In an average accounts payable department, there are a handful of calculations that help determine the financial condition of your company's cash flow. A financial ratio breaks down the data within places like your accounts payable balance or balance sheet to help prevent your company from falling into financial distress. These ratios help make accurate analyses that can look at the company's accounts' overall performances and help review the accounts payables process overall.
An example of these formulas is the current ratio, which looks at your ability to use existing assets to pay off short-term obligations. Another example is the acid-test ratio which looks at your quick assets and inventory instead of your current assets. These are both examples of liquidity ratios, and while there are many types of ratios, this type helps look at your ability to repay obligations. This data can be critical for tracking your performance over an accounting period and can be looked at by investors to make essential decisions.
Another one of these liquidity formulas is the accounts payable turnover ratio, which is often referred to as the payables turnover. This calculation looks at how often you pay suppliers or creditors over a given period of time. The results show a handful of things like identifying potential cash flow problems and looking at how often a company pays off its obligations. Usually, a higher ratio is considered better than a lower ratio, but there are exceptions.
Note that this can be confused with the very similar accounts receivable turnover ratio, which measures the opposite - how often vendors pay back credits over a specific period, such as a fiscal year. This calculation is a good measure for seeing if there is a problem within the credit or payment terms given to suppliers.
What is the AP turnover ratio formula? (with examples)
Using the accounts payable turnover ratio formula is pretty straightforward. You first select the beginning of the period and the end of the period you are measuring. Within that timeframe, you will look at your net credit purchases (sometimes referred to as total supplier purchases) divided by your average accounts payable. It is important to note that you can also use the cost of goods sold instead of net credit purchases depending on the situation, though this may not give you an accurate ratio.
Net Credit Purchases (Total Purchases) / Average Accounts Payable = Accounts-Payable Turnover Ratio
To find your average accounts payable, you can look at the total of your accounts payable at the start and finish of your accounting period, then divide that by 2.
For example, the ABC Company had net credit purchases of $500,000. It had $25,000 in payables at the beginning of the accounting period, and $30,000 at the end of the period.
$500,000 Net Credit Purchases / (($25,000 Initial Payables + $30,000 End Payables) / 2))
$500,000 Net Credit Purchases / $27,500 Average Accounts Payable = 18.2 AP Turnover
What does accounts payable turnover tell you?
Your accounts payable turnover can help you determine if you are using favorable credit terms, paying your suppliers back promptly, or it can be used to judge your creditworthiness. Knowing the average number of times you are paying back your vendors on time can help you know if your AP process is running smoothly, something often reflected through a high ratio. A lower ratio can show that you either are paying your debts slowly or have special credit terms with your vendors.
Is a higher accounts payable turnover better?
Often it is assumed that if you have a high accounts payable turnover ratio, you are more reliable and stable in paying your accounts payable outstanding credits. It isn't always this black and white, however. There are many different credit terms where having a low ratio makes more sense for the company. A good measure is to look at other companies within your sector and compare your calculation to theirs. If your ratio is wildly different, it may be of concern unless you have special credit terms.
Alternatively, there are benefits to quick supplier payments as well. Many have the advantage of early payment discounts, meaning that an extremely high ratio may be expected for your company. There may be no penalty for quick, consistent payments to a supplier unless your company is missing out on credit term deals or you need to raise your liquidity.
How do you convert the AP turnover ratio to number of days outstanding in accounts payable?
If you need to convert your accounts payable turnover ratio to a days payable outstanding formula, all you need to do is divide the result into 365. This calculation reflects the average number of days that your credits aren't paid.
356 / Accounts-Payable Turnover Ratio = DPO (Days Payable Outstanding)
Using our example of ABC Company above, let's apply that here:
356 / 18.2 Accounts Payable Turnover Ratio = 19.6 DPO
You also can use this in other similar formulas using different periods, such as the quarter (90 days) or a month (30 days). Some companies also use 360 days instead of 365 days, depending on their preference. What is considered a good days payable outstanding number varies wildly from one sector to another and from one size of company to another.
What is a good accounts payable turnover ratio in days?
After finding your AP turnover ratio, your first question might be asking if it is a healthy number. Unfortunately, there is no magic number to aim for. Depending on your company size, for example, it can be different from your competitors. Massive companies often have a significantly lower AP turnover ratio due to their ability to negotiate longer credit terms. This figure also looks very different across different sectors. To get an idea for what may be healthy, you have to look at your AP balance and consider what this number reflects about your credit terms and AP workflow. Often, this number is used to help see changes in your companies' behavior and identify any already established issues in your workflow.
How to improve AP turnover
Sometimes AP turnover can reveal that your accounts payable department are getting behind on their workflow. This problem can be understandable, especially for a company going through a lot of changes or growth. It is essential to meet with your team and identify pain points within the current workflow and find ways to improve these areas causing issues for your team. Sometimes this is pure manual data entry, something that can be fixed through automation, and other times they may be related to internal issues.
By taking the first step in identifying the problem, you can also start looking for solutions. Whether a reworked workflow or additional tools to empower your team, you can overcome these hurdles after finding them.
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Routable allows your team to focus on tasks that matter most while handling manual and tedious tasks through friction-free integration. Its accounts payable functionality helps you easily track payment statuses and lets you pay with your desired payment methods to help ensure timely vendor payments. You can even use its sophisticated API to help with bulk processing, giving your team scalability into the future.