Accounts Payable Turnover Ratio: Improve Cash Flow And Boost Financial Efficiency

When it comes to analyzing financial statements, tracking key performance indicators is crucial to evaluating a company's performance. One such essential KPI is the accounts payable turnover ratio. This ratio measures how efficiently a company pays its suppliers within a specific period, making it a vital short-term indicator that continuously fluctuates.

The accounts payable turnover ratio reflects the effectiveness of a company's supplier payment management. It represents the number of times a company settles its short-term debts owed to suppliers. By assessing this ratio, stakeholders can gauge the company's financial health in relation to its payables.

Accounts Payable Turnover Ratio Formula

To calculate the accounts payable turnover ratio, you can use the following formula:

Accounts Payable Turnover Ratio = Total Purchases (or Total Cost of Goods Sold) / Average Accounts Payable. 

Here, “Total Purchases” refers to the overall value of goods sold within the specified time frame. "Average Accounts Payable" is calculated as (Accounts Payable at the start of the period + Accounts Payable at the end of the period) / 2.

Additionally, you can determine the accounts payable turnover days by dividing 365 by the accounts payable turnover ratio.

How to Calculate the Accounts Payable Turnover Ratio?

Let's consider the example of a manufacturing company that made $200,000 worth of credit purchases from its suppliers. Out of this, $24,000 worth of purchases were returned, and the supplier provided an additional $8,000 in discounts. The company had payables of $30,000 at the beginning of the year and $14,000 at the end of the year.

Hence, the average payables for the year were ($30,000 + $14,000) / 2, which amounts to $22,000. After accounting for returns and discounts, the net purchases for the year totaled $166,000.

Thus, the accounts payable turnover ratio can be calculated as $166,000 / $22,000, resulting in 7.54.

This means the company settled its debts approximately 7.54 times within the year. Moreover, the accounts payable turnover days would be approximately 48 days, indicating the average time taken to pay suppliers.

Importance of the Accounts Payable Turnover Ratio

The accounts payable turnover ratio holds immense significance for all stakeholders of a company, serving as a key metric to gauge financial management and creditworthiness.

Better financial efficiency

A high accounts payable turnover ratio indicates that the company efficiently settles its debts. Conversely, a low turnover ratio may raise concerns about cash flow and liquidity issues.

Competitor analysis

Outperforming competitors with a higher ratio signifies effective payables management, suggesting that your company holds a healthier position within the industry.

Strengthened supplier relationships

A high turnover ratio makes a company more attractive to suppliers. Timely payments foster stronger relationships, encouraging suppliers to work collaboratively and offering opportunities for better deals and discounts.

Factors Affecting Accounts Payable Turnover Ratio

The accounts payable turnover ratio can be influenced by various factors, leading to either higher or lower values. Here are some key factors to consider:

Payment Terms

Payment terms play a crucial role in the turnover ratio. Companies with later due dates for their suppliers may experience higher turnover days, resulting in a lower turnover ratio.

Business Industry 

The turnover ratio is closely tied to the industry in which a company operates. Some industries naturally exhibit higher average turnover ratios compared to others. Hence, conducting a thorough analysis of turnover ratios relative to competitors within the same industry is essential.

Creditworthiness

Higher creditworthiness provides a company with a stronger negotiating position when dealing with suppliers. This enables them to secure favorable deals and better payment terms, ultimately contributing to maintaining a higher turnover ratio. Additionally, having access to trade credit also supports this objective.

Limitations of Accounts Payable Turnover Ratio 

Although the accounts payable turnover ratio serves as a good indicator of a company's creditworthiness and cash flow, it does have certain limitations that prevent a comprehensive view of the overall financial health.

Cash purchases not considered

The accounts payable turnover ratio is solely based on credit purchases, disregarding any cash transactions a company may have. Consequently, a company that primarily makes cash purchases might demonstrate strong financial health, but this may not be evident in its turnover ratio.

Different industry norms 

Various industries follow different norms for managing payables and payment terms, resulting in significant variations in average turnover ratios. Comparing ratios between companies in unrelated sectors can be misleading and may not provide accurate insights.

Seasonal effects

Seasonal variations in payables policies can impact quarterly ratio calculations. For instance, retail companies experience higher sales during holidays, leading to a different payables strategy that may skew the turnover ratio for that period.

Timing of invoice payments

The accounts payable turnover ratio is typically calculated at the end of the year, overlooking any early payment discounts or delayed invoice payments throughout the year. These factors can influence the ratio but are not considered in the year-end calculation.

How To Improve Accounts Payable Turnover Ratio

Despite the mentioned limitations, maintaining a high accounts payable turnover ratio is crucial to satisfy investors. Here are some valuable tips to enhance your accounts payable turnover ratio:

1. Negotiate favorable terms: Securing favorable payment terms that align with your financial capabilities is crucial in reducing the number of outstanding payables. Negotiating for a longer payment period provides flexibility in managing invoices, making it easier to plan payments effectively.
2. Take advantage of early payment discounts: Utilizing early payment discounts not only allows you to settle invoices at a lower cost but also ensures that you avoid paying after the due date. This proactive approach positively impacts your turnover ratio.
3. Optimize working capital management: A deep understanding of your working capital enables effective management of payables. Your accounts payable team can assess invoice payment priorities and avoid delayed payments, contributing to an improved turnover ratio.
4. Streamline accounts payable processes:Efficiently streamlining accounts payable processes is essential for on-time payments. This ensures that all invoices are paid promptly, providing a clear view of pending payments. Adopting advanced accounts payable software like ClearTech automates payment runs based on invoice due dates and payment methods, reducing the risk of missing any invoices.

The accounts payable turnover ratio plays a pivotal role as a financial indicator, reflecting a company's ability to manage supplier payments efficiently. Understanding the ratio and its influencing factors can lead to better financial decisions and a stronger creditworthiness. By implementing the suggested tips, your company can work towards maintaining a healthy accounts payable turnover ratio, impressing investors, and contributing to long-term success.

Improve Turnover Ratio With ClearTech

ClearTech's AP automation software ensures prompt invoice payment and fosters improved vendor relationships at every stage. With ClearTech, processing and approving invoices becomes effortless with just a few clicks, ensuring a smooth approval process without any invoices getting stuck. The smart AP dashboards provide a comprehensive view of your AP aging and outstanding bills, offering full visibility of your payables. ClearTech also streamlines payment runs by automating the creation process based on payment methods and due dates, enabling faster book closing and enhancing your accounts payable turnover ratio.