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What is Capital Turnover?
Capital Turnover measures how efficiently a company uses its capital to generate revenue. It shows how many dollars of sales are produced for each dollar of capital employed in the business.
Definition
Capital Turnover is a financial ratio that compares a company’s net sales to its capital employed, indicating how effectively capital is being utilized to drive revenue.
Key Takeaways
- Measures efficiency of capital usage.
- Higher turnover means more revenue generated per unit of capital.
- Helps assess operational efficiency and management effectiveness.
Understanding Capital Turnover
Capital turnover provides insight into how well a company converts investment into revenue. Companies with high asset productivity (such as retail and service businesses) often have higher capital turnover ratios. In contrast, capital-intensive industries may have lower ratios due to heavy investment in fixed assets.
The ratio helps investors understand:
- Whether the company is utilizing capital efficiently.
- How capital structure impacts revenue generation.
- Differences in business models across industries.
Formula
Capital Turnover = Net Sales / Capital Employed
Where Capital Employed = Total Assets − Current Liabilities (or Equity + Long-Term Debt).
Real-World Example
A company with:
- Net Sales: $500 million
- Capital Employed: $250 million
Capital Turnover = 500 / 250 = 2.0
This means the company generates $2 in revenue for every $1 of capital employed.
Importance in Business or Economics
Capital turnover is used to:
- Evaluate operational performance
- Compare efficiency across companies or industries
- Support decisions on capital allocation and investment
Higher turnover generally reflects better capital utilization, though optimal ratios vary by sector.
Types or Variations
- Fixed Asset Turnover: Revenue relative to fixed assets.
- Working Capital Turnover: Revenue generated from working capital.
- Total Asset Turnover: Efficiency of all assets in revenue generation.
Related Terms
- Return on Capital Employed (ROCE)
- Asset Turnover
- Capital Employed
Sources and Further Reading
- Corporate Finance Institute: https://corporatefinanceinstitute.com
- Investopedia: https://investopedia.com
- Financial Analysis Texts: https://jstor.org
Quick Reference
- Efficiency ratio = Sales / Capital Employed.
- Higher value indicates better use of capital.
- Varies significantly across industries.
Frequently Asked Questions (FAQs)
Is higher capital turnover always better?
Not necessarily. Extremely high turnover may indicate underinvestment in assets.
Why do some industries have low capital turnover?
Industries like utilities or manufacturing require heavy investments in equipment and infrastructure.
How is capital turnover related to ROCE?
ROCE = Capital Turnover × Operating Margin. Both efficiency and profitability matter.
