Accounts payable turnover ratio
/What is the Accounts Payable Turnover Ratio?
Accounts payable turnover is a ratio that measures the speed with which a company pays its suppliers. If the turnover ratio declines from one period to the next, this indicates that the company is paying its suppliers more slowly, and may be an indicator of worsening financial condition. A change in the turnover ratio can also indicate altered payment terms with suppliers, though this rarely has more than a slight impact on the ratio. If a company is paying its suppliers very quickly, it may mean that the suppliers are demanding fast payment terms, or that the company is taking advantage of early payment discounts.
How to Calculate the Accounts Payable Turnover Ratio
To calculate the accounts payable turnover ratio, summarize all purchases from suppliers during the measurement period and divide by the average amount of accounts payable during that period. The formula is:
Total supplier purchases ÷ ((Beginning accounts payable + Ending accounts payable) / 2)
The formula can be modified to exclude cash payments to suppliers, since the numerator should include only purchases on credit from suppliers. However, the amount of up-front cash payments to suppliers is normally so small that this modification is not necessary. The cash payment exclusion may be necessary if a company has been so late in paying suppliers that they now require cash in advance payments.
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Example of the Accounts Payable Turnover Ratio
The controller of ABC Company wants to determine the company's accounts payable turnover for the past year. In the beginning of this period, the beginning accounts payable balance was $800,000, and the ending balance was $884,000. Purchases for the last 12 months were $7,500,000. Based on this information, the controller calculates the accounts payable turnover as:
$7,500,000 Purchases ÷ (($800,000 Beginning payables + $884,000 Ending payables) / 2)
= $7,500,000 Purchases ÷ $842,000 Average accounts payable
= 8.9 Accounts payable turnover
Thus, ABC's accounts payable turned over 8.9 times during the past year. To calculate the accounts payable turnover in days (which shows the average number of days that a payable remains unpaid), the controller divides the 8.9 turns into 365 days, which yields:
365 Days / 8.9 Turns = 41 Days
Problems with the Accounts Payable Turnover Ratio
There are several problems with the accounts payable turnover ratio, which are as follows:
Incorrect numerator. Companies sometimes measure the accounts payable turnover ratio by only using the cost of goods sold in the numerator. This is incorrect, since there may be a large amount of administrative expenses that should also be included in the numerator. If a company only uses the cost of goods sold in the numerator, this creates an excessively high turnover ratio.
Impact of cash-on-delivery payments. An incorrectly high turnover ratio can also be caused if cash-on-delivery payments made to suppliers are included in the ratio, since these payments are outstanding for zero days. This is a concern for businesses in poor financial condition, since they are more likely to make these types of payments.
Terms Similar to the Accounts Payable Turnover Ratio
Accounts payable turnover is also known as payables turnover and the creditors' turnover ratio.