How to Calculate Your Accounts Payable Turnover Ratio

Determine whether your cash flow management policies and financing allow your company to pursue growth opportunities when justified. Over time, your business can respond to new business opportunities and changing economic conditions. The accounts payable turnover ratio is a metric that is used to measure the rate at which a business is able to send out payments to suppliers and creditors that extend lines of credit. The ratio is quantified by accounting professionals by calculating, over a specific period of time, the average number of times a company pays its accounts payable balances. The accounts payable turnover ratio measures how efficiently a company pays its suppliers. It is calculated by dividing the total purchases made from suppliers by the average accounts payable during a specific period.

A change in the turnover ratio can also indicate altered payment terms with suppliers, though this rarely has more than a slight impact on the ratio. If a company is paying its suppliers very quickly, it may mean that the suppliers are demanding fast payment terms, or that the company is taking advantage of early payment discounts. The accounts payable turnover ratio indicates to creditors the short-term liquidity and, to that extent, the creditworthiness of the company. A high ratio indicates prompt payment is being made to suppliers for purchases on credit.

This key performance indicator can quickly give you insight into the health of your relationships with your vendors, among other things. The formula for calculating the accounts payable turnover ratio divides the supplier credit purchases by the average accounts payable. In financial modeling, the accounts payable turnover ratio (or turnover days) is an important assumption for creating the balance sheet forecast. 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 the difference between the direct and indirect cash flow methods multiplied by 30 and divided by the number of days in the period to get the AP balance. Your accounts receivable turnover ratio is also an element that will have an impact on your company’s accounts payable turnover ratio.

Accounts payable are short-term debts owed to suppliers and creditors by a business. With this data at your fingertips, cross-departmental collaboration becomes more productive, allowing you to identify opportunities to improve efficiency and AP turnover to help the business grow. Automation can speed up your AP process, as well as keep you up-to-date on payments, due dates, and a centralized place for all your bills.

Auditing how an organization is managing its cash flow

The formula for calculating the AP turnover in days is to divide 365 days by the AP turnover ratio. Mosaic integrates with your ERP to gather all the data needed to monitor your AP turnover in real time. With over 150 out-of-the-box metrics and prebuilt dashboards, Mosaic allows you to get real-time access to the metrics that matter. Look quickly at metrics like your free estimate template AP aging report, balance sheet, or net burn to get vital information about how the business spends money. Review billings and collections dashboards side-by-side to get better insights into cash inflow and outflow to improve efficiency. AP aging comes into play here, too, since it digs deeper into accounts payable and how any outstanding debt could affect future financials.

Effective management of supplier relationships

A business that generates more cash inflows can pay for credit purchases faster, leading to a higher AP  turnover ratio. In the 4th quarter of 2023, assume that Premier’s net credit purchases total $3.5 million and that the average accounts payable balance is $500,000. This article explores the accounts payable turnover ratio, provides several examples of its application, and compares the metric with several other financial ratios. Finally, the discussion explains how your business can improve your ratio value over time. The accounts payable turnover formula is calculated by dividing the total purchases by the average accounts payable for the year. Using those assumptions, we can calculate the accounts payable turnover by dividing the Year 1 supplier purchases amount by the average accounts payable balance.

How to Analyze and Interpret the Accounts Payable Turnover Ratio

• If your AP turnover is too low or too high, you need a ratio analysis to identify what’s causing your AP turnover ratio to fall outside typical SaaS benchmarks.
• Accounts payable turnover is expressed in terms of times, and it shows how many times accounts payable are paid over a given period.
• As a rule of thumb, the lower the creditor turnover ratio, the better it is for the company.
• The issue here is that the AP turnover ratio cannot be used on its own to determine a business’s ability to pay its suppliers and vendors.
• Meals and window cleaning were not credit purchases posted to accounts payable, and so they are excluded from the total purchases calculation.
• This ongoing refinement helps companies maintain an optimal ratio that supports both financial stability and growth objectives.

To improve your AP turnover ratio, it’s important to know where your current ratio falls within SaaS benchmarks. From there, use the following tips to collaborate with other departments to help improve financial ratios as needed. A high turnover ratio indicates that a business is paying off accounts quickly, which is often what lenders and suppliers are looking for. To get the most information out of your AP turnover ratio, complete a full financial analysis.

Application Management

Vendors also use this ratio when they consider establishing a new line of credit or floor plan for a new customer. For instance, car dealerships and music stores often pay for their inventory with floor plan financing from their vendors. Vendors want to make sure they will be paid on time, so they often analyze the company’s payable turnover ratio.

How HighRadius Can Help Improve AP Turnover Ratio

• Accounts payable turnover ratio is a measure of your business’s liquidity, or ability to pay its debts.
• If a company does not believe this is the case, finance leaders may wish to have an explanation on hand.
• Having full transparency into your company’s spending behavior can give you great insights into the areas where accounts payable turnover can be improved.
• The Accounts Payables (AP) Turnover Ratio is crucial for creditors since it helps them assess whether to expand the company’s line of credit.
• It could be a warning that the business is not properly managing its capital or making investments in the future.
• Analyze both current assets and current liabilities, and create plans to increase the working capital balance.

The AP turnover ratio provides important strategic insights about the liquidity of a business in the short term, as well as a company’s ability to efficiently manage its cash flow. A well-managed accounts payable turnover ratio can lead to stronger supplier relationships, better credit terms, and increased profitability through early payment discounts. The ratio is a measure of short-term liquidity, with a higher payable turnover ratio being more favorable. The accounts payable turnover ratio measures the company’s efficiency regarding timely payment to suppliers & short-term debt obligations. It is also advantageous for the company if it pays before time to take advantage of early payment discounts.

Your AP turnover ratio only gains meaning when compared to relevant industry standards. For instance, manufacturing firms may operate on different payment cycles than software companies. However, the company received credits for adjustments and returned inventory amounting to $100,000.

What is the Accounts Payable Turnover Ratio?

Contact us to explore how these receivables solutions can support your growth strategy. Proactively paying supplier or vendor bills on time will not only help you build a better relationship with them but also improve your AP turnover ratio. Having full transparency into your company’s spending behavior can give you great insights into the areas where accounts payable turnover can be improved. Start by adding the accounts payable balance at the end of the chosen period with the accounts payable balance at the beginning of the period.

How to analyze AP turnover ratio effectively?

Trade payables are the amounts a company owes to its suppliers from whom it has purchased goods or services on credit. Minor variances may arise due to slight differences in the components considered in the calculations, but in principle, the AP and Creditors turnover ratios serve the same purpose. Premier used far more cash (a current asset) to pay for purchases in the 4th quarter than in the 3rd quarter. Short-term debts, including a line of credit balance and long-term debt payments (principal and interest) due within a year, are also considered current liabilities. If you’re looking to strategically manage your AP turnover ratio, automation is key.

But, it could also indicate that a business is making strategic financial decisions about upfront investments that will pay off later. The ratio’s influence extends to negotiations with suppliers, where a strong small business tax alert payment history can lead to better terms and increased flexibility. This relationship between payment performance and supplier management highlights the strategic importance of maintaining an optimal turnover ratio.