Cash turnover measures how efficiently a company uses cash to generate sales. The formula divides sales revenue by the average cash balance for a specific period. This ratio helps businesses determine their efficient use of money and compare it to industry standards or competitors.
Cash turnover is a measure of efficiency that allows a company to determine how it has used cash to generate sales. The formula divides sales revenue by the average cash balance for a specific period. Month-end balance sheets contain the information needed to calculate this figure, especially the income statement and balance sheet. Essentially, the cash turnover formula tells a business how many times the company has crossed over its cash balance for the period, whether monthly or yearly. Accountants often use the formula to help create budgets for estimating and controlling business operations.
Sales revenue is a simple number to calculate. The first section of the income statement lists the sales revenue for the period. The total of all revenue lines represents the numerator for the cash turnover formula. The average cash balance takes a little more work to calculate. The opening and ending cash balance divided by two will result in the average cash balance for the period.
For example, a company has $325,000 US dollars (USD) in sales revenue and $50,000 USD in average cash balance for October. Using the cash turnover formula, the company’s turnover is 6.5, which means that the company burned through its cash balance more than six times during the month. The money spent most likely paid for expenses needed to run operations, purchase inventory to manufacture or sell, and pay employees to work in the industry. This example would also work if you use the formula for yearly figures. The annual result will be a much larger number.
Businesses can use the cash turnover formula to determine whether they are using more or less cash in normal operations. For example, the previous example resulted in a cash turnover of 6.5 for October. If September had revenue of $310,000 and a turnover ratio of 5.5, accountants must determine whether an additional 1.0 in turnover ratio was acceptable to earn an additional $15,000 in sales. So, using this ratio will help determine the efficient use of money. If the additional cash outlays for October were excessive, accountants need to find out where the inefficiencies exist in the industry.
The cash turnover ratio is also a reference tool. Businesses can compare their use of cash against industry standards or major competitors. The comparison indicates which company was more efficient at using cash. If the company has a cash turnover ratio below the industry average, there may be a problem in the business. The report works well as a point of reference because it transforms standard accounting information into actionable statistics, making comparisons possible.
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