Learning Outcomes
- Calculate the cash turnover ratio
The cash turnover ratio (CTR) is an efficiency ratio that shows the number of times cash is turned over in an accounting period. The cash turnover ratio works most effectively for companies that do not offer credit sales, however, for the sake of consistency, we’ll calculate the ratio for our prototypical Jonick company.
The formula for calculating the cash turnover ratio is as follows:
[latex]\dfrac{\text{Revenue}}{\text{Average Cash and Cash Equivalents}}[/latex]
- For Jonick, sales for 2019 were $994,000.
- Cash at December 31, 2019 was: $373,000
- Cash at December 31, 2018 was: $331,000
- So the average cash was [latex]\dfrac{373,000+331,000}{2}=\$352,000[/latex]
- That means the cash turnover ratio for 2019 was [latex]\dfrac{994,000}{352,000} = 2.82[/latex]
The cash turnover ratio indicates how many times a company went through its cash balance over an accounting period and the efficiency of a company’s cash in the generation of revenue. Additionally, the cash turnover ratio is often used by accountants for budgeting purposes.
In this case, over the course of one year (2019), the company generated in revenue almost three times the amount of cash. Another way to look at this is to divide the number of days in the year by the cash turnover ratio to get an estimate of the number of days that it takes for a company to replenish its cash balance. In this case, 365 days / 2.82 times per year = approximately 130 days.
A higher cash turnover ratio is desirable, as it indicates a greater frequency of cash replenishment through revenue. However, it is important to note there is no one ideal cash turnover ratio number. As with other ratios, it should be compared to competitors and industry benchmarks.
| Description | 2019 | 2018 |
|---|---|---|
| Sales | $994,000 | $828,000 |
| Cost of merchandise sold | 414,000 | 393,000 |
| Gross Profit | Single Line$580,000 | Single Line$435,000 |
| 2019 | 2018 | |
|---|---|---|
| Assets | ||
| Subcategory, Current assets: | ||
| Cash | $373,000 | $331,000 |
| Marketable securities | 248,000 | 215,000 |
| Accounts receivable | 108,000 | 91,000 |
| Merchandise Inventory | 55,000 | 48,000 |
| Prepaid insurance | 127,000 | 115,000 |
| Total current assets | Single Line$911,000 | Single Line$800,000 |
The key drawback of the cash turnover ratio is that it does not account for credit sales, which are sales made by customers in which the payment is delayed. The cash turnover ratio is most appropriate for companies that do not offer credit sales. Using the cash turnover ratio for companies that offer credit sales skews the CTR by making it larger than it really is.
Additionally, accumulating cash for future acquisitions skews the cash turnover ratio lower. The CTR is best used if the company’s cash balance year-over-year does not see significant changes.
We’ll cover additional ways to measure a company’s liquidity in the next reading but first, let’s test out your knowledge of CTR.
PRACTICE QUESTION
