Guide to Accounts Payable Turnover Ratio Formula & Examples

It’s essential to compare the AP turnover ratio with industry benchmarks or historical data to assess performance relative to peers or previous periods. A significantly higher or lower ratio than industry averages may warrant further investigation into the company’s payment practices, supply chain efficiency, or financial strategy. To improve your accounts payable turnover ratio you can improve your cash flow, renegotiate terms with your supplier, pay bills before they’re due, and use automated payment solutions. Your vendors might not be willing to continue to extend credit unless you raise your accounts payable turnover ratio and decrease your average days to pay. However, it should be noted that this metric cannot directly be compared across different industries or company sizes. Many variables should be examined in conjunction with accounts payable turnover ratio.

Strategies to decrease AP turnover ratio:

This article will deconstruct the accounts payable turnover ratio, how to calculate it — and what it means for your business. The accounts payable turnover ratio of a company is often driven by the credit terms of its suppliers. For example, companies that obtain favorable credit terms usually report a relatively lower ratio. Large companies with bargaining power who are able to secure better credit terms would result in lower accounts payable turnover ratio (source). Another important aspect of the Accounts Payable Turnover Ratio is that it can help a company identify potential cash flow issues.

Measured over time, a decreasing figure for the AP turnover ratio indicates that a company is taking longer to pay off its suppliers than in previous periods. Alternatively, a decreasing ratio could also mean the company has negotiated different payment arrangements with its suppliers. Although your accounts payable turnover ratio is an important metric, don’t put too much weight on it.

For instance, let’s say a company uses all its cash flow to pay bills instead of diverting a portion of funds toward growth or other opportunities. Remember, the decision to increase or decrease the AP turnover ratio should be based on the specific circumstances and financial goals of the company. It’s essential to strike a balance between maintaining good relationships with suppliers and managing cash flow effectively.

How to Increase AP Turnover Ratio

On the other hand, if a company negotiates shorter payment terms, it may have a higher turnover ratio as it pays off its accounts payable more quickly. In conclusion, mastering the Accounts Payable Turnover Ratio is not just about crunching numbers; it’s about gaining valuable insights into your company’s financial health and operational efficiency. In today’s digital era, leveraging technology can significantly enhance your accounts payable processes and positively impact your AP turnover ratio. By incorporating technologies like Highradius’ accounts payable automation software, you can streamline your operations and improve efficiency. The investor can see that Company B paid off its suppliers at a faster rate than Company A. That could mean that Company B is a better candidate for an investment.

That, in turn, may motivate them to look more closely at whether Company B has been managing its cash flow as effectively as possible. Instead, investors who note the AP turnover ratio may wish to do additional research to determine the reason for it. Here’s an example of how an investor might consider an AP turnover ratio comparison when investigating companies in which they might invest.

In short, in the past gaap services year, it took your company an average of 250 days to pay its suppliers. Therefore, over the fiscal year, the company takes approximately 60.53 days to pay its suppliers. Another industry that can benefit from a high Accounts Payable Turnover Ratio is the healthcare industry. Healthcare providers need to purchase a large volume of medical supplies and equipment, and they need to pay their suppliers on time to ensure a steady supply of essential items. A high Accounts Payable Turnover Ratio can help healthcare providers negotiate better prices and payment terms with their suppliers, which can ultimately lead to cost savings for patients.

Analyzing Accounts Payable Turnover Ratios

Beginning accounts payable and ending accounts payable are added together, and then the sum is divided by two in order to arrive at the denominator for the accounts payable turnover ratio. Therefore, over the fiscal year, the company’s accounts payable turned over approximately 6.03 times during the year. In some cases, cost of goods sold (COGS) is the beginner’s guide to bookkeeping used in the numerator in place of net credit purchases. Average accounts payable is the sum of accounts payable at the beginning and end of an accounting period, divided by 2.

1. Whether you aim to increase your turnover ratio to free up cash flow or negotiate extended payment terms to preserve capital, strategic management of accounts payable is key.
2. However, an increasing ratio over a long period of time could also indicate that the company is not reinvesting money back into its business.
3. That, in turn, may motivate them to look more closely at whether Company B has been managing its cash flow as effectively as possible.

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 multiplied by 30 and divided by the number of days in the period to get the AP balance. The accounts payable turnover ratio indicates to creditors the short-term liquidity and, to that extent, the creditworthiness of the company.

As with most liquidity ratios, a higher ratio is almost always more favorable than a lower ratio. Before you can understand how to calculate and use the accounts payable turnover ratio, you must first understand what the accounts payable turnover ratio is. In short, accounts payable (AP) represent the money you owe to vendors or suppliers. This key performance indicator can quickly give you insight into the health of your relationships with your vendors, among other things. It provides justification for approving favorable credit terms or customer payment plans. Again, a high ratio is preferable as it demonstrates a company’s ability to pay on time.