Sometimes referred to as an equity turnover or a working capital turnover, the capital turnover is the total amount of sales revenue divided by the average net capital achieved from the production effort. This essentially makes it possible to compare the usage of working capital with the amount of sales that are generated for a given period of time. From this perspective, the capital turnover can be viewed as an assessment of how effectively the business is using its resources to generate a profit.
The best way to understand how capital turnover is identified is to begin by determining the working capital. If a business has total assets of $5 million in United States dollars (USD), and currently has $3 million USD in liabilities, the working capital comes to $2 million USD. Assuming the business generated $10 million USD in sales for the same period cited, the capital turnover would come to $5 million USD, since the total sales for the period was divided by the working capital on hand.
Companies want to achieve the highest possible amount of capital turnover. This serves as an indicator that the relationship between total sales and the resources needed to produce goods and services to support those sales is healthy, and that the company is in a sound financial situation. Conversely, if the amount of working capital exceeds the amount of sales, that is an indication that the company needs to restructure its operational processes if there is any chance of surviving over the long term.
Many businesses will make it a point to calculate the capital turnover on a regular basis. It is not unusual for this type of evaluation to be conducted on a monthly basis, once the financials for the period are closed and it is possible to identify the current assets, the current liabilities, and the total amount of sales generated in the most recently completed month. Doing so can help business owners identify the beginning of a downward trend, and takes steps to identify the origin before the company can be weakened noticeably.
It is important to note that a single instance of a poor capital turnover does not necessarily mean the business is in distress. A slow season that precedes a normally busy season may create a situation where production is up while sales are down, since the company is gearing up to meet demand in the upcoming months. By knowing how the sales year normally fluctuates for the business, it is possible to identify months in advance where there is an increased chance of a lower capital turnover, and when that lower turnover will be offset by months with a higher turnover.
