Accounts Payable Turnover Ratio

A liquidity ratio that measures how many times a company pays its creditors over an accounting period

What is Accounts Payable Turnover Ratio?

The accounts payable turnover ratio, also known as the payable turnover or the creditor’s turnover ratio, is a liquidity ratio that measures how many times a company pays its creditors over an accounting period. The accounts payable turnover ratio is a measure of short-term liquidity with a higher payable turnover ratio being favorable.

 

Accounts Payable Turnover Ratio

 

Accounts Payable Turnover Ratio Formula

The formula for the accounts payable turnover ratio is as follows:

 

Formula for Accounts Payable Turnover Ratio

 

In some cases, cost of goods sold (COGS) is used in the numerator in place of net credit purchases. Average accounts payable is the sum of accounts payable at the beginning and end of a period divided by 2.

 

Example of Accounts Payable Turnover Ratio

Company A reported annual purchases on credit of $123,555 and returns of $10,000 during the year ended December 31, 2017. Accounts payable at the beginning and end of the year were $12,555 and $25,121, respectively. The company wants to measure how many times the company paid its creditors over the fiscal year.

 

Example of Accounts Payable Turnover Ratio

 

Therefore, over the fiscal year, the company’s accounts payable turned over approximately 6.03 during the year.

 

Accounts Payable Turnover in Days

The accounts payable turnover in days shows the average number of days that a payable remains unpaid. To calculate the accounts payable turnover in days, simply divide 365 days by the payable turnover ratio.

Payable turnover in days = 365 / Payable turnover ratio

 

Determining the accounts payable turnover in days for Company A in the example above:

Payable turnover in days = 365 / 6.03 = 60.53

 

Therefore, over the fiscal year, the company takes approximately 60.53 days to pay its suppliers.

 

Interpretation of Accounts Payable Turnover Ratio

The accounts payable turnover ratio indicates to creditors the creditworthiness of the company. A high ratio indicates prompt payment to suppliers for purchases on credit. It may be due to suppliers demanding fast payments or that the company is taking advantage of early payment discounts.

A low ratio indicates slow payment to suppliers for purchases on credit. It may be due to favorable credit terms or cash flow problems and hence a worsening financial condition.

The accounts payable turnover ratio depends on the credit terms set by suppliers. For example, companies that enjoy favorable credit terms usually report a lower ratio. Large companies with bargaining power are able to secure better credit terms, resulting in a lower accounts payable turnover ratio (source).

Although a high accounts payable turnover ratio is desirable to creditors as it signals creditworthiness, companies should always use up the credit terms extended by suppliers.

 

Use in Financial Modeling

In financial modeling, the accounts payable turnover ratio (or turnover days) is an important assumption for driving the balance sheet forecast. As you can see in the example below, the accounts payable balance is driven by the assumption that cost of goods sold (COGS) takes approximately 30 days to be paid (on average).  Therefore, COGS in each period is multiplied 30 and divided by the number of days in the period. to get the AP balance.

 

accounts payable turnover ratio (or turnover days) example

 

The above screenshot is taken from CFI’s Financial Modeling Course.

 

Key Takeaways

Important takeaways include:

  • The accounts payable turnover ratio is a liquidity ratio that measures how many times a company is able to pay its creditors over a period of time.
  • A high ratio may be due to suppliers demanding fast payments or that the company is taking advantage of early payment discounts.
  • A low ratio may be due to favorable credit terms or a worsening financial condition.
  • Bargaining power plays a big role in the accounts payable turnover ratio. Companies that with strong bargaining power are given longer credit terms and hence a lower accounts payable turnover ratio.
  • Dividing 365 by the accounts payable turnover ratio results in the accounts payable turnover in days, which measures the number of days that it takes a company, on average, to pay creditors.
  • A high accounts payable turnover ratio signals creditworthiness and is sought after by creditors looking to sell on credit to companies.

 

Related Reading

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