Accounts Payable Turnover Ratio

Definition

Accounts payable turnover ratio is an accounting liquidity metric that evaluates how fast a company pays off its creditors (suppliers). The ratio shows how many times in a given period (typically 1 year) a company pays its average accounts payable. An accounts payable turnover ratio measures the number of times a company pays its suppliers during a specific accounting period.

Accounts payables turnover trends can help a company assess its cash situation. Just as accounts receivable ratios can be used to judge a company's incoming cash situation, this figure can demonstrate how a business handles its outgoing payments.

Calculation (formula)

Accounts-payable turnover is calculated by dividing the total amount of purchases made on credit by the average accounts-payable balance for any given period.

Accounts payable turnover ratio = Total purchases / Average accounts payable

There is no single line item that tells how much a company purchased in a year. The cost of sales in the income statement (statement of comprehensive income) shows what was sold, but the company may have purchased either more or less than it eventually sold. The result would be either an increase, or a decrease in inventory. To calculate the purchases made, the cost of goods sold is adjusted by the change in inventory as follows:

Purchases = Cost of sales + Ending inventory – Starting inventory

Again, as with the accounts receivable turnover ratios, this can be expressed in terms of a number of days by dividing the result into 365:

Days Payable Outstanding (DPO) = 365 /Accounts payable turnover ratio

Norms and Limits

Payment requirements will usually vary from supplier to supplier, depending on its size and financial capabilities. A high ratio means there is a relatively short time between purchase of goods and services and payment for them. Conversely, a lower accounts payable turnover ratio usually signifies that a company is slow in paying its suppliers.

But a high accounts payable turnover ratio is not always in the best interest of a company. Many companies extend the period of credit turnover (i.e. lower accounts payable turnover ratios) getting extra liquidity.

Exact Formula in the ReadyRatios Analytic Software

Days Payable Outstanding = ((F1[b][TradeAndOtherCurrentPayables] + F1[e][TradeAndOtherCurrentPayables]+F1[b][CurrentProvisionsForEmployeeBenefits] +F1[e][CurrentProvisionsForEmployeeBenefits])/2)/((F2[CostOfSales]+ F1[e][Inventories] - F1[b][Inventories])/NUM_DAYS)

Accounts payable turnover ratio = 365 / Days payable outstanding

F2 – Statement of comprehensive income (IFRS).
F1[b], F1[e] - Statement of financial position (at the [b]egining and at the [e]nd of the analysed period).
NUM_DAYS – Number of days in the the analysed period.
365 – Days in year.

Note: Employee benefits are considered here as a part of purchases because they are also account payables and also form cost of sales.