sales to working capital ratio

Definition: what is Sales to working capital ratio ?-

  • The SWC ratio is the type liquidity ratio which defines the relationship between the revenue of the company and the amount of cash it holds as inventory and account receivable
  • Sales to working capital ratio tell us how much percentage of working capital is trapped in the company’s inventory and accounts receivable.
  • Therefore, this ratio describes how well a company is using its working capital to generate revenue. It is also helpful to explain to the investor how much cash is needed to support a given level of sales.

sales to working capital ratio Formula

The ratio of annual net sales and working capital is called SWC ratio, You can use the following formula to calculate the company’s sales to working capital ratio.

Sales\quad to\quad working\quad capital\quad ratio\quad =\quad \frac { Net\quad sales }{ Average\quad working\quad capital }

Information on these variables can be found on a company’s financial statements. To calculate net sales, simply cut sales returned from annual gross sales.

Net sales = Sales – Sales returns

To calculate average working capital, we have to reduce current liabilities from current assets. You can also get it by subtracting the account payable from adding the account receivable and inventory

Average working capital = Account receivable + Inventory – Account payable

Example of sales to working capital ratio

Let’s take a look at a simplified example of a company that you can consider as an investment.

We are taking the example of a BHEL company whose financial data you can find in the balance sheet section on the website named Moneycontrol.com
Assumed data is taken in the following array

QUARTERLY RESULTS of BHEL (In Cr. INR)First quarterSecond QuarterThird QuarterFourth quarterMarch 2018
Net sales5,049.815,459.246,030.164,411.099,838.35
Account receivable3500.563100.452800.062200.031800.96
Inventory110006000600060005400
Account payable1200.001100.6900.368001300.0

Q1-Sales\quad to\quad working\quad capital\quad ratio=\frac { 5054.81 }{ 3500.56+1100.00\quad -1200 } =0.3796

Q2-Sales\quad to\quad working\quad capital\quad ratio=\frac { 5459.24 }{ 3100.45+6000\quad -1100.6 } =0.6824

Q3-Sales\quad to\quad working\quad capital\quad ratio=\frac { 6030.16 }{ 2800.03+6000-900.036 } =0.7633

Q4-Sales\quad to\quad working\quad capital\quad ratio=\frac { 4411.09 }{ 2200.03+6000-800 } =0.59

As we saw that the sales to working capital ratio of the four quarters of BHEL company was found, in which the average sales to working capital ratio is about 58%. This means that the company sells 58% of the working capital in the product it produces.

Sales to working capital ratio analysis

Sales to working capital ratio does not have any ideal ratio but those who are good investors consider around 70% to 80% to be a good sales to working capital ratio.

Typically, a certain amount of money is invested in a company to support its operations. Regardless of the change in sales level, this amount must always be maintained at a certain level. When the company does not have sufficient cash to carry out its day-to-day operations, it means that most of the working capital is stuck in receipts and inventories. To reduce this, the company can reduce customer credit. Or may reduce the level of on-hand inventory. However, this can result in lower sales when the company’s payment terms become ugly for customers. Or customers may turn to better-stocked competitors to complete their orders more quickly.

A higher ratio indicates that working capital is used more frequently per year, which means a more frequent flow of capital. A low ratio means that the company’s working capital is not sufficient to generate sales. This is the result of excessive use of accounts receivable and inventions to generate sales, a factor that may be the cause of poor quality debt and obsolete inventory. The most attractive ratios are those that remain constant over time regardless of sales.Download Report

Cations

When the inventory and account receivable of a company keeps increasing continuously, it is not a good sign for any company, this reduces the sales and working capital ratio significantly, which leads to the default of liquidity in the company. stay away from this type of company.

If the sales to working capital ratio of a company exceed 90%, then it is also not a good sign for any company because there is no doubt that the company can support its day to day expenses. But due to very little stock left in the company, the customer will have to return without making any product deal.

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