These organizations are getting dry. The blood (cash) of these organizations getting shrink day by day. Either they are doing the wrong investments or their businesses are not doing well.
This tool (working capital ratio) can help you to prevent these deadfalls.
What is Working Capital Ratio?
The Working Capital Ratio (WCR) is one of the tools from the financial ratio analysis that shows the companies capability to pay its current liabilities.
In other words, WCR shows that, do a company has enough liquid assets which can be used to pay off its short term financial obligations which will due in the period of a year or less than one year. WCR is also known as a current ratio or liquidity ratio which works in the same way.
Having a more WCR means a company has more liquid assets than it’s current liabilities. And If a company has it’s WCR less than 1.0 that means the company running in a danger zone. It shows the company hasn’t enough liquid assets to meet its current liabilities.
Also, it’s not good if the company has the WCR too much. It shows that the company is having more amount of funds than it is required. And the company is not investing it’s money efficiently.
Now, let’s move into its calculation…,
The WCR can be calculated with the help of a simple formula and the simple calculation.
Here it is,
Working capital ratio formula
The formula of working capital ratio contains two main characters from the statement of the Balance Sheet,
Current Assets: The assets of a company that can be converted into cash in a period of one year or less.
Current Liabilities: The liabilities which can be due in the period of one year or less.
So, to calculate the working capital ratio divide the total current liabilities from the total current liabilities.
Here is the step by step process to calculate the working capital ratio of your company.
Steps to calculate the working capital ratio of your company
To calculate the working capital ratio of your company, follow the steps given below.
Step 1: Take the balance sheet of your company
Take the balance sheet from your financial statements. Make sure your balance sheet is updated or it will be better if it is verified by the CA/CS.
Step 2: Pick the total amount of Current Assets.
Take the amount of total current assets from the assets side of your balance sheet.
Step 3: Pick the total amount of Current Liabilities.
Take the total amount of current liabilities from the liabilities side of your balance sheet.
Step 4: Divide the total amount of liabilities from assets.
Just simply divide the total amount of current liabilities from total assets.
You will find the ratio of the working capital of your company.
Let’s see the real example;
Real Example of working capital ratio calculation
Here it is the balance sheet of Walmart to calculate the working capital ratio as an example.
To see the reports in detail visit here.
So, as we have seen before to calculate the WCR we need to take Two values from this above balance sheet.
- Total Current Assets
- Total Current Liabilities
The location of these two (Total Current Assets and Total current liabilities for the year 2019 ) values have been highlighted in the above balance sheet.
Now we just put these amounts in the formula of working capital ratio.
And after the calculation we get,
Here we go!
We got the WCR of Walmart 0.79 for the year of 2019.
As we discussed above,
Having the WCR less than 1.0 is so dangerous for the company’s financial health.
According to their report and the WCR we got, the company has not enough liquid funds to meet its operational expenses.
Now, you may have understood the entire concept of WCR.
But the main part comes now,
Because Knowledge never works, the implementation works. So, that’s important.
The monitor the WCR is always a good habit. It helps you to make the right decisions and take the right actions at the right time.
Monitor the WCR
Being updated about what is happening with your operational funds is important. It should become a routine in your finance department to calculate the WCR or all the ratios come under the ratio analysis. It will make your company alert every time whenever it is doing something wrong. and also it will help you while doing your financial management or taking any decision.
No matter who is leading and handling the finance department in your company, whether you or your employee, that person should have the discipline of analyzing the ratios of financial analysis on a regular basis.
What is a good working capital ratio?
As we have seen above, the working capital ratio tells all about the position of the company’s current assets. Is it having enough liquid funds to pay it’s short term liabilities or not? So,
Let’s see the logic behind this,
If a company has a working capital ratio, less than 1.0 to be specific, 0.8. It means the company has 20% less money to pay its liabilities in the short term. And it is absolutely clear that somewhere the company will falter in the near future. And that’s not good at all.
If having WCR 1.0 it means, the company can at least meet it’s short term payables. But still, the company is running from the boundary line if the safe zone.
If the company is having WCR in between 1.5 to 2 it means the company has the assets more than 50% of what it has to pay in the period of one year. And it sounds quite strong in terms of short liquid funds.
But if the company has it’s WCR more the 2.0 it means the company has current assets more than double of its liabilities. And it shows the company is not investing its money efficiently with its full potential. And also it will affect badly on the return on assets (ROA) of the company.
So, always better to maintain your working capital ratio between 1.5 to 2.0. If it’s not, understand your company is doing somewhere wrong. And you should address the mistakes and take the actions for the sake of improvement and growth.
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