TURNOVER OF ACCOUNTS PAYABLE: FORMULAS, CALCULATION, EXAMPLES - DUDAS - 2024

The turnover of accounts payable is an indicator of short - term liquidity is used to quantify the rate at which a company pays its suppliers. Accounts Payable Turnover shows the number of times a company settles its accounts payable during a period.

Accounts payable are short-term debts that a business owes to its suppliers and creditors. They are reflected in current liabilities on the balance sheet. The accounts payable turnover indicator shows how efficient a company is in paying its suppliers and short-term debts.

Source: pixabay.com

Ideally, a business wants to generate enough revenue to quickly settle its accounts payable, but not so quickly that the business loses opportunities, because that money could be used to invest in other endeavors.

Investors can use accounts payable turnover to determine whether a business has enough income or cash to meet its short-term obligations. Creditors can use the ratio to measure whether they can extend a line of credit to the company.

Formulas

The formula to calculate the accounts payable turnover indicator in a given period is:

Accounts payable turnover indicator = Total purchases from suppliers / Average accounts payable.

To calculate the denominator of the above formula, the following formula is used: Average accounts payable = (Accounts payable at the beginning of the period + Accounts payable at the end of the period) / 2.

Accounts payable average is used because accounts payable can vary throughout the year. The ending balance may not be representative of the total year, therefore an average is used.

Turnover of accounts payable in days

The accounts payable turnover in days shows the average number of days it takes to make a payment. To calculate this indicator, you simply divide 365 days by your accounts payable turnover.

Turnover of accounts payable in days = 365 / turnover of accounts payable.

Turnover analysis

A decreasing turnover indicates that a company is taking longer to pay its suppliers than in previous periods. It could indicate that a company is in financial difficulty.

However, it could also represent that the company has negotiated better payment agreements with its suppliers.

When turnover increases, the company is paying suppliers at a faster rate than in previous periods. This means that you have enough cash on hand to pay off short-term debt in a timely manner, managing your debts effectively.

However, it could also indicate that the company is not reinvesting in its business, resulting in a lower growth rate and lower long-term profits.

How it is calculated

First, the average accounts payable for the period is calculated by subtracting the balance of accounts payable at the beginning of the period from the balance of accounts payable at the end of the period. This result obtained is divided by two, in order to arrive at the average of accounts payable in the period.

Second, the total purchases made from the supplier for the period in question are taken, and divided by the average accounts payable for the period calculated above.

Total purchases from vendors are generally not available in any general purpose financial statement. Most companies will have a vendor purchase record, so this calculation may not be necessary.

Notes on the calculation

The formula can be modified to exclude cash payments to vendors, as the numerator should include only vendor credit purchases.

However, the amount of advance payments to vendors is usually so small that this modification is not necessary. It may be necessary to exclude cash payment, if a business has taken so long to pay suppliers that it is now required to pay in advance.

Companies sometimes measure accounts payable turnover using only the cost of merchandise sold in the numerator. This is incorrect, as there may be a large amount of administrative expenses that must also be included in the numerator.

If a business only uses the cost of merchandise sold in the numerator, this can create excessively high turnover.

Examples

Company A

Company A purchases its materials and inventory from a supplier. During the year the following results were obtained:

- Total purchases from suppliers: $ 100 million.

- Accounts payable at the beginning of the year: $ 30 million.

- Accounts payable at the end of the year: $ 50 million.

Taking into account these values, the average of accounts payable of company A for the whole year is calculated:

Annual Average Accounts Payable = ($ 30 million + $ 50 million) / 2) = $ 40 million.

Thus, the annual accounts payable turnover is calculated as follows: $ 100 million / $ 40 million, equivalent to 2.5 times. In other words, company A settled its accounts payable 2.5 times in the year.

To determine the turnover of accounts payable in days for Company A, we have:

Turnover of accounts payable in days = 365 / 2.5 = 146.

Therefore, during the fiscal year, Company A takes approximately 146 days to pay its suppliers.

Company B

Suppose that during the same year Company B, a competitor of Company A, had the following results:

- Total purchases from suppliers: $ 110 million.

- Accounts payable at the beginning of the year: $ 15 million, and by the end of the year: $ 20 million.

Taking these values ​​into account, the average accounts payable of company B is calculated: ($ 15 million + $ 20 million) / 2 = $ 17.5 million.

Thus, the turnover of accounts payable is calculated: $ 110 million / $ 17.5 million, equivalent to 6.3. In other words, Company B settled its accounts payable 6.3 times during the year.

To determine the turnover of accounts payable in days for Company B we have: Turnover of accounts payable in days = 365 / 6.3 = 58.

Therefore, during the fiscal year, Company B takes approximately 58 days to pay its suppliers.

Compared to Company A, Company B is paying its suppliers at a much faster rate, in fewer days.

References

1. Will Kenton & Chris B Murphy (2019). Accounts Payable Turnover Ratio Definition. Taken from: investopedia.com.
2. CFI (2019). What is the Accounts Payable Turnover Ratio? Taken from: corporatefinanceinstitute.com.
3. Steven Bragg (2019). Accounts payable turnover ratio. Accounting Tools. Taken from: accountingtools.com.
4. My Accounting Course (2019). Accounts Payable Turnover Ratio. Taken from: myaccountingcourse.com.
5. James Wilkinson (2013). Accounts Payable Turnover Analysis. The Strategic CFO. Taken from: strategiccfo.com.