Accounts Payable Turnover Ratio - Explained
What is the Accounts Payable Turnover Ratio?
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Table of ContentsWhat is the Accounts Payable Turnover Ratio?How to Calculate the Accounts Payable Turnover RatioWhat Does the Accounts Payable Turnover Ratio Tell You?A Decreasing Accounts Payable Turnover RatioAn Increasing Accounts Payable Turnover RatioExample of the Accounts Payable Turnover RatioThe Difference Between the Accounts Payable Turnover and Accounts Receivable Turnover RatiosLimitations of Using the Accounts Payable Turnover Ratio
What is the Accounts Payable Turnover Ratio?
The amounts payable turnover ratio of a company is the rate at which a company pays the debts that it owes its suppliers or vendors. This ratio is a short-term, liquidity ratio that measures the number of times a company pays off its suppliers during a period of time.
Accounts payable is the short-term debt a company owes is suppliers. The ability of a company to pay off accounts payable and how efficient it is in paying is reflected in the accounts payable turnover ratio of the company.
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How to Calculate the Accounts Payable Turnover Ratio
The accounts payable turnover ratio is a liquidity ratio that compares the net credit purchases by a company to the average accounts payable at a particular time. The Formula for calculating the accounts payable turnover ratio is;
Average Accounts Payable
There are two ways of calculating the average accounts payable of a company. First, you can deduct the accounts payable balance at the beginning of the period from the accounts payable balance at the end of the period to arrive at the average. Second, you can divide the total accounts payable for the beginning and end of the period by 2.
What Does the Accounts Payable Turnover Ratio Tell You?
The accounts payable turnover ratio of a company is an indicator of solvency or insolvency of a company relating to how quick a company pays off debt or owes its suppliers. Also, the number of times a company pays off its accounts payable is reflected in the turnover ratio. Basically, the accounts payable turnover ratio of a company is an indicator of the amount of cash or revenue the company owns. It also measures the extent at which the company meets short-term debt obligations.
A Decreasing Accounts Payable Turnover Ratio
A company can either have a decreasing turnover ratio or an increasing turnover ratio. When a company takes longer time to pay off short-term debts, it will have a decreasing turnover ratio. A company that takes longer time before paying off clients of regarded weak financially, thereby not attractive to investors. On the other hand, having a decreasing accounts payable turnover could mean that the company has negotiated with suppliers it owes.
An Increasing Accounts Payable Turnover Ratio
A company that has an increasing accounts payable turnover ratio pays off its debt at a faster speed when compared with previous periods. An increasing turnover ratio indicates a positive management of short-term debts and accounts payable by a company. It also indicates some level of financial strength in the company. However, an increasing turnover ratio is not always a positive indication, it could be as a result of failure of the company to reinvest in the business. When a company is spending all its revenue to pay off debts without reinvesting into the business, it will have an increasing turnover ratio which is not healthy for the growth of the company. Here are some important points to hold onto:
- An accounts payable turnover ratio is a liquidity ratio (short-term) that measures how well a business pays off its accounts payable during a period of time.
- The turnover ratio also indicates the number of times the company pays it debts in a given period.
- Having a decreasing turnover ratio does not necessary mean the company does not have the financial capacity to pay debts, rather, the company may be reinvesting in the business.
- An Increasing turnover ratio might not necessarily mean that the company is solvent, it could be that the company is not reinvesting in its business.
Example of the Accounts Payable Turnover Ratio
If Company A buys inventory from a vendor for the past year and the inventory worths $150 million after the accounts payable at the beginning of the year and at the end of the year is calculated. The turnover ratio for the company would be calculated using;
Average Accounts Payable
(average accounts payable is calculated by subtracting the payable balance at the beginning of the period from the accounts payable balance at the end of the period). This formula can be used in calculating the turnover ratio for all available companies.
The Difference Between the Accounts Payable Turnover and Accounts Receivable Turnover Ratios
The accounts receivable turnover ratio is the opposite of accounts payable turnover ratio. It measures the rate at which a company collects the money owed by customers. It reflects the speed at which short-term debt is paid to a company by its customers. This reveal the effectiveness of the company in managing its credits. Accounts payable turnover ratio deals with the rate at which a company pays off its accounts payable, money or owes suppliers or vendors). Both terms are two sides of a coin. While the former shows how quickly a company is paid by its customers, the later shows how fast a company pays off its debts.
Limitations of Using the Accounts Payable Turnover Ratio
There are certain limitations attributable to the use of accounts payable turnover ratio by companies. Usually, financial ratios are used in comparing companies in relation to their performance. In the case of accounts payable turnover ratio, it might be inaccurate to compare two companies that have high turnover ratios for example. One of the two companies might not be reinvesting into its business causing an increasing ratio while the other company may by reinvesting and at the same time paying off its debts fast. Now, comparing these two companies just because they have high turnover ratios is not a healthy comparison. Therefore, investigating why a company has either high or low turnover ratio is essential.
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