Sure, here are some notes on the turnover method of working capital assessment:
- The turnover method is a simple method of assessing a borrower’s working capital requirements based on their projected sales.
- The method assumes that a certain percentage of the borrower’s sales will be tied up in current assets, such as inventory and accounts receivable.
- The amount of working capital required is then calculated as a percentage of projected sales.
- The turnover method is typically used for small businesses with relatively simple operations.
- It is also a good method for businesses that are in cyclical industries, as the method can be adjusted to reflect the seasonal nature of the business.
Here are the steps involved in the turnover method:
- Estimate the borrower’s projected sales for the next year.
- Determine the average inventory turnover ratio and the average accounts receivable turnover ratio for the industry.
- Calculate the amount of working capital required as follows:
Working capital requirement = (Projected sales) x [(1 – Inventory turnover ratio) + (1 – Accounts receivable turnover ratio)]
- The borrower’s contribution to working capital is typically 20-30% of the working capital requirement.
- The bank’s lending limit is then the remaining 70-80% of the working capital requirement.
The turnover method is a simple and easy-to-use method of assessing working capital requirements. However, it is important to note that the method does not take into account all of the factors that can affect a borrower’s working capital needs. For example, the method does not consider the borrower’s payment terms, their credit policy, or their inventory management practices.
As a result, the turnover method should be used in conjunction with other methods of assessing working capital requirements, such as the cash budget method or the average collection period method.