Payables turnover

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The payables turnover ratio is the number of times, on average, that accounts payable turn over during the year [1] ,i.e. that a company pays its accounts payable during the accounting period. This ratio reflects the relative size of accounts payable, a company's urgency in paying suppliers and the credit terms offered by suppliers [2].

Ratio Analysis

The payables turnover ratio is one of the ratios needed in financial statement analysis, which is based on the computing and interpreting different ratios. Using them, the relations between particular items of financial statements are presented. These indicators are useful in assessing the financial situation, serving as a benchmark for comparing the company's results with the results of competitors, which allows the company's performance to be assessed [3].

Using indicators, it is possible evaluate[4]:

Payables turnover ratio belongs to the group of Operating capability ratios. These ratios are used to measure the company's efficiency to use its economic resources to be able to generate revenues[5].

How to calculate the payables turnover ratio?

The formula is:

Accounts payable turnover = Inventory Purchases* / Average accounts payable

Inventory Purchases = Cost of Goods Sold + Change in Inventory

Example

Company X's cost of goods sold in 2015 year was US$110,550, and its inventory decreased by US$8,000. Accounts payable at the beginning and end of the year were, respectively, US$12,695 and US$26,985. The company wants to measure how many times it paid its creditors over the fiscal year.

Accounts payable turnover = Inventory Purchases / Average accounts payable

Inventory Purchases = 110,550-8,000 = 102,555 Average accounts payable = (12,695 + 26,985)/2 = 19,840

Accounts payable turnover = 102,555 / 19,840 = 5.17

Therefore, over the fiscal year, the company's accounts payable turned over approximately 5.17 times during the year.

Having accounts payable turnover, it is possible to calculate Accounts Payable Turnover in Days:

Accounts Payable Turnover in Days = 365 / Accounts payable turnover

Accounts Payable Turnover in Days = 365 / 5.17 = 70.59

Therefore, over the fiscal year, the company takes approximately 70.59 days to pay its suppliers.

What does the payables turnover ratio result mean?

Depending on the result, the indicator can inform about [6][7]:

  • Too high turnover may inform that company is losing the "free" credit provided by account payable, because of making payments too quickly.
  • Too low turnover (than the average for its industry) may indicate that the company is having financial difficulties.
  • High result of payables turnover ratio means that the company does not need a lot of time between the purchase of inventory and the cash payment.

Advantages of Payables turnover

The payables turnover ratio is a useful metric for assessing the efficiency of a company's accounts payable system. The advantages of a high payables turnover ratio include:

  • Improved cash flow as money is not locked up in accounts payable, allowing more funds to be used elsewhere.
  • Increased ability to negotiate better terms with suppliers, such as discounts or extended payment terms.
  • Greater liquidity and financial flexibility, as there is less money tied up in accounts payable.
  • A lower risk of default on accounts payable, as the company is able to pay them on time.
  • A higher return on investment, as money is not being held in accounts payable but is being put to use in other areas of the business.

Limitations of Payables turnover

The payables turnover ratio can be a useful tool for assessing the efficiency of cash flow management, however there are some limitations to consider. These include:

  • Not taking into account changes in the accounts payable balance over the period of time - the ratio does not reflect any changes in the total amount of accounts payable, only the frequency of payments.
  • Not accounting for the effect of any discounts given or received - the ratio does not consider any discounts taken or offered when making payments, which can impact the effective cost of payments.
  • Not reflecting the quality of accounts payable management - the ratio does not account for any late payments or other issues that can reduce cash flow efficiency.
  • Not considering the type or size of transactions - the ratio does not take into account any differences in the size or type of payment, which could affect the overall cost of accounts payable.

Other approaches related to Payables turnover

The payables turnover ratio is an important measure of a company's liquidity, but there are other approaches to analyzing a company's accounts payable as well. These include:

  • Analysis of the terms of payment - An analysis of the terms of payment in a company's accounts payable can provide insight into the company's liquidity and how quickly it pays its bills.
  • Analysis of accounts payable aging - This approach looks at the accounts payable in terms of how long they have been outstanding and allows you to see if the company is paying its bills in a timely manner.
  • Analysis of accounts payable by vendor - This approach looks at accounts payable by vendor and can provide insight into the company's relationships with its suppliers.

In summary, the accounts payable turnover ratio is an important measure of a company's liquidity, but there are other approaches to analyzing accounts payable that can provide additional insight into the company's financial health.

Footnotes

  1. ↑ L. Nikolai, J. Bazley, J. Jefferson, 2010, p. 284
  2. ↑ B. Needles, M. Powers, 2010, p. 365
  3. ↑ J. Wahlen, J. Jones, D. Pagach, 2012, p. 438
  4. ↑ J. Wahlen, J. Jones, D. Pagach, 2012, p. 438
  5. ↑ J. Wahlen, J. Jones, D. Pagache, 2012, p. 442
  6. ↑ J. Wahlen, J. Jones, D. Pagach, 2012, p. 444
  7. ↑ L. Nikolai, J. Bazley, J. Jefferson, 2010, p. 284


Payables turnover — recommended articles
Average payment period — Average collection period — Days payable — Cash Flow-to-Debt Ratio — Solvency ratios — Debt management ratio — Acid-test ratio — Operating cash flow ratio — Capital gearing

References

Author: Katarzyna Skrzyniarz

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