Accounts Payable Turnover Ratio: Definition, How to Calculate

Premier used far more cash (a current asset) to pay for purchases in the 4th quarter than in the 3rd quarter. When Premier increases the AP turnover ratio from 5 to 7, note that purchases increased by $1.5 million, while payables increased by only $100,000. To determine the correct KPI for your business, determine the industry average for the AP turnover ratio. For example, accounts receivable balances are converted into cash when customers pay invoices. To calculate the average accounts payable, use the year’s beginning and ending accounts payable.

Formula and Calculation of the AP Turnover Ratio

Our partners cannot pay us to guarantee favorable reviews of their products or services. Instead, investors who note the AP turnover ratio may wish to do additional research to determine the reason for it. That, in turn, may motivate them to look more xero review 2020 closely at whether Company B has been managing its cash flow as effectively as possible.

Ramp’s AP automation software uses AI to record, track, approve, and pay audit excel financial model course all your vendor invoices, saving you time and money. Whether the term “trade payables” or “accounts payable” is used can depend on regional or industry practices or may reflect slight differences in what is included in the accounts. However, fundamentally, both ratios serve the same purpose in financial analysis. Analyze both current assets and current liabilities, and create plans to increase the working capital balance. A high turnover ratio indicates a stronger financial condition than a low ratio. Generating a higher ratio improves both short-term liquidity and vendor relationships.

How to Calculate AP Turnover?

In some cases, cost of goods sold (COGS) is 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. Calculate the average accounts payable for the period by adding the accounts payable balance at the beginning of the period to the balance at the end of the period. Both benchmarks are important metrics for assessing a company’s financial health.

1. Monitor all vendor discounts and take them if your available cash balance is sufficient.
2. The AR turnover ratio measures how quickly receivables are collected, while AP turnover reports how quickly purchases are paid in cash.
3. The AP turnover ratio provides valuable insights into a company’s payment management efficiency and financial health.
4. For example, a company’s payables turnover ratio of two will be more concerning if virtually all of its competitors have a ratio of at least four.
5. To calculate the average accounts payable, use the year’s beginning and ending accounts payable.

For example, if your goal is to get more favorable payment terms from suppliers, a decreasing AP turnover ratio could be a signal that your approach is working. A low AP turnover ratio means that you’re paying your suppliers back a bit more slowly. For example, it’s often favorable to hold onto cash as long as possible so you can use that working capital in other areas of your business. In summary, both ratios measure a company’s liquidity levels and efficiency in meeting its short-term obligations. They may be referred to differently depending on the region, industry, or even within different sectors of some companies, but they denominate the same financial metric. Effective cash management helps a company balance the goal of paying vendors quickly with the need to maintain a specific cash balance for operations.

Four Things Great Companies Do to Improve Cash Flow

The accounts payable turnover ratio, or AP turnover ratio, is a financial metric that measures the rate at which you pay your suppliers and vendors. It reflects how many times your company can pay off its accounts payable within a given accounting period. A higher ratio indicates faster payments, while a lower ratio may suggest potential cash flow issues or delays in settling debts. The accounts payable turnover ratio measures the rate at which a company pays off these obligations, calculated by dividing total purchases by average accounts payable. The AP turnover ratio, on the other hand, calculates how many times a company pays its average accounts payable balance in a period. In other words, the accounts payable turnover ratio is how many times a company can pay off its average accounts payable balance during the course of a year.

Since a company’s accounts payable balances must be paid in 12 months or less, they are categorized as a current liability in the financial statements like the balance sheet. Meals and window cleaning were not credit purchases posted to accounts payable, and so they are excluded from the total purchases calculation. The inventory paid for at the time of purchase is also excluded, because it was never booked to accounts payable. A high ratio indicates that a company is paying off its suppliers quickly, which can be a sign of efficient payment management and strong cash flow.

Most companies will have a record of supplier purchases, so this calculation may not need to be made. In and of itself, knowing your accounts payable turnover ratio for the past year was 1.46 doesn’t tell you a whole lot. Furthermore, a high ratio can sometimes be interpreted as a poor financial management strategy.