Last Updated on August 29, 2023
For business owners, efficiency is everything, particularly in today’s economy. But how is the efficiency of a business’s financial processes accurately measured? One of the best ways to do so is by calculating your cash turnover ratio.
The cash turnover ratio highlights a company’s efficiency and can even provide a glimpse into overall profitability. To find your ratio, you’ll need your business’s accounting data and sales revenue handy. But before diving straight into the cash turnover ratio formula, let’s first explore what this metric means and what it can tell you about your business.
What Is Cash Turnover Ratio?
The cash turnover ratio is a formula that assesses how well a company turns its cash balances into sales revenue during a certain period of time. The solution to the formula is expressed as a number that represents how many times a company’s average cash balance is used to generate revenue during a given period, which is typically one year.
What Is a “Good” Cash Turnover Ratio?
As with most financial measures, it is unreasonable to quantify what the average business should aim for when it comes to this ratio. Factors such as a business’s age, industry, size, location, and financial goals make it so that each business will have a ratio that they should aim for. This is why it’s vital to make a habit of calculating this ratio, because you can then compare your existing ratio to that of previous fiscal years, and hopefully see an upward trend!
While there is no benchmark number that signals a “good” turnover ratio, generally speaking, the higher the better, as that indicates increased efficiency and profitability. However, a higher ratio could also indicate that you are burning through cash too quickly, which could reveal other cash flow management issues. Looking at this particular financial measure alongside other key business metrics can give you a more holistic picture of company performance.
Why Is Cash Turnover Ratio Important?
Business owners can use this ratio to determine how efficiently their company uses its cash and the profitability of processes that directly correlate with revenue.
The cash turnover ratio provides evidence of why implementing efficient accounts payable and accounts receivable processes is so important for businesses. Typical accounting tasks aren’t the most exciting aspect of running a company, but by ensuring your accounting procedures are as structured and logical as possible, you can greatly improve your overall cash management.
Additionally, if your cash turnover decreases from year to year, it could be indicative that either your business might be struggling or that you might need to get creative by incorporating new strategies aimed at boosting your revenue.
Cash Turnover Ratio (CTR) Formula
CTR = Revenue/(Cash + Cash Equivalents)
As you can see, the cash turnover ratio is quite simple to calculate. All you need are the following:
- Cash equivalents
When adding up your cash and cash equivalents, it’s best practice to take averages from your most recent two accounting periods for the most accurate data.
If you’re a new business owner, make sure you know the difference between revenue vs. income before exploring this ratio any further. You can find revenue at the top-line of your company’s income statement, while cash and cash equivalents should be at the top of your company’s balance sheet.
Once you’ve gathered these three totals, you can go ahead and calculate your cash turnover ratio.
Cash Turnover Ratio Example
Take the following scenario:
ABC Staffing is a small but a growing staffing agency. After reaching two fiscal years in business, the owner decides to evaluate her cash management ability, so she calculates her CTR.
The company is growing at an impressive rate, having generated $1 million in revenue in fiscal year 2023. The owner had cash and cash equivalents of $25,000 at the end of the previous accounting cycle (2022) and $50,000 at the end of the current cycle (2023). The average of these cash equivalents if $37,500, so she would use this data point for her cash turnover ratio formula.
Therefore, calculating her cash turnover would read as follows:
1,000,000/37,500 = 26.667
This means that ABC Staffing, on average, restored its cash balance 26 to 27 times during the fiscal year 2023.
Tips and Resources to Improve Cash Turnover Ratio
The obvious tip to improve your cash turnover ratio is to increase your revenue, which you can strive to do by shifting your prices, exploring new sources of revenue, and improving customer retention.
However, increasing revenue can be indirectly accomplished by enhancing other financial measures or areas of your business.
You can start by:
- Improving your cash flow
- Exploring small-business specific cash flow management strategies
- Implementing new accounts payable management strategies
- Increasing your working capital
- Selling accounts receivable to finance your business
- Utilizing alternative lending methods
As a business owner, having the fullest understanding of your finances will allow you to key in on areas for improvement and ultimately make better-informed business decisions. To do so, ensure that you’ve created and analyzed your three key financial statements: profit and loss statement, balance sheet, and cash flow statement.
Once you’ve done so, you can move on to calculating financial measures similar to the cash turnover ratio, such as your cash conversion cycle.
Cash Turnover Ratio FAQs
What is the meaning of cash turnover ratio?
The cash turnover ratio is a financial measure that business owners can use to help determine the overall efficiency and profitability of their businesses.
What does the cash turnover ratio tell you?
Expressed as a number of days, the cash turnover ratio tells you how many times your business is able to replenish its cash in a given fiscal year.
How do you calculate the cash turnover ratio?
To calculate your cash turnover ratio, simply divide your revenue by the total of cash and cash equivalents you had for a given period. For improved accuracy, take the average of your total cash plus cash equivalents from your previous two cycles.
Michael McCareins is the Content Marketing Associate at altLINE, where he is dedicated to creating and managing optimal content for readers. Following a brief career in media relations, Michael has discovered a passion for content marketing through developing unique, informative content to help audiences better understand ideas and topics such as invoice factoring and A/R financing.