Working capital turnover ratio is computed by dividing the cost of goods sold by net working capital. It represents how many times the working capital has been turned over during the period.
The formula consists of two components – cost of goods sold and net working capital. If the cost of goods sold figure is not available or cannot be computed from the available information, the total net sales can be used as numerator.
Net working capital is equal to current assets minus current liabilities. This information is available from the balance sheet. For more explanation consider the following example:
Exide company sells batteries that are used in vehicles. The current assets and current liabilities as on 31 December, 2012 are given below:
|Cost of goods sold||$||300,000|
Required: Compute working capital turnover ratio from the above information.
= 300,000 / 60,000
= 5 times
The working capital turnover ratio of Exide company is 5. It means the company has turned over its working capital 5 times in 2012.
Generally, a high working capital turnover ratio is better. A low ratio indicates inefficient utilization of working capital. The ratio should be carefully interpreted because a very high ratio may also be a sign of insufficient working capital.