Current Ratio – Formula, Meaning, Assumptions and Interpretations
February 12, 2025
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Working Capital to Sales Ratio = Working Capital / Sales
Stating the working capital as an absolute figure makes little sense. Consider two companies, both having the same working capital of USD 100. While one company uses this working capital to generate sales of USD 500, the other uses the same amount as working capital to generate USD 1000 in sales. Which one do you think will be more profitable? Which one do you think is more efficient?
When companies use the same working capital to generate more sales, it means that they are using the same funds over and over again. This is why this ratio is also called “Working Capital Turnover Ratio” as it measures the number of times working capital has been turned over. The higher the sales, the more the profits and therefore the more appropriate use of working capital has been made.
The working capital to sales ratio uses the working capital and sales figures from the previous year’s financial statements. Hence, there is obviously an assumption that working capital and sales have been accurately stated. Companies may over stock or under stock because of expectations of shortage of raw materials. These influences are however short term. Thus while reading this number the analyst must compare it with the past numbers to see if this is usual state of affairs for the company or whether this is an exception.
These investors may be true because the stock market takes any news of cash shortage very seriously and the stock plummets in the market. But the price in the stock may be short term.
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