Working Capital Turnover For Your Construction Business
- Cost Construction Accounting
- Aug 7, 2022
- 5 min read
Updated: Jan 8
If your bonding company rejected your application or your bank denied your line of credit, your working capital turnover ratio might be the culprit. This single metric tells lenders, sureties, and investors whether you're efficiently managing your cash or drowning in it.
For construction companies operating on tight margins, understanding and optimizing your working capital turnover isn't just good accounting, it's crucial for winning projects and staying competitive.
Table of Contents: |
What Is Working Capital?
Working capital represents the cash and liquid assets available for daily operations, calculated by subtracting current liabilities from current assets.
The Working Capital Formula:
Working Capital = Current Assets - Current Liabilities |
Current assets include cash, accounts receivable, inventory, work in progress, and retainage receivable. Current liabilities include accounts payable, short-term loans, accrued expenses, and the current portion of long-term debt.
For example, if your company has $850,000 in current assets and $420,000 in current liabilities, your working capital is $430,000. This buffer funds ongoing projects and handles surprises.
Calculating Average Working Capital
To find average working capital, add your working capital at the beginning and end of a given period typically a fiscal year and divide by two. This approach smooths out seasonal fluctuations or one-time events that might skew your numbers.
The Formula:
Average Working Capital = (Beginning Working Capital + Ending Working Capital) / 2 |
By using average working capital in your turnover ratio calculation, you ensure your analysis reflects the true, ongoing capacity of your business to support sales and meet short-term obligations. This is especially important in construction, where project cycles and payment schedules can cause significant swings in working capital from month to month.
Understanding Working Capital Turnover Ratio
The working capital turnover ratio measures how efficiently a company uses its working capital to generate sales revenue. It shows how many dollars of sales are generated for every dollar of working capital tied up.
Working Capital Turnover Ratio = Net Annual Sales ÷ Average Working Capital |
Net sales are found on the income statement and are calculated by subtracting returns, allowances, and discounts from gross sales. A high working capital turnover ratio usually signals strong operational efficiency and effective management of receivables, inventory, and payables.
Example in Action
Contractor A: $8,000,000 revenue, $2,000,000 average working capital → Ratio = 4.0
Contractor B: $8,000,000 revenue, $1,200,000 average working capital → Ratio = 6.67
Contractor B generates the same revenue with $800,000 less working capital tied up, freeing funds for equipment, bids, or reserves. A higher turnover ratio indicates better operational efficiency and stronger cash flow, as resources are being used more effectively to generate sales.
In contrast, a low ratio may signal inefficiency, such as excess inventory, slow receivables, or underutilized assets, which can negatively impact cash flow and operational flexibility. However, a very high ratio might also suggest the company is not investing enough in future growth.
What's a Good Ratio for Construction Companies?
1. Bonding Capacity
Surety companies scrutinize your working capital turnover when underwriting performance and payment bonds. A strong ratio proves you can efficiently manage cash flow across multiple projects essential for bonding on public and large commercial work.
A ratio below industry averages raises red flags. Sureties may reduce your bonding capacity, increase your bond costs, or require additional collateral.
2. Access to Financing
Banks and lenders use this metric to assess your creditworthiness. A healthy turnover ratio demonstrates:
Strong operational management
Efficient use of resources
Lower risk of cash flow crises
When you apply for a line of credit or equipment loan, your working capital turnover helps lenders predict your ability to generate revenue and repay debt.
3. Operational Efficiency
Beyond impressing lenders, this ratio reveals operational truths:
Are you collecting receivables quickly enough?
Is too much cash tied up in inventory?
Are your billing processes efficient?
Can you handle backlog without additional financing?
4. Competitive Advantage
Higher efficiency means you can:
Bid on more projects simultaneously
Weather payment delays better
Invest in growth opportunities
Handle unexpected project costs without panic
Warning Signs: When Your Ratio Tells a Dangerous Story
Ratio Below 2.0: You're Overcapitalized or Inefficient
Indicates: Excess inventory, slow receivables, or billing delays.
Action: Tighten billing procedures, review AR aging reports, and improve collections. Improving efficiency in this area can free up working capital, enabling more sales and supporting business growth.
Extremely High Ratio (Above 15)
Indicates: Too little working capital, which can strain liquidity and limit growth capacity. While it may indicate strong sales relative to working capital, it also increases the risk of insolvency if cash reserves are insufficient.
Action: Negotiate favorable payment terms with suppliers to improve liquidity, and secure credit lines.
Negative Working Capital: Red Alert
If your current liabilities exceed your current assets, you have negative working capital. Your turnover ratio is meaningless at this point, you're in survival mode. This typically signals:
Overextended on projects
Poor collections
Taking on work without adequate capitalization
Action needed: Immediate cash flow intervention. Consider factoring receivables, negotiating payment extensions, or halting new project bids until you stabilize.
How to Improve Your Working Capital Turnover
Accelerate Accounts Receivable: Invoice promptly, automate billing, offer early payment discounts, and track days sales outstanding.
Optimize Inventory: Regularly review stock levels, adopt just-in-time ordering, and negotiate supplier terms. Improving inventory management helps free up capital and supports efficient operations. Monitoring inventory turnover is essential, as a high inventory turnover indicates efficient inventory management and better working capital utilization.
Improve Project Cash Flow: Structure payment schedules to match costs, request deposits, and minimize retainage.
Extend Accounts Payable Strategically: Use full payment terms without harming supplier relationships.
Increase Revenue Without Increasing Working Capital: Focus on faster-turnover projects, improve margins, and adjust pricing strategies. Analyzing your pricing strategy, including price increases or promotional discounts, can impact customer demand, sales performance, and working capital turnover.
Operational efficiency is suggested by a high working capital turnover ratio, indicating effective management of receivables, inventory, and payables.
The Bottom Line: Make Your Working Capital Work Harder
Your working capital turnover ratio is a real-time health check of your construction business’s efficiency and sustainability. Maintaining a strong ratio supports financial stability, growth, and attractiveness to lenders and sureties. Efficient capital management is key to success make your working capital work harder.
Turn Efficiency Into Opportunity with CCA
At Construction Cost Accounting (CCA), we specialize in the specific financial needs of construction SMEs. We don't just calculate your ratio; we provide the specialized bookkeeping, precise job costing, and real-time WIP analysis required to move your ratio into that profitable sweet spot.
Stop letting cash flow anxiety limit your growth and bonding capacity. Securing your next line of credit or performance bond starts with managing your cash flow today.
Schedule a free, no-obligation Working Capital Health Check with a CCA expert now. Let us help you optimize your financial performance and secure the bonding capacity you need to grow.
Comments