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What is the Working Capital Turnover Ratio?

October 12, 2023 • 1498 views

There are several accounting tools that allow businesses to understand their financial performance. Working capital turnover ratio is one such parameter that allows to understand how much you make for every rupee you spend. It helps you to see how your company has utilised its working capital to generate revenue. This blog delves into the depths of working capital turnover ratio. Read on!

What is the Working Capital Turnover Ratio?

Working Capital Turnover Ratio can be referred to as a financial health check-up of your venture. It helps you to understand how efficiently and effectively you have used your working capital to generate profits. We have divided this topic into simpler terms in the below points:

  • Working Capital: The funds and assets available at your disposal for meeting your daily business needs are known as working capital. You can calculate it by subtracting your current liabilities from your current assets.
  • Working Capital Turnover Ratio: It is a measure representing how appropriately you have used the working capital. If you have a high turnover ratio, then shows that your venture is performing well. The ratio also reflects how much you are making for every rupee you are spending.

How to Calculate Working Capital Turnover Ratio?

Calculating your working capital turnover ratio will help you understand how well you have utilised your working capital. Thus, you can use the below formula for calculation:
Working Capital Turnover Ratio = Net Sales / Average Working Capital

ALSO READ :- What is Working Capital Term Loan - Meaning, and How It Works?

Example of Working Capital Turnover Ratio

Assume you run a retail store in India and your net sales (total revenue after discounts and returns) are Rs. 10 Lakh for the past year. Whereas your working capital (subtract current liabilities from current assets) is Rs. 3 Lakh. Then as per the above mentioned formula is 

Rs. 10,00,000 / Rs. 3,00,000 = 3.33 (Working Capital Turnover Ratio)

3.33 is a good working capital turnover ratio. It shows that you have used your working capital wisely to generate sales. 
Then, if you plan to take a loan to expand your business, your positive turnover ratio of 3.33 will convince lenders that you are capable to repay the loan. Thus, you can apply for a Business Loan for Working Capital at Poonawalla Fincorp and get a loan up to Rs. 50 Lakh with nominal interest rates, starting at just 15% per annum.

Advantages of Using a Working Capital Turnover Ratio

The following points will help you understand the key benefits of calculating working capital turnover ratio:

  • Determines Stability

If your company has a bad turnover ratio, then your business might have insufficient working capital to fulfil the daily operations. This may result in incurring debts. Therefore, managing working capital can allow your venture to avoid such problems. This ratio helps you to know if the funds are being used efficiently or not. 

  • Improves Financial Health

The turnover ratio of your venture will help in managing the cash flow. Efficient utilisation of working capital will significantly improve your business’s financial health. You can even use it to prevent situations like taking loans and debts due to insufficient working capital. A high turnover ratio shows that your business is doing well, this will even help you convince investors to put funds in the business.

  • Increases Business Worth

Good working capital turnover ratio increases the value of your venture as well. A high working capital turnover ratio will allow you to build goodwill and stand out among the other competitors. This will ultimately build a good brand image, opening doors to the success of your venture.

Disadvantages of Using a Working Capital Turnover Ratio

The following points will help you understand the disadvantages of capital turnover ratio:

  • Only Financial Factors are Considered

This ratio is calculated by only considering the financial aspects of your company. Even though financial elements are vital, non-financial elements also have a huge impact on your company. 

  • High Turnover Ratio can Potentially be Negative

A high turnover ratio can appear to be positive, however, not always. A high ratio can indicate that your company has insufficient funds to match growth. This can potentially create huge problems for your company if the ratio of capital to sales is not optimised. 

Why Does the Working Capital Turnover Ratio Matter for Loans?

You may think, "Why do lenders care about this ratio?" This is so because when you apply for a loan, lenders want to know if you can repay it. They make sure that your business can generate enough revenue to cover the loan and interest. The following points will help you learn more about it:

  • Assessing Your Ability to Repay: A high turnover ratio shows that you're effectively using your resources to generate profits. It suggests that you have a good chance of repaying the loan.
  • Understanding Financial Health: Lenders prefer giving loans to financially stable businesses. Thus, a good ratio suggests your business is healthy and stable, which convinces lenders to approve your loan application.

Factors Affecting the Working Capital Turnover Ratio

There are several factors that can impact a company's working capital turnover ratio. They are as follows:
1.    Type of Industry: Different businesses have different requirements. Retail shops, like clothing stores, can have a lower ratio because they have a big inventory. Whereas service-based businesses, like consulting firms, have a high ratio as they don’t need a big inventory.

2.    Seasonal Business: If you have a seasonal business, then your turnover ratio would change throughout the year. It can be low during off-seasons whereas it would be high during the peak seasons.

3.    Inventory Management: Efficient management of your inventory is vital for a high turnover ratio. Having a big or outdated inventory can create issues that would decrease the turnover ratio.

4.    Supplier Payments: If you have a reselling business, you need to make payments to the supplier. Thus, managing these payments is crucial as delays in paying your suppliers can impact your ratio.

ALSO READ :- 9 Key Factors Affecting Your Working Capital

How to Improve Your Working Capital Turnover Ratio?

Now that you know the importance of turnover ratio, then let’s read some of the best ways to improve it:
1.    Simplify Business Operations: Find and explore different strategies to make your daily business operations simple and efficient. It will help you in reducing the wastage of your working capital eventually improving your ratio.

2.    Managing Inventory: It is prudent to only keep items that are necessary to meet your business operations. This ensures effective management of inventory, resulting in a good turnover ratio. 

3.    Faster Receivables: Encourage your clients to make their payments on time. Timely payments can free up funds and improve your working capital turnover ratio.

4.    Work on Increasing Sales: Try to sell more products or services but plan your expenses first. This will make your ratio strong and show that your business has been doing well.

To Conclude

Working Capital Turnover Ratio is a powerful tool that can help you get loans and improve the financial health of your business. If your business has a high turnover ratio and is in dire need of funds to meet the demand, apply right now for a Business Loan from Poonawalla Fincorp. You can get a loan amount of up to Rs. 50 Lakh with competitive interest rates, starting from just 15% per annum. 

Frequently Asked Questions About Working Capital Turnover

1.    Is 2.1 a good working capital turnover ratio?
Yes, it is a good working capital turnover ratio. It shows that for every Rs. 1 you spend, you make Rs. 2.1.

2.    What are the eligibility criteria to apply for a Business Loan?
You need to be aged between 24 and 65 years. Your business should be at least 2 years old and have a minimum yearly turnover of Rs. 6 Lakh. Lastly, you need to have a minimum CIBIL score of 700 to apply for a Business Loan.

Disclaimer

We take utmost care to provide information based on internal data and reliable sources. However, this article and associated web pages provide generic information for reference purposes only. Readers must make an informed decision by reviewing the products offered and the terms and conditions. Loan disbursal is at the sole discretion of Poonawalla Fincorp.
*Terms and Conditions apply

poonawalla fincorp team

Poonawalla Fincorp Team

Our team of expert writers and editors are passionate about providing authentic and valuable information on finance. Our aim is to simplify financial and finance-related concepts. We strive to help our readers become more aware and empowered to make informed financial decisions.

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