Stock to Working capital Ratio
The amount of a company’s current assets that it has at any one moment, in excess of the amount that it owes in terms of its current obligations, is referred to as the company’s net working capital (NWC).
These finances are what make it possible for a company to carry out its day-to-day activities. The cash that is invested in a company’s inventory is often considered to be one of the company’s short-term assets. But if this inventory number is quite significant in comparison to other assets, it might distort the image of exactly how easily accessible a company’s cash is for paying off short-term loans. This picture can be skewed if this inventory amount is relatively substantial in comparison to other assets. Sometimes a firm’s inventory may suffer from unusually low turn-over, or it may simply become obsolete and impossible to sell. Both of these scenarios are problematic for the company.
You can get a more accurate picture of a company’s liquidity position by calculating exactly what proportion of a business’s working capital is tied up in its inventory using the inventory to net working capital ratio. This ratio allows you to calculate exactly what proportion of a business’s working capital is tied up in its inventory.
Stock (Inventory) to Working capital Ratio = Inventory / (Accounts Receivables+ inventory – Accounts Payable)
Cautions & Further Explanation
To correctly detect patterns in the utilisation of a company’s working capital, it is essential to analyse a company’s inventory to net working capital ratio across a number of periods.
Such patterns may serve to highlight any operational issues a business may be experiencing, such as the growing ratio values linked to large amounts of out-of-date inventory, poor buying oversight, and inaccurate sales predictions.
The inventory to NWC ratio is best used in conjunction with an analysis of a company’s inventory turnover rate, since stock that continuously turns over swiftly will be far more beneficial to an organization’s level of liquidity.
In general, a company’s liquidity is stronger the lower its inventory to working capital ratio is. This will be especially true for companies that keep a lot of inventory and need a certain amount of cash to run their operations.
Although some experts believe that ratio values under 100% are adequate evidence of a company’s liquidity, this figure sometimes proves to be overly general for all circumstances. Utilizing industry averages as a reference point in your research can help you draw more insightful conclusions since inventory to WC ratios vary significantly across businesses and industries.
