What is the Accounts Payable Turnover Ratio?
The accounts payable turnover ratio is a ratio that measures the speed at which a company pays its suppliers. The ratio is calculated by taking the company’s total purchases from suppliers and dividing it by its average accounts payable outstanding amount over the same period.
Using an example, let’s say Company X makes $200M in supplier purchases in any given year, and, on average, holds an accounts payable outstanding balance of $20M during the year. Company X’s AP Turnover Ratio would be 10. Assuming all bills are paid, this means that Company X, on average, pays its bills 10 times over the course of the period.
Understanding the Accounts Payable Turnover Ratio
The following points can be taken from the ratio:
- The ratio is a measure of short-term liquidity used to quantify the rate at which a company pays off its suppliers
- The ratio shows how many times a company completely pays off its Accounts Payable during a period
Investors often use the ratio to determine if a company has enough cash to revenue to meet its short-term obligations. Creditors often look at the ratio to determine risk and an appropriate line of credit to extend to the company.
Understanding Trends in the AP Turnover Ratio
Decreasing Trendline – A decreasing turnover ratio indicates that a company is taking longer to pay off its suppliers than in previous periods. While not always the case, a negative trendline could indicate that a company is struggling to pay its bills, and therefore struggling financially. It is important to look at other factors that may have decreased the AP Turnover Ratio such as whether a company has renegotiated the terms of payment with suppliers.
Increasing Trendline – When the ratio is increasing, it means that the company is paying off its debts at a quicker rate than in previous periods. An increasing ratio typically means that a company has more cash on hand to pay off its short-term debts. However, having too high of a ratio or increase can sometimes mean that companies are not investing back into their business.
Determining What the Best Turnover Ratio is
It is important for companies to determine what payment schedule best fits their needs. A high turnover ratio may look flashy to investors, but businesses may find more benefit in strategically using their liquid capital elsewhere.
It may be worthwhile for businesses to invest time in negotiating payment terms with suppliers, or comparing their turnover to similar businesses in the industry.
Strategically Growing and Maintaining a High Turnover Ratio
Vendors often offer significant discounts for businesses that pay their bills early. Oftentimes these discounts outpace the potential or projected growth of a company, therefore it proves useful in most instances for companies to maintain a high turnover ratio.
Adopting an AP automation platform like EZ Cloud can assist your organization in capitalizing on early pay discounts.