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 compare to Average Account Payable.
If the ratio is falling from period to period, that mean 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 liquidity problem of the company. Yet, there are many more reasons that effect this ratio and we will explain this in detail in this article.
In this article, we will explain you the basis understanding of Accounts Payable Turnover, along with formula explanation. Example and analysis will let you deeply understand about this ratio.
Now, let move to the formula so that you can get better understanding
Accounts Payable Turnover is calculate by Total Suppliers Purchases / Average Accounts Payable
The two main importance 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 better understanding.
ABC Company operating in the cloths manufacturing industry. The total purchase on 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 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 tell us that in average, ABC pay it suppliers one per months or every month per year. It seem quite good from the suppliers point of view. However, to assess whether this figure is good or not, the need to compare this figure with experiences or industry average.
Let say, base on expenses, in average the Account Payable Turnover is 15. That mean, if we are the creditor, ABC sound not good in term 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 case flow management strategy to hold some of payment to suppliers.
Just because the payment is not frequency as the market, it does not mean ABC has bad experiences creditor. Probably, ABC has better relationship with it suppliers and the payments are base on term.