Accounts payable turnover ratio is a measure to quantify the rate at which a company pays off its suppliers and short term debts.
Accounts payable is listed on the balance sheet as a liability. It’s a short term debt that the company owes to its creditors.
Here is the formula to calculate accounts payable turnover ratio;
Accounts payable turnover = Purchases / average accounts payable
Average accounts payable = (beginning accounts payable + ending accounts payable) / 2
What accounts payable turnover ratio tells you
The number of days payable indicates the average number of days the company takes to pay its suppliers.
Accounts payable turnover ratio measures how many times per year the company theoretically pays off all its creditors.
You will not get the total credit purchase of the company as it is not reported by the company in its income statement. Therefore total purchase is considered in the numerator to calculate payable turnover ratio.
If the payable turnover ratio is high in comparison to industry standard, then it can be assumed that the company is not managing available credit facilities effectively.
Low payable turnover ratio indicates the company is not paying its creditors on time. It takes longer to pay off its suppliers. A decrease in ratio indicates that the company might be in financial distress.
Increase in accounts payable turnover ratio indicates that the company is paying off suppliers at a faster rate than in the previous periods. It also indicates that the company has plenty of cash to pay off its short term obligation towards suppliers. Most importantly it signals that the management has managed the cash and debt effectively.
Comparison of financial ratios with immediate competitors is the best way to understand and interpret the financial ratios. If the accounts payable turnover ratio is very high in comparison to industry standards, then it indicates that the management is not reinvesting money back into the business effectively, which could result in lower growth rate or low earnings in the long term.
Similarly accounts receivable turnover ratio is also used to assess the management’s efficiency.
Example: How to calcualte accounts payable turnover ratio
Total purchases for the year is 100 Crores
Beginning accounts payable is 30 Crores
Ending accounts payable is 50 Crores
Accounts payable turnover ratio = Total purchases / average accounts payable = 100 Crores / 40 Crores = 2.5
Average accounts payable = (30 Crores + 50 Crores)/2 = 40 crores
2.5 times means, the company paid off accounts payables 2.5 times during the financial year.
