What is the account payable turnover ratio?
We are going to learn one of the parts of the ratio analysis that is the account payable turnover ratio which every entrepreneur is always concerned about how the turnover of account payable is happening.
We can define the account payable turnover ratio as it is a part of ratio analysis and kind of asset management ratio.
It is used to measure how effective the way a company pays its account payable or credits to its business partner or clients.
I mean what is a timeframe so that’s what they are always looking for?
Let’s understand how fast a company can manage to pay its credits from the customers or pay the same to others.
This ratio is concerned with the liquid asset and on the credit of the company that is why; it is also called as creditor’s turnover ratio.
It is a liquidity ratio that is used to measure the average number of times a company pays its credit to creditors with a specific period of time.
This ratio is related to the company’s account, that is why known as account payable turnover ratio.
In simple words, it determines how many times a company pays its account payable during the current fiscal year.
The times’ frame for paying the account payable depends on the production cycle and financial health of the company.
Generally, this time frame for some companies is 90 days while some companies take 6 months to collect accounts payable from the customers.
Advantage of Account Payable Turnover Ratio
- It checks the effectiveness of payments of accounts payable by the clients or companies.
- A high value of this ratio indicates the payment of an account payable is efficient and the party pays off the credit quickly.
- It monitors and tracks the current trend of the market.
- This shows the efficiency of the management of a company.
- It also determines how efficiently using its assets to pay the creditors.
- Good staffing and scheduling give effective results in a pay off the payable amount.
- More in pay off credit, more liquidity, and cash to the company.
Disadvantage of Account Payable Turnover Ratio
- It can vary every moment in a fiscal year.
- This ratio is not able to show the effectiveness of issuing and pay off the credit.
- In the case of poor management for pay off of account payable, the company turns into a financial burden.
- Loose bonding in pay off generates resistance in the growth of the company.
- A low value of this ratio indicates the poor management in paying off accounts payable to the suppliers.
Formula of Account Payable Turnover Ratio
Let’s understand the Formula the account payables turnover ratio formula is something like this the total net credit purchase. Absolutely, you are analyzing that right divided by the average accounts payable so from the net credit purchase.
Let’s understand what exactly we are talking about here. Now account payable turnover is basically another name of the turnover ratio.
Now in this ratio, we will consider the credit purchase and the accounts account payable.
What are the credit purchases?
The amount that the firm would receive due in the near future and purchase made o the basis of credit is called credit purchase.
The sum of the total number of credit purchases is called total credit purchase.
Here, lets when you minus the credit as returns and allowances from total credit purchase, would be net credit purchase.
These figures can find from the income statement of the balance sheet of the company for a particular financial year.
What is the average account payable?
When a firm sells its goods on a credit basis it takes a decent time to pay off.
So the amount that the firm would pay off the due of the credit purchase from the suppliers in the near future is called accounts account payable.
For averaging the account payable, let’s take the total number of accounts account payable at the beginning of the year plus the total number of accounts payable at the end of the year. The resultant is divided by 2.
These figures are available in the balance sheet of a company. You can extract the figure from there.
Extraction of formula
Now, this ratio is a measure that computes the proportion of how much the net credit purchase a firm has paid off and how much average account payable form is dealing with.
Now let’s have a look at the formula the account payables turnover ratio. APTR is equal to your total net credit purchase divided by the account of your average account payable right.
So let’s understand with the help of an example so that you may have a clear idea of what we are trying to compute.
Example of Account Payable Turnover Ratio
Let’s say, there’s a company called ABC Inc and they have the following data like net credit purchase data. Let’s say in dollars. They have some accounts account payable data as $40,000 and they have this is basically the opening data and we have an account payable closing data is $60,000. The total credit purchase of $5,00,000.
Now find out the account payable formula over here. Now in this above example, we’ll have all the information available. First, we will find out the average account payable.
So the average account payable is going to be your opening. So I’ll put this in a bracket. We’ll have the opening plus the closing and then we’ll divide by two which will give us $50,000.
| $40,000 + $60,000|
Average Account payable = ———————————— = $50,000
|Credit Purchase = $5,00,000|
So by using the formula of account payable turnover, we’ll get something like, this AP turnover ratio is equal to your net credit purchase divided by the average account payables.
So let’s try and put the numbers credit purchase is your file AP divided by 50,000 which will give us 10 times.
If we compare the ratio with other companies under a similar industry we’ll be able to interpret whether this number is efficient or not?
Account Payable Turnover Ratio in Days
The above example is which is calculated for a fiscal year. Now let’s need to know the result in days, so calculate the above result.
The APR (Account Payable Turnover Ratio) in days represents the average number of days of time span in which a party may pay the credit purchase to the company.
Following is the formula of account payable turnover ratio:
Therefore, to collect credit purchase takes time in days approximately 37 days. So the company should set a timeline for the credit facilities to the customers on the basis of 30 days policy. The value of the ratio in days shows some late payment to the company.
Interpretation and Analysis of Account Payable Turnover Ratio
The higher account payable turnover ratio implies that the higher frequency of converting the account payables into cash which is of the curtain.
It’s absolutely a good thing because if you are able to convert your account payables into cash quickly that means you have high liquidity. And that’s good for the company. That’s good for the pocket of the company right.
This ratio is related to activity and efficiency that is why it is called efficiency ratio. This is an indicator of the operational and financial performance of the company.
A high value of this ratio also shows the high-quality base customers who are able to pay the credit purchase quickly.
Do you know the credit policy for the pay off of credit purchases?
Let’s know the credit policy; it is a policy for the company which provides the credit purchase to the customers.
The company should set itself credit policy as per the operational cycle that can make available the fund to the company for next and continuity of operation.
Generally, the credit policy is for the company in the range of 30 days, 20 days, and 10 days.
It depends on the culture and sector of the concerned company.
So now let’s get back to our explanation on the account payable turnover formula. Now in the above ratio, we have two components the first component is the net credit purchase.
We need to keep in mind that here we cannot take the total net credit purchase. We need to separate the cash purchase and the credit purchase and that we need to deduct any purchase return.
Remember this thing very sure that you know you did need to deduct any purchase at unrelated to the credit purchase from the credit scene.
So you could so your purchase is going to be your credit purchase minus any purchase return then you will get the right answer.
The second component is the average this is your first component okay. Your average accounts account payable average accounts account payable.
So to find out the average account visible we need to consider two elements again the opening account payable and the closing to find out the average of the two.
Now, what is exactly the significance the use of the account payable formulas see account payable turnover is basically an efficiency ratio?
It is used to see how many times the account payable has been seen collected during the fiscal year.
You’re right now the third thing had the higher the account payable turnover ratio is healthy as we have already discussed okay.
That’s healthy for the company and it denotes that the time interval between the credit purchase and the receipt of the cash is low.
That means that the form is quite efficient in collecting the account payable. On the other hand, a low lower accounts account payable turnover ratio is not good or enough for the company.
And against at the time interval between the credit purchase and the receipt of the money is higher.
As a result, there is always a risk of not receiving the money that’s called the bad debts right.
When an investor looks at the account payable turnover he or she needs to know how efficient the form is in connecting the two amounts. If there is a risk in dealing or noticing the payment it may directly affect the cash from the company.
Now, this is your account payable turnover calculator if you put numbers over here. Let’s say your net credit purchase is 1 million okay and your average accounts account payable which are standing in your balance sheet is filed.
So it’s going to be half so you mean you are saying that you know my net credit scenes are 1 million but the amount outstanding that I have to recover from the daters is only five lac dollars.
So what’s going to be an account payable turnover ratio two times right. So that’s a good that’s a bad number. You can say no. You are only able to convert your net-great purchase only two times into cash.
Now as this number is going to increase. Let’s say we are going to make it six like your data will go down which means your account payable turnover ratio will go down.
So what interpretation we can make as the account payable goes down keeping the net credit purchase.
As the same your account payable turnover goes down and that means it’s not good but as this amount decreases. It will automatically increase and if we put one lac tall. Over here we’ll get 10x as the number so put down your own numbers and try and make an interpretation of the same.
Thank you, everyone