Sales to working capital ratio is a liquidity and activity ratio that shows the amount of sales revenue generated by investing one dollar of working capital. Working capital is the difference between current assets and current liabilities, and it represents the short-term funds required to run the business operations. Turnover is the net sales of the company, which is the gross sales minus the returns, allowances, and discounts.
The sales to working capital ratio measures how efficiently the company is using its working capital to generate sales. A high ratio indicates that the company is able to generate a large amount of sales with a small amount of working capital, which means that the company is managing its current assets and liabilities well. A low ratio implies that the company is investing too much in working capital to support its sales, which may result in bad debts, obsolete inventory, or cash flow problems.
The formula for the Sales to Working Capital Ratio is as follows:
![\[ \text{Sales to Working Capital Ratio} = \frac{\text{Net Sales}}{\text{Average Working Capital}} \]](https://excelcalculations.refrigeratordiagrams.com/wp-content/ql-cache/quicklatex.com-2e8e2cd88a019890469a1f40d44d9599_l3.svg "Rendered by QuickLaTeX.com")
Here, the components of the formula are defined as follows:
: This represents the total revenue generated by a company after
deducting any sales returns, discounts, and allowances.
: This is calculated by taking the average of the
beginning and ending working capital over a specific period. The formula for Average Working Capital is:
![\[ \text{Average Working Capital} = \frac{\text{Beginning Working Capital} + \text{Ending Working Capital}}{2} \]](https://excelcalculations.refrigeratordiagrams.com/wp-content/ql-cache/quicklatex.com-4eaf4cd2c4df773acf4074325433a9fb_l3.svg "Rendered by QuickLaTeX.com")
The Working Capital itself is calculated as:
![\[ \text{Working Capital} = \text{Current Assets} - \text{Current Liabilities} \]](https://excelcalculations.refrigeratordiagrams.com/wp-content/ql-cache/quicklatex.com-71818a49bc6273716e7fad39968bd87d_l3.svg "Rendered by QuickLaTeX.com")
How to Calculate Sales to Working Capital Ratio in Excel
To calculate the sales to working capital ratio in excel, we need to have the following data:
- Net sales: This is the total sales revenue of the company after deducting the returns, allowances, and discounts. We can find this value in the income statement of the company.
- Current assets: These are the assets that can be converted into cash within one year, such as cash, accounts receivable, inventory, and prepaid expenses. We can find this value in the balance sheet of the company.
- Current liabilities: These are the obligations that have to be paid within one year, such as accounts payable, accrued expenses, short-term debt, and taxes payable. We can find this value in the balance sheet of the company.
Once we have these data, we can follow these steps to calculate the sales to working capital ratio in excel:
- Step 1: Calculate the working capital by subtracting the current liabilities from the current assets. Enter the formula
=B2-B3in cell B4, where B2 is the current assets and B3 is the current liabilities. - Step 2: Calculate the sales to working capital ratio by dividing the net sales by the working capital. Enter the formula
=B1/B4in cell B5, where B1 is the net sales and B4 is the working capital. - Step 3: Format the result as a percentage with two decimal places. Select cell B5 and click on the Home tab. In the Number group, click on the Percentage button and then click on the Increase Decimal button twice.
The following table shows an example of the sales to working capital ratio calculation in excel:
| A | B | |
|---|---|---|
| 1 | Net Sales | $10,000,000 |
| 2 | Current Assets | $4,000,000 |
| 3 | Current Liabilities | $2,000,000 |
| 4 | Working Capital | =B2-B3 |
| 5 | Sales to Working Capital Ratio | =B1/B4 |
Interpretation and Analysis
The sales to working capital ratio of 500.00% means that the company is generating $5 of sales for every $1 of working capital invested. This indicates that the company is very efficient in using its working capital to support its sales and growth. However, a very high ratio may also imply that the company is underinvesting in working capital, which may limit its future expansion or expose it to liquidity risks.
The sales to working capital ratio may vary depending on the industry, business cycle, and company size. Therefore, it is important to compare the ratio with the industry average, the historical trend, and the competitors to get a better understanding of the company’s performance and position.
Example Scenario
Let’s assume that we want to compare the sales to working capital ratio of two companies, A and B, that operate in the same industry. The following table shows their financial data:
| A | B | |
|---|---|---|
| Net Sales | $20,000,000 | $15,000,000 |
| Current Assets | $8,000,000 | $6,000,000 |
| Current Liabilities | $4,000,000 | $3,000,000 |
| Working Capital | $4,000,000 | $3,000,000 |
| Sales to Working Capital Ratio | 500.00% | 500.00% |
Both companies have the same sales to working capital ratio of 500.00%, which means that they are equally efficient in using their working capital to generate sales. However, company A has a higher net sales and working capital than company B, which means that company A has a larger scale and more resources to grow. Therefore, company A may have an advantage over company B in terms of market share and profitability.
There are other ratios that can be used to measure the efficiency and liquidity of a company’s working capital, such as:
- Working capital turnover ratio: This is the ratio of net sales to average working capital. It shows how many times the working capital is turned over in a year. A higher ratio indicates a faster turnover and a lower investment in working capital.
- Current ratio: This is the ratio of current assets to current liabilities. It shows the ability of the company to pay its short-term obligations with its current assets. A higher ratio indicates a higher liquidity and a lower risk of insolvency.
- Quick ratio: This is the ratio of current assets minus inventory to current liabilities. It shows the ability of the company to pay its short-term obligations with its most liquid assets. A higher ratio indicates a higher liquidity and a lower risk of insolvency.
