Accounts Payable Turnover Ratio

Definition

The accounts payable turnover ratio is an accounting liquidity measure that evaluates how quickly a company pays its creditors (suppliers). The ratio shows how often a company pays its average accounts payable in a given period (typically 1 year). An accounts payable turnover ratio measures the number of times a company pays its suppliers during a given fiscal period.

Accounts payable turnover ratios can help a company assess its cash position. Just as accounts receivable turnover ratios can be used to assess a company's incoming cash situation, this figure can show how a company 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.

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

"Average Accounts Payable" is the average amount of accounts payable outstanding during the same period.

The accounts receivable turnover ratios can be expressed in terms of a number of days by dividing the result into 365 (it's Days Payable Outstanding, DPO):

The calculation of the accounts payable turnover ratio does not depend on the standard of reporting (IFRS or US GAAP). The ratio is calculated the same way regardless of the reporting standard used. However, the way in which these amounts are reported may differ between IFRS and US GAAP due to differences in accounting standards and disclosure requirements. However, this would not affect the calculation of the accounts payable turnover ratio.

Accounts Payable Turnover Ratio Norms and Limits

Payment requirements will usually vary from supplier to supplier, depending on its size and financial capabilities. If the accounts payable turnover ratio is very high, it suggests that the company is paying its bills promptly and has a good relationship with its suppliers. A high ratio may indicate effective management of working capital and liquidity.

If the accounts payable turnover ratio is very low, it may indicate that the company is taking an extended time to pay its bills or taking advantage of long payment terms offered by its suppliers. This could put a strain on the company's relationships with its suppliers and potentially harm its credit rating.

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.

Here are a few ways a company can optimize its accounts payable turnover ratio:

1. Negotiate favorable payment terms with suppliers: By negotiating longer payment terms with suppliers, a company can increase its accounts payable turnover ratio.

2. Streamline the accounts payable process: By improving the efficiency of its accounts payable process, a company can reduce the amount of time it takes to pay its bills and increase its accounts payable turnover ratio.

3. Implement an electronic payment system: By using electronic payment systems, a company can reduce the time it takes to process and pay bills, which can increase its accounts payable turnover ratio.

4. Regularly review and reconcile accounts payable: By regularly reviewing and reconciling its accounts payable, a company can identify and correct any discrepancies or errors that may be delaying payments and impacting its accounts payable turnover ratio.

5. Take advantage of early payment discounts: By taking advantage of early payment discounts offered by suppliers, a company can reduce its accounts payable balance and increase its accounts payable turnover ratio.

It's important to note that optimizing the accounts payable turnover ratio is just one aspect of managing a company's finances, and a high ratio may not always be the best choice for a particular business. It's important to consider all factors and make informed decisions that are in the best interest of the company as a whole.

Importance of Accounts Payable Turnover Ratio

Calculating and tracking the accounts payable turnover ratio is important for a company because it provides insight into the company's cash management and supplier relations. The ratio measures how quickly a company is paying its bills, and it can help a company identify potential problems with its accounts payable process.

A high accounts payable turnover ratio indicates that the company is paying its bills promptly, which may lead to better relationships with suppliers and improved access to favorable payment terms. On the other hand, a low ratio may indicate that the company is taking too long to pay its bills, which could hurt its relationship with suppliers and affect its credit rating.

Overall, tracking the accounts payable turnover ratio is an important aspect of financial analysis and provides valuable information for decision-making, such as assessing the efficiency of working capital management, evaluating supplier relationships, and forecasting future cash flows.

Formula in ReadyRatios Analysis Software

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.