How to Calculate Accounts Payable Turnover

Calculating the accounts payable turnover ratio is done by dividing net credit purchases by average accounts payable. The higher the number, the more quickly a company pays its vendors.

Deciphering the accounts payable turnover ratio and other similar ratios helps you make better decisions. Accounting numbers are historical in nature, and may not predict the future, they have a story you want to hear.

In order to understand the full picture, some accounting numbers must be analyzed by combining, comparing or converting them into ratios. Ratios are calculated by formula. The accounts payable turnover ratio compares the relationship between net credit purchases and average accounts payable to determine how fast a company pays its accounts payable.

This article will discuss further some specific aspects about the accounts payable turnover ratio including:

• ‍What does the accounts payable turnover ratio mean?
• How often should I calculate the accounts payable turnover ratio?
• How do I calculate the net purchases and the average accounts payable?
• What is a good number for accounts payable turnover?
• How do I use the accounts payable turnover ratio in my business?

What does the accounts payable turnover mean?

The accounts payable turnover ratio measures how often accounts payable turnover, or in other words how fast a company pays their bills.

If your business had an accounts payable turnover of 4, that would mean you pay your average payables 4 times during the period. The higher the number the more frequent you pay.

Here are some examples for perspective.

How often should I calculate the accounts payable turnover ratio?

Typically, the accounts payable turnover ratio is calculated on an annual basis. It can be calculated more frequently, even monthly, to ensure you catch potential problems early.

It is important to calculate the number; however, it is more important to compare to prior period numbers for a measure of are you getting better, worse or staying the same. A comparison over time identifies trends to help prevent potential problems.

How do I calculate the net credit purchases and the average accounts payable?

Let’s take a look at the formula again and define each part.

NET CREDIT PURCHASES

Net credit purchases is the total amount you bought on credit during the period. When the calculation is for a month, only count the credit purchases during the month. If your calculation is for a year, consider all credit purchases for the year.

Since accounts payable only relates to credit purchases it is important to remove any cash purchases, otherwise the calculation may produce an incorrect ratio.

You can calculate net credit purchases by taking the beginning purchases balance, less the ending purchases balance, minus any cash purchases during the period.

AVERAGE ACCOUNTS PAYABLE

Average accounts payable means the average payable balance during the period. To calculate take the beginning balance of the period plus the ending balance of the period and divide it by 2.

You can find your accounts payable balance in the liability section of your balance sheet for the respect periods.

What is a good number for accounts payable turnover?

So, what is a good number for the accounts payable turnover ratio? Is my number a good number?

Like most things there isn’t one fixed answer but consider the following.

1. ‍Compare the ratio to previous periods and determine which direction the number is heading. A turnover ratio that is getting bigger means the company is paying its suppliers quicker. It probably means the company has plenty of cash and is also collecting receivables timely in order to pay their vendors timely. Likewise, a decreasing ratio means you are paying slower and may have cash shortages or delays in accounts receivable collections. In a perfect world, you want to reinvest cash back into your business and continue growing. So, paying too frequently may indicate money is not being reinvested and thus missing out on investment opportunities.
2. Compare the ratio to industry standards. This is not perfect, but does provide some indication how you compare to other companies of the same type. Keep in mind, industry standards will vary because companies vary in size and geographical location.
3. Don’t take the ratio at face value. Always investigate further as high or low, there may be a valid reason for the number at hand.

How do I use the accounts payable turnover ratio in my business?

You use the accounts payable turnover ratio to help manage cash flow. This is done by improving policies and procedures. Remember, a ratio is only useful if you use it.

Here are some ideas to help you improve or manage your accounts payable turnover ratio.

• ‍Monitor the trends in your ratio and adjust based on results
• Compare cash inflows to outflows and match them accordingly. You can do this by looking at other ratios such as accounts receivable turnover days and inventory turnover days.
• Inspire your sales department with incentives to increase sales and thus increase inventory turnover and thus increase purchases.
• Focus on improving accounts receivable collections. The faster you collect the faster you can pay.
• Research and discover the optimal turnover for your business.

No one likes to pay bills, and unlike accounts receivable where the focus is to increase turnover, accounts payable turnover is a balancing act between vendor relations, investment in projects, and cash. Finding the right balance for your company and industry can take time, effort and experience but doing so will produce a more effective business in the long run.