Accounts Payable Turnover Ratio

What is Accounts Payable turnover ratio

Accounts payable turnover ratio is how fast a company pays off its suppliers and creditors. This is important to measure a company’s financial health and cash flow management. A higher ratio means better payments.

Key Points

• Accounts Payable Turnover Ratio measures how efficient a company is in paying suppliers, higher ratio means better cash flow and stronger financials.
• Calculate this by dividing net credit purchases by average accounts payable and monitor to know the trend and areas for improvement.
• A good AP Turnover Ratio means good vendor relationships and financial stability, but businesses must balance a high ratio with cash flow management to avoid problems.

Definition of Accounts Payable turnover ratio

Accounts Payable Turnover Ratio, also known as payables turnover ratio, is how fast a company pays off its suppliers and creditors. This is important in cash flow management and maintaining healthy financial relationships with vendors. A higher ratio means a company is more efficient in paying debts, which means better cash flow and stronger financials.

Understanding the AP Turnover Ratio helps businesses to optimize cash flow and financial standing. Monitoring this ratio gives you insights into short-term liquidity and the ability to meet financial obligations and stay in good standing with suppliers.

How to calculate AP turnover ratio

To calculate Accounts Payable Turnover Ratio you need to know total purchases and average accounts payable balances. The payable turnover ratio formula is simple but needs accurate data to be reliable. Regular calculation helps businesses to track payment efficiency and identify areas for improvement.

AP turnover ratio formula

The formulato get an accurate ratio is simple: Net credit purchases divided by Average accounts payable. Use net credit purchases (also called total credit purchase) which is total credit purchases minus returns (not gross purchases) to get an accurate ratio.

Total Supplier Purchases ÷ Average Accounts Payable  

Where: 

• Total Supplier Purchases = The cost of goods or services purchased on credit.
• Average Accounts Payable = (Beginning A/P + Ending A/P) ÷ 2 

Example calculation of AP turnover ratio

Let’s use an example to illustrate the calculation. A company starts with $0 accounts payable and ends with $2,000. The average accounts payable is $1,000. Total net credit purchases for the period is $30,000. AP Turnover Ratio is calculated by dividing $30,000 by $1,000, which is 30.

This shows how the AP Turnover Ratio gives you an insight into the company’s payment habits. A ratio of 30 means the company pays its suppliers 30 times within the period, that’s high.

What is a good AP turnover ratio

A high AP Turnover Ratio means good vendor relationships. Companies with high ratios are considered reliable and creditworthy, they get better credit terms and potential discounts which improves cash flow and financials.

On the other hand, a low AP Turnover Ratio may mean financial distress, such as cash shortages or difficulty in meeting short-term debts. Monitoring regularly helps you to be proactive in financial management and stable and efficient over time.

High vs low AP turnover ratios

A high AP Turnover Ratio means efficient payment to suppliers and solid cash flow management. But it may also mean strict credit terms from suppliers. A high ratio can mean good supplier relationships and financial efficiency.

Conversely, a low AP Turnover Ratio means a slower payment process may mean cash flow issues. This can negatively impact a company’s reputation among suppliers and strain relationships.

A “good” AP Turnover Ratio depends on the industry and cash flow strategy:

• High Ratio (10+ times per year) – Means the company pays suppliers fast, may help maintain good vendor relationships and take advantage of early payment discounts. But it may also mean the business is not optimizing its cash flow.
• 5-10 times per year – Adequate
• Below 5 times per year – Means the company takes longer to pay bills, may mean cash flow problems or holding onto cash for longer. If it drops too low, suppliers may impose stricter credit terms.

Balancing high and low AP Turnover Ratios is crucial to financial stability and supplier trust.

How to improve your AP turnover ratio

Improving your AP Turnover Ratio involves strategies that optimize payment processes and cash flow to improve accounts payable turnover. Taking advantage of early payment discounts offered by suppliers can increase your AP Turnover Ratio and reduce average payables turnover in days.

Using accounts payable automation tools streamline workflows, reduce errors, and speed up processing. Implementing good accounts payable practices and working with payment processing companies can further refine your AP strategies.

Matching DPO with DRO and speeding up inventory turnover optimizes cash flow and supplier relationships.

Take early payment discounts

Taking early payment discounts strategically improves your accounts payable turnover ratio. Paying suppliers who offer these discounts first reduces overall purchase costs and improves cash flow.

Negotiate and use early payment discounts when cash is available or use a line of credit at reasonable interest rates. This improves the AP Turnover Ratio and supplier relationships.

Use accounts payable automation

Using accounts payable automation improves your AP Turnover Ratio. Automated invoice processing systems reduce manual tasks, increase accuracy, and speed up the payment cycle. These systems provide real-time reporting and analytics, give better visibility into accounts payable processes, and provide informed decision-making.

Adopting these technologies streamlines workflows and overall financial performance.

AP turnover ratio downsides

While AP Turnover Ratio is useful, relying on it alone can hide financial problems. Declining ratios may mean strained credit relationships. Paying invoices too fast may mean losing interest earnings or incurring short-term loan interest.

Payment terms and cash availability affect the AP Turnover Ratio. Delaying vendor payments can stretch the cash conversion cycle and impact overall liquidity and operational efficiency.

AP Turnover Ratio is a metric you must monitor to manage cash flow, supplier relationships, and financial stability.