Accounts Payable Turnover Ratio is one of the Financial Ratios that use to assess the liquidity problem of the company by using the relationship between Total Suppliers Purchases or Credit Purchases during the period compared to Average Account Payable.
If the ratio is falling from period to period, that means Accounts Payable Outstanding or Average Accounts Payable are increasing from period to period as well.
Increasing account payable from period to period can imply that the company might have financial difficulty and that is why we said this ratio measure the liquidity problem of the company. Yet, there are many more reasons that affect this ratio and we will explain this in detail in this article.
In this article, we will explain to you the basic understanding of Accounts Payable Turnover, along with a formula explanation. Example and analysis will let you deeply understand this ratio.
Now, let move to the formula so that you can get a better understanding
Accounts Payable Turnover is calculate by Total Suppliers Purchases / Average Accounts Payable
The two main important elements in calculation this ratio is Total Suppliers Purchase and Averages Account Payable.
- Total Suppliers Purchase is the total purchases on credit for the period. Mostly in twelve months. This amount is excluding the total purchase on cash payment.
- Average Accounts Payable is quite simple. It is the average account payable for the period. In other words, the average between beginning and ending accounts payable.
Now, let move to the example so that we can get a better understanding.
ABC Company operating in the cloths manufacturing industry. The total purchase on the credit of ABC during the period is 5,500,000 USD. The outstanding account payable at the end of 2014 and 2015 is 500,000 USD and 400,000 USD respectively.
Calculate Accounts Payable Turnover of ABC company?
As we can see in the scenario, the total credit purchase of ABC for the period is 5,500,000 USD and an average of Account Payable is around 450,000 [(500,000 + 400,000)/2].
Then, turn over would be 12.22 (5,500,000 / 450,000). This ratio tells us that on average, ABC pays its suppliers one per month or every month per year. It seems quite good from the supplier’s point of view. However, to assess whether this figure is good or not, they need to compare this figure with experiences or industry average.
Let say, base on expenses, on average the Account Payable Turnover is 15. That means if we are the creditor, ABC sound not good in terms of payment to its creditors. And we need to consider whether we should provide the credit sales to it or not. Yet, if we are ABC, it is probably one of the cash flow management strategies to hold some of the payment to suppliers.
Just because the payment is not frequent as the market, it does not mean ABC has bad experiences creditors. Probably, ABC has a better relationship with its suppliers and the payments are base on the term.