Accounts payable turnover is a measure of how quickly a company pays its suppliers for the goods or services it purchases on credit. It shows how efficiently a company manages its short-term liquidity and cash flow. A higher ratio means that the company pays its suppliers faster, which can indicate good creditworthiness and financial health. A lower ratio means that the company pays its suppliers slower, which can signal financial distress or poor cash management.
To calculate the accounts payable turnover ratio, you need to know the total amount of purchases made on credit, and the average balance of accounts payable during a period. The average accounts payable is the sum of the accounts payable at the beginning and the end of the period, divided by two. The ratio is then obtained by dividing the total purchases on credit by the average accounts payable. The ratio can be expressed in terms of times or days. If the ratio is in times, it shows how many times the company pays its suppliers in a period. If the ratio is in days, it shows the average number of days it takes for the company to pay its suppliers.
The accounts payable turnover ratio can vary depending on the industry, the size of the company, the payment terms, and the business cycle. Therefore, it is useful to compare the ratio with the industry average, the company’s historical performance, or the company’s competitors. A higher ratio than the benchmark can indicate that the company has a strong bargaining power with its suppliers, or that it is taking advantage of early payment discounts, or that it is improving its credit rating. A lower ratio than the benchmark can indicate that the company has a weak bargaining power with its suppliers, or that it is facing cash flow problems, or that it is delaying its payments to conserve cash. However, a very high or very low ratio can also have drawbacks. A very high ratio can mean that the company is missing out on opportunities to invest its cash in other profitable projects. A very low ratio can mean that the company is risking its reputation and relationship with its suppliers, or that it is facing legal actions or penalties for late payments.
The formula for Accounts Payable Turnover is:
Accounts Payable Turnover = Net Credit Purchases / Average Accounts Payable
Where:
- Net Credit Purchases = Total credit purchases – Purchase returns
- Average Accounts Payable = (Beginning AP + Ending AP) / 2
Procedures
- Gather Data: Collect information on credit purchases, purchase returns, and accounts payable for the period.
- Organize Data in Excel: Create a table with columns for credit purchases, purchase returns, beginning accounts payable, ending accounts payable, net credit purchases, and average accounts payable.
- Calculate Net Credit Purchases: Use the formula: Net Credit Purchases = Total Credit Purchases – Purchase Returns
- Calculate Average Accounts Payable: Use the formula: Average AP = (Beginning AP + Ending AP) / 2
- Apply Accounts Payable Turnover Formula: Use the formula: Accounts Payable Turnover = Net Credit Purchases / Average Accounts Payable
Scenario
Let’s consider a hypothetical scenario for Company XYZ:
- Total Credit Purchases: $500,000
- Purchase Returns: $20,000
- Beginning Accounts Payable: $50,000
- Ending Accounts Payable: $30,000
Now, let’s plug these values into our Excel table and calculate the Accounts Payable Turnover.
| Description | Amount ($) |
|---|---|
| Total Credit Purchases | $500,000 |
| Purchase Returns | $20,000 |
| Beginning AP | $50,000 |
| Ending AP | $30,000 |
| Net Credit Purchases | =B2-B3 |
| Average AP | =(B4+B5)/2 |
| AP Turnover | =B6/B7 |
Calculation and Result
Net Credit Purchases = $500,000 – $20,000 = $480,000
Average AP = ($50,000 + $30,000) / 2 = $40,000
Accounts Payable Turnover = $480,000 / $40,000 = 12
So, the Accounts Payable Turnover for Company XYZ in this scenario is 12.
Additional Approaches
- Days Payable Outstanding (DPO): DPO measures the average number of days a company takes to pay its suppliers. It is calculated as (Number of Days in the Period / Accounts Payable Turnover).
- Comparative Analysis: Compare the Accounts Payable Turnover with industry benchmarks or previous periods to assess the company’s efficiency in managing payables.
