Advantages and Disadvantages of Capital Turnover Ratio
Capital Turnover ratio is the tool used to measure the company sale toward the average stockholder equity. It shows how efficiently the company uses shareholder equity to generate sale and expand the business.
The higher the ratio, the better company performance. It shows that company is doing well and able to generate a higher sale from the capital employ.
On the other hand, a low ratio means that the company cannot generate enough sales from the available equity. They need to use the resource to expand more business activities in order to increase sales.
Capital Turnover Ratio Formula
| \[Capital\ Turnover\ Ratio = {Annual\ Sale \over Average\ Total\ Equity}\] |
Advantages of Capital Turnover Ratio
- To push management to utilize the available resource: The ratio will put pressure on the management to generate sales from the available equity.
- To raise funds to support operation: When the ratio is too high, it shows that the company does not have enough resources to support its activities. Management should be looking to raise more funds from shareholders.
- Maximum Profitability: The more sale we generate, the more profit we make. It is a good sign that the company will be able to increase the shareholders’ wealth.
- Attract more investors: High ratio will attract more investors as it indicates that company is doing well. Investors are looking to invest their money in a company that can generate more sales and profit.
Disadvantages of Capital Turnover Ratio
- The ratio too high may show that company does not have enough capital to support its operation: The company may look to increase sales as well the ratio. However, a high ratio may not always be a good sign, it shows that the company does not have enough capital to support business activities.
- Only depend on monetary value: The ratio only uses the monetary value which ignores non-monetary figures.