Accounts Payable Turnover:
Definition and Significance:
Accounts payables turnover ratio measures the company’s response to bills raised by its suppliers in certain timeline and time it takes to pay vendor bills. High accounts payable ratio means higher turn around in paying the suppliers and is a good sign as far as measuring companies ability to manage suppliers is concerned and while commanding a best possible price in procurement as quick payment to suppliers always result in better negotiation of price.
Every business has its comparison matrix to the industry it operates in, so does the Accounts Payable Turnover Ratio of a company when analysing it as favourable by vendors when compared to its peers.
How to calculate accounts Payables Turnover Ratio: Total Purchases / Average accounts payable.
To calculate Accounts Payables Ratio two components are used namely Total purchases a company made in a given year (Cost of Goods Sold during the year + Closing stock – Opening Stock) and Average Accounts Payable (Beginning accounts payable + Ending Accounts Payable / 2).
Assume Company X is in a manufacturing business of gears and purchases raw materials worth $500000
during the year from vendors, as per Company X’s balance sheet its Opening Accounts Payable ware $75000 and Ending Accounts Payable was $50000.
To calculate the Average Accounts Payable, we need to Add Starting and Ending figures from above i.e. $75000 + $50000 and divide it by 2, we get an Average Payables = $62500.
Now the accounts payable turnover is = $500000 (Purchases) / $62500 = 8 times a year.
This means Company X Accounts Payable is 8 times a year as an average or simply put it pays in average of 46 days to its vendors bill raised during the year 46 days. (365 days / 8 = 46 Days)