
This shows that the company is more efficient in managing its working capital as it generates Revenue.
Continuous growth in Revenues coupled with a fall in average working capital lead to a gradual increase in the working capital turnover ratio.
Hence, through this trend analysis, we could identify the better liquidity management of Home Depot.
Comparison with similar companies
Apart from trend analysis, it is also important to compare any Financial Ratio of the company with other similar companies in the same industry.
This helps in understanding how is the company performing relative to its peers.
Home Depot
As discussed as part of Trend Analysis, the working capital turnover ratio for Home Depot has been increasing.
For the past 5 years, the Company’s revenue is in an uptrend.
Also, it was able to decrease its working capital requirement.
As a result of both, it could achieve an increase in its turnover ratio.
Currently, the Home Depot working capital turnover ratio is 48 times.
Amazon
In the case of Amazon, clearly, there is an increase in the turnover ratio for the past few years.
Back in 2014, it was only 25 times and subsequently, in the next two years, the company recorded robust growth in its sales while maintaining its working capital requirement.
As a result of the above factors, the ratio jumped to 87 times.
Although there has been a fall in the ratio, the Amazon working capital turnover ratio is currently 52 times.
This is relatively the best among all the companies under the discussion.
ExxonMobil
Unlike companies in the retail sectors, when we look at ExxonMobil- a US-based multinational oil & gas company, we can clearly see that the company has a negative working capital.
The situation is similar to what we have seen in the case of Walmart.
For the past 5 years, revenues are decreasing. But the company is able to reduce its working capital requirement. As a result of this, there is an increase in the company’s turnover ratio.
Currently, ExxonMobil working capital turnover ratio is negative 28 times.
Apple
In the case of Apple, the ratio is decreasing for the past 5 years.
This is because the working capital requirement for Apple for the past 5 years has grown significantly.
While the revenues are growing moderately, the significant growth in working capital requirement has reduced the overall turnover ratio.
Currently, Apple’s working capital turnover ratio is 7 times.
This ratio is relatively higher when compared with other tech-based companies.
Apart from companies in the retail sector, let us see how different is the ratio profile for tech-based companies like Facebook, Google (Alphabet) and Microsoft.
Relative to other companies, we can clearly see that the ratios are in low single digits.
These companies generally have moderate current liabilities on their Balance Sheet relative to current assets. This results in higher than normal working capital i.e, the denominator will be relatively higher.
The companies generate Revenue often backed with significant working capital.
Hence, such companies have a relatively lower working capital turnover ratio of only 1-2 times.
The ratio in the case of Facebook has been quite volatile for the past few years.
Currently, Facebook working capital turnover ratio is 1.3 times.
Although this appears very low, this is consistent with other tech-based companies like Google, Microsoft.
Unlike Facebook, the ratio in the case of Google is growing steadily for the past 5 years.
The growth in average working capital was lower relative to Revenue growth.
Hence, this helped the company in improving its turnover ratio.
Currently, Google working capital turnover ratio is 1.4 times.
Microsoft
As evident from the chart above, the ratio in the case of Microsoft has been volatile.
The Company had a healthy turnover ratio of 1.28 times back in 2014.
But, in subsequent years, the growth in working capital requirement surpassed the growth in sales.
This decreased the turnover ratio between 2015-2017.
For the year ending June 2019, the average working capital was relatively lower which helped the company in boosting its turnover ratio.
Currently, Microsoft working capital turnover ratio is 1.16 times.
How to improve working capital turnover ratio
Below are few important aspects which can help in increasing the working capital turnover ratio.
Increase Sales
The basic and the ideal way is to try increasing the revenue of the company while maintaining the working capital requirement steady.
Decrease Working capital
Managing working capital requires careful planning and thorough execution of various strategies.
The company must try to decrease the overall working capital requirement.
This helps in increasing the WC turnover ratio
Reduce the credit period
Reducing the credit period to customers can lead to better liquidity since the money is received early.
This will invariably increase the cash balance and help in meeting the working capital requirement easily.
Timely collection
Receiving money due from customers on a timely basis will increase the cash available to the operation. This will increases the working capital of the company.
Purchase on credit
Avoid making heavy purchases using cash since it reduces the liquidity position of the company substantially.
Always evaluate if the purchase can be made on credit.
Re-negotiate with the suppliers
Extending your existing payment cycle with suppliers can boost the company’s working capital requirement to a greater extent.
Better inventory management
Track inventory periodically by calculating Inventory turnover ratio and Days Inventory on hand.
Adopt better supply chain management techniques and monitor the inventory movement to identify any blockage of inventories.
