How Do You Calculate Accounts Payable Turnover?
Accounts payable turnover is a solvent Financial Ratio that is used to determine the efficiency of handling accounts payable. This metric establishes the number of times a company can meet its average accounts payable balance within a given period.
A higher accounts payable turnover ratio means that a business is paying its suppliers and vendors in the shortest time possible. It may indicate that the company is making use of early payment discounts to minimize costs. Though very high value may suggest that the company is not utilizing optimum credit terms and might be losing out on the opportunity to keep more cash for a longer time.
In contrast, a low AP turnover ratio is an indicator of a company that is slow to pay its bills. This may indicate negative profitability, low productivity, or that the company is struggling to obtain sufficient cash inflows to meet its obligations.
In the following section, we will explain and show how to calculate the accounts payable turnover formula.
What is this measure called Accounts Payable Turnover?
Accounts payable turnover is the frequency with which a business repays a sum of its average accounts payable during a given period. This period is either annually or quarterly…
This ratio shows how many days on average a company takes to pay its suppliers, and can be useful in understanding the company’s liquidity and efficiency. It also shows the trends that can affect future cash receipts and payments in the future.
Here is the accounts payable turnover formula:
Accounts Payable Turnover Ratio = Total Purchases for the period / Average accounts payable
Execution of the steps to arrive at the accounts payable turnover We can now navigate through the following steps to arrive at the accounts payable turnover ratio:
Now, let us discuss a detailed example of how accounts payable turnover could be calculated using the example of a certain company.
1. Decide on what reporting period you need to calculate for
First, you should determine whether you want to examine turnover on an annual, quarterly, monthly, or some other basis. It is time to determine the annual AP turnover.
2. Determine total purchases over the year
Sum the total value of the acquisitions the company made from suppliers in the year. For instance, suppose the total purchases made for the whole year were $ 5,000,000.
3. Compute average accounts payable
Take the sum of the accounts payable balance at the beginning and end of the year, and then divide it by two. This gives you the average AP balance for the full year.
Let's assume the accounts payable balance for our company was:
Beginning of year AP balance: $500, 000
End of year AP balance: $600,000
Therefore, the average or mean average percentage (AP) of the two figures is $550,000 – ($500,000 + $600,000) / 2.
4. Plug the amounts in the accounts payable turnover formula:
Accounts Payable Turnover Ratio = Total annual purchases / Average accounts payable
For our example company, this would be:
5,000,000 / 550,000 = 9.09
5. The ratio can be analyzed and interpreted to understand the relation between the two variables.
This accounts payable turnover ratio of 9.09 indicates that the company was able to turn over the average accounts payable figure of 9.09 in the year.
Another way to interpret this is that the company’s payment of suppliers and vendors was done after approximately 40 days. You can work it out by dividing 365 days by the turnover rate (365 divided by 9.09 equals 40.15 days).
Ideally, it is acceptable for most companies to take approximately 40 days or 9.09 turnover to pay their vendors. It is important to investigate what is behind such high or low figures to determine their validity.
What Influences Accounts Payable Turnability?
Some key factors that influence accounts payable turnover include:
• Payment terms with suppliers: Higher payment terms result in lower stock turnover rates.
• Availability of cash or credit: More cash/credit means that a company is capable of paying its dues at a faster rate.
• Discounts for early payment: Such discounts may contribute to the payment of the amount owed before the due date.
• Company growth: The increase in purchases from growth can raise the level of turnover.
• Industry standards and norms: This remains true depending on the industry that your freelancer is in.
The accounts payable turnover ratio therefore serves as a useful benchmark for finance teams, CFOs, or small business owners to assess the efficiency of managing suppliers and short-term liabilities. Metric comparison every year or with industry benchmarks allows for the detection of favorable and unfavorable shifts in working capital, liquidity, and even business processes in general.
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