In order to generate and maintain sales a business needs to invest some of its working capital. This working capital is invested in accounts receivable and the inventory of the business. The accounts payable are offset against these investments. This indicates that there is a certain ratio that exists between the working capital and the sales of the business even if the level of sales changes or not.
The relationship between the sales and the capital investment can be measured with the help of sales to working capital ratio. A trend line of this ratio is maintained to find out the spikes or the dips of this ratio. The spike of the ratio indicates that the business has decided to grant more credit to the customers in order to encourage more sales by the customers. The trend line is used as an excellent source for the decision making process regarding the working capital of the business. The formula of sales to working capital ratio can be shown as under:-
Sales to Working Capital Ratio = Annual Sales of the business/ Accounts Receivable +Inventory – Accounts Payable
There are a number of outcomes of this ratio that are directly related to the management decision of the use of the working capital such as tightening the credit for the customers may reduce sales, reducing the size of the inventory may also have negative effect on sales.
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