Menu Close

Sales to Working Capital Definition

Definition

The word earnings to working capital ratio identifies some calculation which makes it possible for an investor-analyst to comprehend whether a business is facing a liquidity issue. Since the metric may vary from industry, this ratio will be best utilised as a standard or monitored overtime.

Calculation

Sales to Working Capital = Annualized Sales Revenue / Working Capital

Where:

  • While existing assets comprise balance sheet items like cash, marketable securities, prepaid expenses, accounts receivable, and inventory; working-capital eliminates balances payable by metric.

Explanation

Liquidity measures allow the investor-analyst to comprehend the provider ‘s long term viability concerning financial wellbeing. That is generally evaluated by examining balance sheet items such as accounts receivable, usage of inventory, accounts receivable, and also shortterm obligations. One of those techniques to comprehend the total liquidity position of a provider is by simply calculating their earnings to working capital ratio.

Also known as working capital growth, earnings to working capital funding accounts payable by current assets and gives a better index of bandwidth compared to metrics such as earnings to assets that are current. Since inventory available and earnings using credit cards may be different by industry, this metric will be best employed as a standard or monitored with the years to start looking for an undesired pattern. By way of instance, a ratio which increases with time can signal a reduction in stock, which not just causes it tough to send product but may also signal difficulty raising money to cover purchases.

Example

The director of a big mutual fund will love to appraise the liquidity position of Company ABC. He considers the earnings to working capital ratio could offer a fantastic comprehension of the provider ‘s standing relative to its competitors. He asked his analytic team to figure this metric as time passes for Company ABC as well to reevaluate the ratio contrary to many of the provider ‘s direct competitors.

The analytic team identified the grade value as 7.2, as the dining table below comprises Company ABC’s information throughout the previous few decades.

Year Inch Year two Year 3
Sales $107,740,800 $123,840,000 $148,608,000
Current Assets $26,935,200 $21,351,724 $22,180,299
Current Liabilities $9,250,000 $5,474,801 $5,098,920
Working Capital $17,685,200 $15,876,923 $17,081,379
Sales to Working Capital 6.1 7.8 8.7

While Company ABC’s ratio has been better compared to standard, the statistics indicated a sharp rise during the previous 3 decades. Based on the investigation, the director asked his analytic team to have a closer look several extra liquidity metrics.