Working capital productivity is a measure of how efficiently a business uses its working capital to generate sales. Working capital is the difference between current assets and current liabilities, and it represents the amount of funds available to run the day-to-day operations of a business. A higher working capital productivity ratio indicates that a business is able to generate more sales with less working capital, which implies better liquidity and profitability.
The formula for working capital productivity is:
To calculate working capital productivity, we need to obtain the annual sales and the total working capital of a business. Annual sales can be obtained from the income statement, and total working capital can be calculated from the balance sheet as follows:
Current assets are the assets that can be converted into cash within one year, such as cash, accounts receivable, inventory, and prepaid expenses. Current liabilities are the obligations that are due within one year, such as accounts payable, accrued expenses, short-term debt, and taxes payable.
Procedures
To calculate working capital productivity in excel formula, we can follow these steps:
- Enter the annual sales and the current assets and liabilities of a business in separate cells in an excel worksheet. For example, we can enter the following data for a hypothetical company:
| A | B | |
|---|---|---|
| 1 | Annual Sales | $10,000,000 |
| 2 | Current Assets | $2,000,000 |
| 3 | Current Liabilities | $1,000,000 |
- In another cell, enter the formula for total working capital, which is
=B2-B3. For example, we can enter this formula in cell B4. This will give us the total working capital of the business, which is $1,000,000. - In another cell, enter the formula for working capital productivity, which is
=B1/B4. For example, we can enter this formula in cell B5. This will give us the working capital productivity ratio of the business, which is 10. - Format the cells as desired, such as adding labels, decimals, or percentage signs. For example, we can format the cells as follows:
| A | B | |
|---|---|---|
| 1 | Annual Sales | $10,000,000 |
| 2 | Current Assets | $2,000,000 |
| 3 | Current Liabilities | $1,000,000 |
| 4 | Total Working Capital | $1,000,000 |
| 5 | Working Capital Productivity | 10.00 |
Explanation
The working capital productivity ratio of 10 means that the business generates $10 of sales for every $1 of working capital. This indicates that the business is able to use its working capital efficiently and effectively, and it has a high turnover of its current assets and liabilities. A high working capital productivity ratio also implies that the business has a strong cash flow and a low risk of insolvency.
However, working capital productivity is not the only indicator of a business’s performance, and it should be used in conjunction with other ratios and metrics, such as profitability, liquidity, solvency, and growth. A very high working capital productivity ratio may also indicate that the business has insufficient working capital to support its operations, which may lead to cash flow problems, missed opportunities, or lower quality of products or services. Therefore, a business should aim to maintain an optimal level of working capital that balances the trade-off between efficiency and risk.
Example
To illustrate the concept of working capital productivity, let us consider a scenario where two businesses, A and B, operate in the same industry and have the same annual sales of $10,000,000. However, they have different levels of working capital, as shown in the table below:
| A | B | |
|---|---|---|
| Annual Sales | $10,000,000 | $10,000,000 |
| Current Assets | $2,000,000 | $4,000,000 |
| Current Liabilities | $1,000,000 | $2,000,000 |
| Total Working Capital | $1,000,000 | $2,000,000 |
| Working Capital Productivity | 10 | 5 |
Using the excel formula, we can calculate the working capital productivity of both businesses as follows:
| A | B | |
|---|---|---|
| Annual Sales | $10,000,000 | $10,000,000 |
| Current Assets | $2,000,000 | $4,000,000 |
| Current Liabilities | $1,000,000 | $2,000,000 |
| Total Working Capital | =B2-B3 |
=C2-C3 |
| Working Capital Productivity | =B1/B4 |
=C1/C4 |
The result is:
| A | B | |
|---|---|---|
| Annual Sales | $10,000,000 | $10,000,000 |
| Current Assets | $2,000,000 | $4,000,000 |
| Current Liabilities | $1,000,000 | $2,000,000 |
| Total Working Capital | $1,000,000 | $2,000,000 |
| Working Capital Productivity | 10.00 | 5.00 |
From the table, we can see that business A has a higher working capital productivity than business B, which means that business A is more efficient in using its working capital to generate sales. Business A has a lower amount of current assets and liabilities, which means that it has a faster turnover of its inventory, receivables, and payables, and it has less idle cash or debt. Business B, on the other hand, has a lower working capital productivity, which means that it is less efficient in using its working capital to generate sales. Business B has a higher amount of current assets and liabilities, which means that it has a slower turnover of its inventory, receivables, and payables, and it has more idle cash or debt.
However, this does not necessarily mean that business A is better than business B in terms of overall performance. Business B may have a higher profitability, liquidity, solvency, or growth than business A, depending on other factors, such as the cost of goods sold, the operating expenses, the interest rate, the tax rate, the market demand, the competitive advantage, and the strategic goals. Therefore, working capital productivity should not be used in isolation, but rather as one of the many tools to evaluate and compare the performance of different businesses.
Other Approaches
There are other ways to calculate or improve working capital productivity, such as:
- Using different time periods for sales and working capital, such as quarterly, monthly, or weekly, depending on the nature and seasonality of the business.
- Using average working capital instead of total working capital, which is the average of the beginning and ending working capital for a given period, to smooth out any fluctuations or outliers.
- Using net working capital instead of total working capital, which is the difference between current assets and current liabilities excluding cash and short-term debt, to focus on the non-cash components of working capital.
- Using sales to net working capital ratio instead of working capital productivity ratio, which is the inverse of working capital productivity ratio, to measure how many dollars of net working capital are required to generate one dollar of sales.
- Implementing working capital management strategies, such as optimizing inventory levels, accelerating receivables collection, extending payables terms, negotiating better credit terms, and investing excess cash, to improve the efficiency and effectiveness of working capital.
