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Guide to the Accounts Payable Turnover Ratio

Guide to the Accounts Payable Turnover Ratio
Susan Guillory
Susan GuilloryUpdated November 30, 2022
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Accounts payable turnover ratio is one of many financial metrics that measures a firm’s liquidity, or ability to pay its debts. It looks specifically at how quickly (or slowly) a company is paying its suppliers for the products and services it uses in its day-to-day operations. Businesses that rely on lines of credit typically benefit from a higher turnover ratio, since creditors will use this metric to gauge whether to extend credit and for how long. A higher turnover ratio can also help your company qualify for different types of small business loans, since lenders will see you as lower risk.Read on for a closer look at accounts payable turnover ratio, from how to calculate it to what it can reveal about your business.

What Is Accounts Payable Turnover Ratio?

Accounts payable turnover ratio is a short-term liquidity measure used to measure the rate at which a company pays off its suppliers. In small business accounting, the turnover ratio is used to show the average number of times a company pays its accounts payable balances during a specified time period. The ratio can be calculated for any time period, though an annual or quarterly calculation tends to be the most useful.The accounts payable turnover ratio is a key indicator of a company’s liquidity and how it is managing cash flow. A high accounts payable ratio signals that a company is paying its creditors and suppliers quickly, while a low ratio suggests the business is slower in paying its bills. 

How Does Accounts Payable Turnover Ratio Work?

Accounts payable represent the money you owe to vendors or suppliers for goods and services purchased with trade credit. Accounts payable appear on your business’s balance sheet as a current liability.When you purchase something from a vendor with the agreement to pay for the purchase later, you make an entry into your accounting system debiting an expense and crediting accounts payable.The accounts payable turnover ratio only looks at your accounts payable. Other short-term debts — like credit card balances and short-term loans — are excluded from the calculation.This number is important to potential investors, creditors, and lenders who want to be assured that your business has enough liquidity to meet your financial obligations. If you are able to pay your vendors quickly, you pose less of a risk.

Calculating the Accounts Payable Turnover Ratio

Accounts payable turnover is typically calculated by dividing a business’s total purchases by its average accounts payable balance during the same period. While that may sound confusing, it’s actually not difficult to calculate once you look at the turnover ratio formula.

Accounts Payable Turnover Ratio Formula

Here’s the formula to use when calculating accounts payable turnover ratio:Total purchases / ((Beginning accounts payable + ending accounts payable) / 2) = Accounts payable turnover ratioYour total purchases are all the purchases made on credit and posted to accounts payable for the period. You want to exclude any purchases paid for with cash, credit card, or check. Some businesses exclude non-inventory purchases, but this is not correct and can inflate your accounts payable turnover ratio.You can get the beginning and ending accounts payable for the period you are analyzing from your balance sheet as of the beginning of the period and the end of the period. Alternatively, you can use your accounts payable aging report from your accounting software.

Example

Let’s put this formula into action.Let’s say you purchased $5,000 in supplies on credit last quarter. Your beginning accounts payable for that quarter were $3,500 and your ending accounts payable were $1,600.$5,000 / (($3,500 + $1,500) / 2) = Accounts payable turnover ratio$5,000 / $2,500 = 2Your accounts payable turnover ratio would be two. In other words, your business pays its accounts payable at a rate of 2 times per quarter. Is this high or low? It depends. It can be helpful to look at what turnover ratio averages are in your industry to know where your ratio stands. It can also be useful to track your ratio over time to see if it rises or falls.

How Investors Look at Accounts Payable Turnover Ratio

The accounts payable turnover ratio shows potential investors, lenders, and creditors how many times per period a company pays its accounts payable – or, in other words, the speed at which it pays its suppliers. This provides insight into whether a company has enough cash to meet its short-term obligations. Looking at one turnover ratio, however, doesn’t tell the full story. As a result, analysts will often want to look at how accounts payable turnover ratio is changing over time.

Increasing

If your turnover ratio is increasing, it indicates that your company is paying off suppliers at a faster rate than in previous periods. This indicates that the company has sufficient cash available to pay off its short-term debt on time and in full, and is likely managing its debts and cash flow effectively. This can make it easier to qualify for small business loans with attractive rates and terms.

Decreasing

If your ratio decreases over time, it indicates that your company is taking longer to pay off its suppliers than in previous periods. This can be a sign that your firm is in financial distress. However, a decreasing accounts payable turnover ratio isn’t always a bad sign. It can also mean the company has negotiated different payment arrangements with its suppliers. 

Accounts Payable vs Accounts Receivable Turnover Ratio

A close cousin to the accounts payable turnover ratio is the accounts receivable turnover ratio. Both of these turnover ratios offer clues into a company’s financial performance and may be looked at by potential investors or creditors, or when you apply for a small business loan. However, there are some key differences.The accounts payable turnover ratio measures how quickly a firm pays its short-term debts. The accounts receivable turnover ratio, on the other hand, shows how quickly a firm collects short-term debts and gets paid. The accounts receivable turnover ratio is used to provide insight into how well a company uses and manages the credit it extends to customers.A high accounts receivable turnover ratio indicates a company is effectively collecting what it’s owed, whereas a low ratio can signal a company is struggling in its collection process or is extending credit to the unreliable customers.You calculate the accounts receivable turnover ratio by dividing net credit sales by your average accounts receivable.
Accounts Payable Turnover RatioAccounts Receivable Turnover Ratio
Measures creditworthinessMeasures effectiveness of collecting receivables
Tells how quickly a firm pays its suppliersTells how quickly a firm gets paid by suppliers
Impacts cash flowImpacts cash flow
Of interest to investors, creditors, and lendersOf interest to investors, creditors, and lenders

Strengths and Weaknesses of Accounts Payable Turnover Ratio

Like all financial ratios, the accounts payable turnover ratio can provide useful insights in a firm’s financial position, but also has some limitations. Here’s a look at its pros and cons.
ProsCons
Provides clues into a firm’s financial healthDoesn’t provide a complete picture of a business's finances
Can spot problems that, if left unaddressed, could harm relationships with vendorsNo universal scale of what  a “good” or “bad ratio is
Tracking ratios can reveal what direction a company is going inA high ratio isn’t always a positive  – it could be due to lack of investment
Can be used to compare a firm’s performance to that of its competitorsAll firms don’t use the same calculation standards, which can skew comparisons

Pros

Your accounts payable turnover ratio provides a window into how healthy your business is. Comparing this ratio quarter over quarter, or year over year, can give you a sense of whether your business’s financial health is improving or heading towards difficulty.Even if your business is doing well, having a low or decreasing accounts payable turnover ratio could have a negative effect on your relationships with your suppliers and vendors, making this an important metric to track.The turnover ratio is also a useful way to compare your company’s performance to that of other firms in your industry.

Cons

The accounts payable turnover ratio, while useful, doesn’t provide a full picture of a business's finances. There may be a good reason why a company has a low or decreasing ratio (such as a change in the payment arrangements with its suppliers). In addition, a high ratio isn’t necessarily always a good thing, since it could indicate that a firm is not investing in its future or using its cash properly, which could impede future growth.Another limitation of the turnover ratio is that there is no precise scale of what a “good” or “bad” ratio is since numbers can vary from one industry to another.Plus, the ratio isn’t always calculated in the same way. If you decide to compare your accounts payable turnover ratio to that of competitors, you need to make sure those businesses are using the same standards of calculation you are. Some companies will include cash and credit card purchases or exclude non-inventory purchases, which can skew results.

The Takeaway

The accounts payable turnover ratio is a short-term liquidity measure. It tells you how quickly – or slowly – your company pays off its accounts payable during a fiscal period. Calculating and keeping track of your turnover ratio can provide useful insights into your firm's current and future financial health. Ideally, a company wants to generate enough revenue to pay off its accounts payable quickly, but not so quickly the company misses out on opportunities because they could use that money to invest in other initiatives.

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Frequently Asked Questions

How is accounts payable turnover calculated?
What is considered a good accounts payable turnover ratio?
Is it better to have a high or low accounts payable turnover?
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About the Author

Susan Guillory

Susan Guillory

Susan Guillory is the president of Egg Marketing, a content marketing firm based in San Diego. She’s written several business books, and has been published on sites including Forbes, AllBusiness, and Cision. She enjoys writing about business and personal credit, financial strategies, loans, and credit cards. Follow her on Twitter @eggmarketing.
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