What Is the Accounts Payable Turnover Ratio? Definition and Formula
By Indeed Editorial Team
Published August 18, 2021
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
There are many financial metrics that accounting professionals use to analyze the financial stability of a company. One of those metrics is the accounts payable turnover ratio, which measures how quickly a company pays its debts. Knowing the definition, meaning and formula of this ratio can help you calculate this important metric accurately. In this article, we define the accounts payable turnover ratio, provide the formula and steps to calculate it, explain how it differs from the accounts receivable turnover ratio and offer an example.
What is the accounts payable turnover ratio?
The accounts payable turnover ratio is a financial measurement that shows the average number of times a company pays off its accounts payable during a specific time period, usually one year. Accounts payable is the amount of short-term debt that a company owes. The accounts payable turnover ratio shows how efficiently a company pays this debt. Creditors may consider this ratio to determine whether to extend a line of credit to the company, while investors may use it to see whether a company has enough cash to meet its short-term obligations.
What does the accounts payable turnover ratio indicate?
The accounts payable turnover ratio can either increase or decrease over time. Here is what those changes can indicate:
An increasing ratio shows that a company is paying off its debts more quickly than it has in the past. This can indicate that it has enough cash flow to pay its obligations in a timely manner. An increasing ratio can also mean that a company is getting incentives, such as early payment discounts, to make these payments quickly. It could also mean the company is actively working to improve its credit rating. Generally, businesses that require lines of credit want to have an increasing ratio because creditors use this metric to evaluate risks when lending money.
A decreasing ratio means that a company is taking longer to pay off its debts than it has previously. While a decreasing ratio can sometimes indicate that a company is having cash flow problems, it can also mean that a company has negotiated different payment terms or lower interest rates with its creditors. If a company has a decreasing ratio, it's a good idea to compare this ratio with similar companies in the same industry. If other businesses have similar turnover ratios, it can show the company is meeting the standard for the industry.
Formula for accounts payable turnover ratio
There is a formula that accounting professionals use to find the accounts payable turnover ratio. You use these figures in the formula:
Total supply purchases: This is the amount of purchases that a business made using credit over the period.
Average accounts payable: This is the average accounts payable balance over the period.
Knowing those terms, the formula looks like this:
Accounts payable turnover ratio = Total supply purchases / Average accounts payable
How to calculate the accounts payable turnover ratio
Here are the steps to calculate the accounts payable turnover ratio:
1. Determine the total supply purchases
If the company has a record of supplier purchases, you can usually find the total supply purchases figure there. Otherwise, you can do some basic math to determine this number. Locate the cost of goods sold over the period on the company's income sheet and the beginning and ending inventory purchases on the balance sheet. The income statement shows the company's revenue and expenses, while the balance sheet shows the company's assets, liabilities and equity. Once you have the numbers, add the costs of goods sold and the ending inventory and subtract the beginning inventory. The formula looks like this:
Total supply purchases = Cost of goods sold + ending inventory — beginning inventory
Related: Balance Sheet: Template and Example
2. Calculate the average accounts payable
To calculate the average accounts payable, find the accounts payable balance in the liabilities section of the balance sheet. This section lists the beginning accounts payable, or the balance at the beginning of the period, and the ending accounts payable, which is the balance at the end of the period. When you have those numbers, add the beginning and ending accounts payable balances and divide by two. The formula looks like this:
Average accounts payable = (Beginning accounts payable + ending accounts payable) / 2
3. Find the turnover ratio
Once you've determined the separate parts of the ratio, you can calculate this metric. Divide the total supply purchases by the average accounts payable. Though you can easily do this metric manually, many accounting software programs can also calculate this metric automatically for you. Here is the formula:
Accounts payable turnover ratio = Total supply purchases / Average accounts payable
4. Record the metric
Now that you have the metric, you can record it on the balance sheet. Companies can use this ratio as an indicator of their liquidity, which means their ability to pay debts. They may show this figure to potential creditors to prove how effectively they can manage their cash flow. Sometimes, creditors may ask for the accounts payable ratio in days, which shows the average number of days a company takes to pay back its debts. You can calculate that measurement using this formula:
Turnover in days = Number of days in the period / accounts payable turnover ratio
Accounts payable ratio vs. accounts receivable ratio
Accounting professionals may be responsible for calculating another financial metric, the accounts receivable turnover ratio. This metric differs from the accounts payable turnover ratio in several key ways, including:
The accounts receivable turnover ratio is a metric that shows how quickly a company collects its receivables. This is the money that clients owe to the company. In comparison, the accounts payable ratio is a measurement that shows how quickly the company pays its own short-term debts.
Read more: What Is Accounts Receivable Turnover?
Similar to the accounts payable ratio, an accounts receivable ratio can either increase or decrease over time, but this change has different indications than a fluctuating accounts payable ratio. An increasing accounts receivable ratio can mean that a company collects its payments efficiently and has customers who pay debts quickly. A low accounts receivable ratio could mean that it has slow collection processes.
The accounts receivable ratio is an efficiency ratio, which means it measures how effectively a business uses its assets and liabilities to generate income. The accounts payable ratio, however, is a liquidity ratio. This type of ratio measures a company's ability to pay its debts.
Example of accounts payable turnover ratio
Here is an example of finding the accounts payable turnover ratio for a business:
A contracting company purchases its materials and supplies for the year at a cost of $750,000. At the beginning of the year, the company's accounts payable balance was $40,000. At the end of the year, this balance was $350,000. To calculate the accounts payable turnover ratio for the company over the year, you first calculate the average accounts payable using this formula:
Average accounts payable = ($40,000 + $350,000) / 2 = $195,000
Now that you have the average accounts payable, use that number and the total supply purchases to calculate the account payable turnover ratio:
Accounts payable turnover ratio = $750,000 / $195,000 = 3.84
In this example, the ratio is 3.84. This means the company pays off its short-term debts about 3.84 times each year. To calculate the turnover ratio in days, use this formula:
Turnover in days = 365 / 3.84 = 95.05
The turnover in days is 95.05. This means the company pays its debts about once every 95 days during the year.
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