The accounts payable (A/P) turnover ratio is a liquidity measure that shows how fast a business pays its suppliers during a specific period. The A/P turnover formula is:
| Accounts Payable Turnover | = | Total Credit Purchases |
| Average Accounts Payable |
Key Takeaways:
- The A/P turnover ratio can provide insights into the business’ cash management and payables management.
- Theoretically, a high A/P turnover would mean that the business is able to pay its debt more frequently. Meanwhile, a low A/P turnover may imply cash flow problems since the business may be having a hard time settling payables.
- Comparing A/P turnover with industry averages is the best way to assess if your business’ A/P turnover ratio is within normal levels.
Accounts Payable Turnover Ratio Calculator
Accounts Payable Turnover Ratio Example
To illustrate how to compute the A/P turnover, let’s assume the following data:
- Total credit purchases: $8,000
- Beginning A/P: $2,000
- Ending A/P: $3,000
Step 1: Calculate average A/P
Add the beginning and ending balance of A/P and then divide it by 2 to get the average.
| Average A/P | = | ($2,000 + $3,000) | = | $2,500 |
| 2 |
When getting the beginning and ending balances, set the desired accounting period for analysis. For example, get the beginning- and end-of-month A/P balances if you want to get the A/P turnover for a single month.
Step 2: Determine A/P turnover
By using the formula provided, compute the A/P turnover. Remember to include only credit purchases when determining the numerator of our formula. Cash purchases are excluded from our computation, so ensure you remove them from the total amount of purchases.
| A/P Turnover | = | $8,000 | = | 3.2 times |
| $2,500 |
Common Mistakes in Calculating the A/P Turnover Ratio
Calculating A/P turnover seems straightforward, but some common pitfalls can distort the results and lead to inaccurate interpretations. Here are some of the most frequent mistakes:
Problem | Solution | |
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Not Accounting for Seasonality |
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Ignoring Different Payment Terms |
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Using Inconsistent Data |
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Overlooking Returns & Discounts |
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Neglecting Context |
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Focusing Solely on the Number |
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Why the Accounts Payable Turnover Matters
The A/P turnover ratio is one of the financial ratios used in financial ratio analysis. It is also a valuable metric for assessing a company’s financial health, efficiency, and relationships with suppliers. By monitoring this ratio, businesses can optimize their cash flow, improve operations, and strengthen their financial standing.
Here are some ways that you can use the A/P turnover:
- Comparing against industry standards: A high or low A/P turnover may mean a lot of things if analyzed individually. However, the meaning could change if compared with industry standards. There are industries wherein a high or low A/P turnover is normal. Hence, it’s best to look at companies within the same industry to determine if your business’ A/P turnover is within the normal level. You may check IBISWorld for industry-related ratios and information.
- Spotting inefficient cash management: In relation to the first bullet, a high and low cash position may indicate inefficient cash management. The A/P turnover can reveal if the business is struggling with or swimming in cash. If it’s the former, it may affect the business’ credit score and reputation with vendors. Otherwise, the latter would mean that the business is not reinvesting excess cash to improve business operations and generate more revenue.
- Assessing the cash position of the business: The A/P turnover can provide information about the business’ cash position by looking at how many times the business pays its payables. While analyses are not necessarily conclusive, a high turnover may indicate a high cash position, while a low turnover may indicate a low cash position.
- Detecting poor A/P management: A low A/P turnover is an indication of poor A/P management. The business’ inability to settle payables could translate into many things. First, there might be a cash flow problem. Second, the business is not effectively monitoring all payables. Third, the business is not utilizing lines of credit for purchases and instead uses cash payments—and this is unhealthy since credit lines can improve overall liquidity without burning too much cash.
- Looking for ongoing trends: Part of financial analysis is studying trends. You may compare month-to-month or year-over-year A/P turnovers to spot seasonalities and normal occurrences in business operations.
Ways to Improve Your Accounts Payable Turnover Ratio
You can try to improve your ratio by following our tips below.
- Take advantage of early payment discounts. Many vendor suppliers offer an early payment discount to encourage prompt payment. Generally, it’ll run 1% to 3% if payment is made within seven to 10 days of the invoice date. If you take advantage of these discounts, you will save money and increase your A/P turnover ratio automatically because you’ll make your payments well before the standard due date.
- Pay vendor supplier bills on time. A quick way to increase your A/P turnover ratio is to pay your bills on time consistently. To maintain positive cash flow, I don’t recommend you pay bills early—unless you can take advantage of early payment discounts. In this case, you should schedule your payments to arrive one to two days before the due date.
- Review cash management policies and practices. Cash shortage is a common problem for most small businesses. If you spot an ongoing trend of low A/P turnovers, you might want to investigate your business’ cash management policies and practices to determine where cash problems lie.
- Review A/P practices. Sometimes, problems with cash flow arise from poor collection of A/R, which would then affect your ability to pay payables.
A/P Turnover vs A/R Turnover Ratios
While both are turnover ratios, each reveals a different aspect of business operations. As discussed earlier, A/P turnover measures how quickly a company pays its suppliers. Meanwhile, the A/R turnover pertains to how quickly a company collects from customers.
These two ratios have a direct relationship. If the company can’t collect receivables quickly, there will be little cash. With little cash, it would be impossible to pay suppliers quickly, which would then result in a low A/P turnover. Overall, it is beneficial to analyze these two ratios together when conducting financial analysis.
Frequently Asked Questions (FAQs)
In general, you want a high A/P turnover because that indicates that you pay suppliers quickly. However, you should always find out why your A/P turnover ratio is trending high or low. While a high A/P turnover can be positive, it could also mean that you pay bills too quickly, which could leave you without cash in an emergency.
First, it doesn’t reflect the whole picture. It primarily focuses on short-term liabilities and doesn’t provide insights into long-term debt obligations or overall financial stability. Also, a high turnover ratio doesn’t necessarily mean the company is profitable—it simply indicates how quickly it pays its suppliers. A company could be efficiently paying bills but still struggling with sales or profitability.
Industry benchmarks can be obtained from financial data providers (like Dun & Bradstreet, S&P Capital IQ, and Bloomberg), industry associations, and research reports.
While the A/P turnover ratio quantifies the rate at which a company can pay off its suppliers, the days payable outstanding (DPO) ratio indicates the average time in days that a company takes to pay its bills. They essentially measure the same thing—how quickly are bills paid—but use different measurement units. The turnover ratio is measured in the number of times per year, whereas DPO is measured in days.
DPO = (Accounts Payable × Number of Days) ÷ Cost of Goods Sold
An increasing A/P turnover ratio indicates that a company is paying off suppliers at a faster rate than in previous periods, which also means that the number of DPO is less.
A/P Turnover in Days = (Average Accounts Payable ÷ COGS) ÷ 365 days
Bottom Line
The accounts payable turnover ratio tells you how quickly you’re paying vendors that have extended credit to your business. The keys are to calculate the ratio on a periodic basis to identify trends and compare your ratio to the industry standard.
