Accounts Payable: Definition, Uses, and AP Turnover Ratio

Creditors look at AP turnover because it’s a good indication of how quickly a company is paying its bills. A high ratio is a good sign that a company has a strong cash position and is both willing and able to meet its financial obligations. Accounts payable turnover ratio is just another way of saying accounts payable turnover. This ratio helps creditors analyze the liquidity of a company by gauging how easily a company can pay off its current suppliers and vendors. Companies that can pay off supplies frequently throughout the year indicate to creditor that they will be able to make regular interest and principle payments as well.

If your business has cash availability or can make a draw on its line of credit financing at a reasonable interest rate, then taking advantage of early payment discounts makes a lot of sense. The A/P turnover ratio and the DPO are often a proxy for determining the bargaining power of a specific company (i.e. their relationship with their suppliers). So the higher the ratio, the more frequently a company’s invoices owed now hiring tech professionals to suppliers are fulfilled. The important thing is to make sure the time period you choose is as “typical” for your company as possible. If your AP balance changes a lot between the beginning and end of the month, don’t just look at the first 5 days or the last 5 days. Companies that have busy AP departments with many bills and payments often start by looking at their AP turnover over a 5-day or 10-day period.

1. Your average accounts payable balance is found in the current liabilities section of your company’s financial statements by adding the beginning and end of year accounts payable balances and dividing that by two.
2. Account payable turnover is a key metric that helps businesses determine how efficiently they pay their creditors and assess their creditworthiness.
3. As with most financial metrics, a company’s turnover ratio is best examined relative to similar companies in its industry.

A good way to get a feel for AP turnover in your own industry is to look up industry leaders on a service like discoverci.com. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career.

Improving your AP turnover ratio is crucial to managing cash flow and ensuring that your company is financially healthy. Luckily, there are software and services that can help identify any issues with cash flow management and streamline payments. You can calculate the average accounts payable for the specific period by referencing your financial statement.

How to calculate accounts payable turnover ratio

Meanwhile, obligations to other companies, such as the company that cleans the restaurant’s staff uniforms, fall into the accounts payable category. Both of these categories fall under the broader accounts payable category, and many companies combine both under the term accounts payable. Another, less common usage of «AP,» refers to the business department or division that is responsible for making payments owed by the company to suppliers and other creditors. The 91 days represents the approximate number of days on average that a company’s invoices remain outstanding before being paid in full. For example, if a company’s A/P turnover is 2.0x, then this means it pays off all of its outstanding invoices every six months on average, i.e. twice per year. If your ratio is below 5.2, creditors might be more concerned, but it could also mean that you’re deliberately slowing your payments to use your cash somewhere else.

To calculate the accounts payable turnover ratio, the company’s net credit purchases are divided by the average accounts payable balance. This ratio provides insight into the company’s ability to manage its short-term liabilities and highlights its creditworthiness. This is an important metric that indicates the short-term liquidity and creditworthiness of a company. A higher accounts payable turnover ratio is generally more favorable, indicating prompt payment to suppliers. On the other hand, a low ratio may indicate slow payment cycles and a cash flow problem. A high AP turnover ratio shows suppliers and creditors that the company has the working capital to pay its bills frequently and can be used to negotiate favorable credit terms in the future.

Investors and lenders keep a close eye on liquidity, debt, and net burn because they want to track the company’s financial efficiency. But, if a business pays off accounts too quickly, it may not be using the opportunity to invest that credit elsewhere and make greater gains. Finding the right balance between a high and low accounts payable turnover ratio is ideal for the business.

They also promote strong communications between business finance and operations, which need to work together to make both strategic and tactical decisions. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment https://www.wave-accounting.net/ analysis topics, so students and professionals can learn and propel their careers. Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.

Accounts Payable Turnover Ratio Definition, Formula, and Examples

Graphing the AP turnover ratio trend line over time will alert you to a break from your typical business pattern. Corporate finance should perform a broader financial analysis than an accounts payable analysis to investigate outliers from the trend. The AR turnover ratio formula is Net Credit Sales divided by the Average Accounts Receivable balance for the period measured. Similarly calculated, the AP turnover ratio formula is net credit purchases divided by Average Accounts Payable balance for that time period. To generate and then collect accounts receivable, your company must sell purchased inventory to customers.

When you receive and use early payment discounts, you increase the AP turnover ratio and lower the average payables turnover in days. For instance, if a company’s accounts receivable turnover is far above that of its peers, there could be a reasonable explanation. However, it is rarely a positive sign, i.e. it typically implies the company is inefficient in its ability to collect cash payments from customers. The rules for interpreting the accounts payable turnover ratio are less straightforward. Beginning accounts payable and ending accounts payable are added together, and then the sum is divided by two in order to arrive at the denominator for the accounts payable turnover ratio.

How is the AP Turnover Ratio calculated?

Achieving a high AP turnover ratio is possible, and a company can work with a reputable payment processing company like Corcentric to get its ratio where it wants it to be. AP represent the money owed for goods or services that have been received by the company but not yet paid for. Accounts payable are short-term debts owed by a company to its suppliers or creditors.

This can be done by consolidating multiple invoices into a single payment or automating payments so they are made as soon as invoices are received. A high ratio for AP turnover means that your company has adequate cash and financing to pay its bills. Net credit purchases are total credit purchases reduced by the amount of returned items initially purchased on credit. Remember to use credit purchases, not total supplier purchases, which would include items not purchased on credit. DPO counts the average number of days it takes a company to pay off its outstanding supplier invoices for purchases made on credit. The total supplier purchase amount should ideally only consist of credit purchases, but the gross purchases from suppliers can be used if the full payment details are not readily available.

Taking a Strategic Look at AP Turnover Ratios

Nimble, high-growth companies rarely wait until the end of the year to conduct financial analyses. Instead, they make it a habit to track key metrics like cost of goods sold (COGS), liquidity ratios, high account balances, and more on a regular basis. Tracking how your turnover changes can help you determine the health of your business’s cash flow.

Example: Industry Comparison of Account Payable Turnover

As you can see in the example below, the accounts payable balance is driven by the assumption that cost of goods sold (COGS) takes approximately 30 days to be paid (on average). Therefore, COGS in each period is multiplied by 30 and divided by the number of days in the period to get the AP balance. Some businesses pay creditors too fast, leaving them with insufficient funds to cover other bills, while others unnecessarily miss payments and damage relationships with suppliers. As previously mentioned, accounts payable turnover ratio is a liquidity ratio.

We don’t think that this approach is comprehensive enough to get a handle on cash flow. Therefore, we suggest using all credit purchases in the formula, not just inventory and cost of sales that focus on inventory turnover. To gain insights from account payable turnover, it is essential to compare the ratio with industry benchmarks and understand the implications of higher turnover ratios for creditworthiness. A higher accounts payable turnover ratio indicates that a company pays its creditors more frequently within a given accounting period. This reflects the company’s ability to effectively manage its accounts payable and maintain good relationships with suppliers. Account payable turnover is crucial for businesses as it measures the efficiency of their payment cycle and provides insight into opportunities for optimizing cash flow through favorable credit terms.

Based on this calculation, Company XYZ has an accounts payable turnover ratio of 4, indicating that the company paid its creditors four times during the accounting period. It is important to note that the ratio does not provide a direct measure of the company’s financial health but serves as an indicator of its payment patterns and creditworthiness. The AP turnover ratio is unique in that businesses want to show they can pay their bills on time, but they also want to show they can use their investments wisely.