Accounts Payable Turnover Ratio

Accounts Payable Turnover Ratio is an accounting liquidity metric that evaluates how fast a company pays off its creditors (suppliers), and is used to show investors how many times per period (typically 1 year) the company pays its average payable amount.

Just as accounts receivable ratios can be used to judge a company’s incoming cash situation, this figure can demonstrate how a business handles its outgoing payments. Therefore accounts payables turnover trends can help a company assess its cash situation

Accounts-payable Formula

Accounts-payable turnover is calculated by dividing the total amount of purchases made on credit by the average accounts-payable balance for any given period.

Accounts payable turnover ratio = Total purchases / Average accounts payable

An accounts payable turnover ratio measures the number of times a company pays its suppliers during a specific accounting period. In other words, this ratio can be said to be the average number of times in a financial year that payables are “turned over” (or paid with cash) – thus the reason for the term “turnover” ratio.

For example, if a company makes $100 million in purchases from suppliers in a year and at any given point holds an average accounts payable of $20 million, the accounts payable turnover ratio for the period is 5 ($100 million/$20 million).

It is important to note that there is no single line item that can tell how much a company purchased in a year. The cost of sales in the income statement shows what was sold, but the company may have purchased either more or less than it eventually sold. The result would be either an increase, or a decrease in inventory. To calculate the purchases made, the cost of goods sold is adjusted by the change in inventory using another formula:

Purchases = Cost of sales + Ending inventory – Starting inventory

Payment requirements will usually vary from supplier to supplier, depending on its size and financial capabilities. A high accounts payable turnover ratio means there is a relatively short time between purchase of goods and services and payment for them. Conversely, a lower accounts payable turnover ratio usually signifies that a company is slow in paying its suppliers.

Investors, or traders such as those using the Banc De Binary options trading platforms, can use this information to figure out if a company in which they have vested interests is in financial trouble or not. The accounts payable turnover ratio is a measure of short term liquidity. If the turnover ratio is falling from one period to another, this is a sign that the company is taking longer to pay off its suppliers than it was before. The opposite is true when the turnover ratio is increasing, which means that the company is paying of suppliers at a faster rate. This info can act as a green or red flag to traders by giving them a clearer image of the state of the finances of the company they are investing in.