How Can Others Find Out the Efficiency of Working Capital Management?
Investors and analysts look at an organization’s working capital to find out its overall financial health and efficiency. Working capital is basically the funds that a company requires to maintain its business operations on a daily basis. It is made up of many components, the 3 most significant being accounts receivable, accounts payable, and inventory levels.
An assessor of an organization’s working capital management has to consider the inventory turnover ratio, collection ratio, and working capital ratio.
Inventory Turnover Ratio
This ratio gives information about how many times a company has sold and replaced its stock over a given time period. The formula for it divides sales by inventory. High stock turnover ratios are often interpreted as ones suggesting inefficient purchasing or very vigorous sales. To find out which one is the case, an analyst looks at average stock figures and turnover rates.
This ratio gives an idea about the average time a company needs to get the funds due from its customers. Lower ratio values are favorable because the timely accounts receivable collection is vital to making sure that a company keeps sufficient cash flow for meeting its operating costs.
Working Capital Ratio
This one suggests to analysts and investors whether a business has enough assets to cover its financial obligations in the short-term. A ratio falling between 1.20 and 2.0 is often considered satisfactory.