The appropriate level of liquidity varies depending on the individual company in question. But you can use the ratio sales to working capital metric to help determine whether a company has too many or too few current assets compared to its current liabilities. This metric looks like this:
Here’s how to use this equation:
Find sales at the top of the income statement.
Calculate working capital by subtracting current liabilities from current assets (both of which you find on the balance sheet).
Divide the value of the company’s sales by its working capital to get the sales to working capital.
A very high number may indicate that a company doesn’t keep enough current assets available to maintain inventory levels for the number of sales it’s making. A very low number may mean that the company is keeping such a high proportion of its assets current that it isn’t using its assets to generate sales.
Watching how a company’s sales to working capital varies over time compared to that of its competitors can help give context to the other liquidity metrics by measuring how effectively the company is managing its working capital.
