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How is Current Asset Turnover Ratio Calculated?
What is Current Asset Turnover Ratio?
The current assets turnover ratio indicates how many times the current assets are turned over in the form of sales within a specific period of time. A higher asset turnover ratio means a better percentage of sales. That is why the more the amount of current asset turnover ratio, the better the ability of the company to generate sales.
Creditors. look for a higher current asset turnover ratio because it shows that a company is strong in its fundamentals. The creditors. look at the current asset turnover ratio because they are interested in the performance of the company in terms of net sales. As the current assets turnover ratio offers. an insight into the number of turnovers. of net sales, it is considered a benchmark of the quality of the company’s sales.
Current Asset Turnover Ratio Calculation
The formula used to calculate the Current Assets Turnover Ratio is as follows −
Formula −
$$\mathrm{\mathrm{Current\: Assets\: Turnover}\:=\:\frac{\mathrm{Liquid\: Sales}}{\mathrm{Liquid \:Liabilities}}}$$
Alternately,
$$\mathrm{\mathrm{Current\: Assets\: Turnover}\:=\:\frac{\mathrm{Net\: Sales}}{\mathrm{Current\: Assets}}\:\times 100}$$
When we divide net sales by current assets and multiply it by 100, the value of sales that occurred due to an investment of Rs. 100 is obtained. Therefore, the current assets turnover ratio, when expressed in percentage terms, indicates the net sales that have occurred due to the investment of each Rs. 100 in the process.
For example, when current assets turnover is 30%, it means that a company has sold worth Rs. 30 when it has invested Rs. 100 in the form of various current assets, such as short-term expenses, inventory, prepaid expenses, outstanding income, sundry debtors. and other current assets.
If a company’s net sales are Rs. 500 billion and its current assets are worth Rs. 50 billion, then its current assets turnover is as follows −
$$\mathrm{\frac{\mathrm{Rs.500}}{Rs.50}\:\times 100\:=\:1000\%}$$
It means that the company has made sales worth Rs. 1,000 for every Rs. 100 invested in the current assets.
Characteristics of Calculating Current Assets Turnover
Some of the key characteristic features of calculating current assets turnover are as follows −
Awareness of Sales power
Measuring the current assets turnover ratio helps companies stay aware of their sales power. It is significantly necessary for any company to increase the sale of their products to keep moving forward and thereby generate revenues. If the company fails to generate revenues through its products and services, chances are that it will go bankrupt soon in the near future.
Signal for Company’s Promising Future
The current assets turnover ratio is a signal for the future of the company that is measured in present terms. It provides a view into the sales figures that, in turn, can show the profitability or performance of the company in the market. Like most other financial ratios, the current assets turnover ratio is a comparative ratio that needs to be calculated in conjunction with other forms of ratios. Making a decision depending solely upon the current assets turnover ratio can be faulty as it fails to show other features of conditions of a company.
For example, the current assets turnover ratio does not show the turnover in terms of debt. So, it cannot measure the efficiency of the company to service long-term debt.
Shows Performance of the Company
There are a host of turnover ratios that are to be measured along with the current asset turnover ratio.
Some of these include −
The creditor turnover ratio
Stock turnover ratio
Debtor turnover ratio, and
Working capital turnover ratio.
Measuring the current assets turnover ratio in comparison to these ratios can show the performance of the company in a better manner.
In order to measure the return on sales, the sales return should be subtracted from net sales. This gives a true value of current sales that is applicable to the measurement of the current assets turnover ratio.
Conclusion
The higher the current asset turnover ratio, obviously the better it is because a higher score in asset turnover means more sales obtained for an investment of a fixed amount (usually Rs. 100). That is why the creditors look for higher current asset turnover ratios to offer loans to eligible companies.
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