Sales to Working Capital Ratio

Definition

The sales to working capital ratio is an asset utilization measure that allows investors to understand how much cash is needed to generate a certain level of sales.  This ratio is oftentimes tracked by investors over time, since it can provide insights into the company's need to raise additional funds in order to grow sales.  Ratios that are higher than the industry average are desirable.

Calculation

Sales to Working Capital = Net Sales / (Accounts Receivable + Inventory - Accounts Payable)

Where:

  • Net Sales = Gross Sales - Returns

Explanation

Asset utilization measures allow investors to understand how well a company uses its assets in operations.  Investors will typically track sales to working capital over time, looking for long term patterns in this metric. Companies with ratios that are higher than their industry average, or have ratios that increase over time, are desirable.

The components of the ratio can be used to explain its usefulness to analysts:

  • Net Sales:  excludes returned merchandise, thereby eliminating double-counting items returned to inventory.
  • Accounts Receivable:  if a company increases sales by lowering its creditworthiness standards, sales will increase at a slower rate than accounts receivable increases, and the sales to working capital ratio will decrease over time.
  • Inventory:  ideally, companies want to increase sales at a slower rate than the need to increase inventory.  If a company needs to increase inventory to get products out to consumers faster, the sales to working capital ratio will decrease.

Example

Earlier in the year, Company A's credit and collections department determined the company could tighten its credit policy without significantly hurting sales.  At the same time, Company A eliminated several slow moving product lines from the company's portfolio of offerings.  The table below demonstrates the impact of these process improvements on Company A's sales to working capital ratio over the last four quarters:

  Quarter 1 Quarter 2 Quarter 3 Quarter 4
Net Sales $2,500,000 $2,350,000 $2,467,500 $2,590,900
Accounts Receivable $833,300 $430,800 $411,300 $388,600
Inventory $1,250,000 $940,000 $863,600 $777,300
Accounts Payable $104,200 $78,300 $72,000 $64,800
Working Capital $2,187,500 $1,449,100 $1,346,900 $1,230,700
Sales to Working Capital Ratio  1.1:1  1.6:1  1.8:1  2.1:1

Related Terms

accounts receivable, accounts payable, inventory, working capitalsales to administrative expense ratio, sales backlog ratio, sales to employee, sales to fixed assets, sales returns to gross sales ratio