Cash turnover is an efficiency ratio that allows a company to determine how it used cash to generate sales. The formula divides sales revenue by the average cash balance for a specific period. Month-end financial statements contain the information necessary to compute this figure, namely the income statement and balance sheet. Essentially, the cash turnover formula tells a company how many times the company went through its cash balance for the period, whether monthly or annual. Accountants often use the formula to help create budgets for estimating and controlling business operations.
Sales revenue is a simple number to compute. The income statement’s first section lists sales revenue for the period. The total of all revenue lines represents the numerator for the cash turnover formula. Average cash balance takes a bit more work to compute. The company’s beginning cash balance 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, meaning the company burned through its cash balance more than six times during the month. Cash spent most likely paid the expenses necessary to run operations, purchase inventory to produce or sell, and pay employees for working in the business. This example would also hold true if using the formula for annual figures. The annual result will be a much larger number.
Companies can use the cash turnover formula to determine if 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 $310,000 USD in sales and a turnover ratio of 5.5, accountants must determine if an additional 1.0 in the turnover ratio was acceptable to gain an additional $15,000 in sales. Hence, the use of this ratio will help determine the efficient use of cash. If the additional cash expenditures for October were excessive, accountants must find out where the inefficiencies exist in the business.
The cash turnover ratio is also a benchmark tool. Companies can compare their use of cash to the industry standard or a leading competitor. The comparison indicates which company was more efficient when using cash. If the company has a lower cash turnover ratio than the industry average, a problem may exist in the business. The ratio works well as a benchmark because it turns standard accounting information into usable statistics, making a comparison possible.