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What is an Accounts Payable Turnover Ratio?

The accounts payable turnover ratio is a short-term liquidity accounting ratio. It is an indicator that quantifies how quickly a company pays its suppliers. Accounts payable turnover indicates how many times a company’s accounts payable are paid off in a given period.

Accounts payable are short-term debts owed to suppliers and creditors by a business. The accounts payable turnover ratio measures a company’s ability to pay suppliers and short-term debts efficiently.

A useful activity ratio for gaining insight into a company’s finances is the accounts payable turnover ratio. It shows a company’s ability to pay its suppliers and can be utilised in any financial statement analysis.

A company’s goal should be to create enough revenue to pay off its accounts payable fast, but not so rapidly that it misses out on chances by not investing that money in other operations.

Accounts Payable Turnover Ratio Formula

The Formula for Accounts Payable Turnover Ratio is:

Creditors or Accounts Payable Ratio – Net Credit Purchases / Average Accounts Payable

Where,

Net Credit Purchases = Total Credit Purchases – Discounts – Returns of Purchases

Average Accounts Payable = (Accounts payable at the beginning of the year + Accounts payable at the end of the year) / 2

How to Calculate Accounts Payable Turnover Ratio?

To calculate the accounts payable turnover ratio, you need to first calculate the net purchase and average accounts payable for the financial year under analysis.

The following is an example of how to calculate the accounts payable ratio:

ParticularsAmount
Total Credit PurchasesRs 6,00,000
Total DiscountsRs 40,000
Purchase Returns Rs 120,000
Accounts Payable as on 1st April 2021Rs 1,60,000
Accounts Payable as on 1st March 2021Rs 80,000
Average Accounts Payable(Accounts Payable at the Beginning of the Year + Accounts Payable at the End of the Year) / 2Rs 1,20,000(Rs 1,60,000 + Rs 80,000) / 2
Net Credit PurchasesTotal Credit Purchases – Discounts – Returns of PurchasesRs 4,40,000Rs 6,00,000 – Rs 40,000 – Rs 1,20,000
Accounts Payable Turnover RatioNet Credit Sales / Average Accounts Payable3.67Rs 4,40,000 / Rs 1,20,000
Accounts Payable Turnover (Days)99.65 days(365 / 3.67)

Interpretation of Accounts Payable Turnover Ratio

High Accounts Payable Turnover Ratio

If the turnover ratio is rising then it would imply that the business pays its suppliers more quickly than in previous periods. A growing ratio indicates that the corporation has enough cash on hand to pay down its short-term debt on schedule. As a result, a rising accounts payable turnover ratio may indicate that the company is effectively managing its debts and cash flow.

A growing ratio over time, on the other hand, could signal that the company is not reinvesting in its business. Moreover, which could lead to a lower growth rate and lower earnings in the long run. A company’s goal should be to create enough revenue to pay off its accounts payable fast, but not so rapidly that it misses out on chances by not investing that money in other ventures.

Low Accounts Payable Turnover Ratio

A lower turnover ratio shows that a company is paying its suppliers later than in previous times. The rate at which a company pays its obligations may reveal information about its financial health. A falling ratio could indicate that a company is in economic difficulties. A declining percentage, on the other hand, could indicate that the corporation has negotiated new payment terms with its suppliers.

Limitations of Using Accounts Payable Turnover Ratio

  • It’s best to compare a company’s financial ratio to other companies in the same industry, as it is with other financial ratios. Each industry may have a standard turnover ratio that is exclusive to that sector.
  • A limitation of the ratio may be when a company has a high turnover ratio, which creditors and investors would regard as a favorable development. If the ratio is significantly greater than that of other companies in the same industry. It may signal that the company is not investing in its future or correctly managing its capital.
  • To put it another way, a high or low ratio should not be regarded at face value. However, it should instead prompt investors to look into the rationale for the high or low ratio.

How to Improve Creditors Ratio?

  • Increase your credit facilities with vendors or renegotiate the payment terms.
  • Determine whether you can raise the price of the goods or services to meet faster supplier payments.
  • Examine the ratio of accounts receivables to total assets. If it’s low, the company can have trouble collecting money from customers. This will have a negative impact on their ability to pay the vendors.
  • Examine the financial situation. Determine the impact on your operations due to minimizing of the outstanding payable periods to boost the turnover ratio

Accounts Receivable Turnover vs Accounts Payable Turnover

Accounts payable and receivable turnover ratios are calculated similarly. Nonetheless, they provide various perspectives on a company’s financial activity. The accounts receivable turnover ratio measures how well a company collects money owed to it by customers. It demonstrates whether a business can effectively manage the credit lines it gives to clients and how quickly it collects debt. If a company’s ratio is low, it may be having trouble collecting money or granting credit to the wrong customers.

Simply explained, the accounts payable turnover ratio indicates how rapidly a company pays its vendors. The accounts receivable turnover ratio, on the other hand, measures how rapidly a company receives payment from its customers.

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