What is the 'Accounts Payable Turnover Ratio'
The accounts payable turnover ratio is a short-term liquidity measure used to quantify the rate at which a company pays off its suppliers. Accounts payable turnover ratio is calculated by taking the total purchases made from suppliers, or cost of sales, and dividing it by the average accounts payable amount during the same period.
BREAKING DOWN 'Accounts Payable Turnover Ratio'The measure shows investors how many times per period the company pays its average payable amount. Accounts payable, also known as payables, represents short-term debt obligations that a company must pay off. The accounts payable is listed under a company's current liabilities on its balance sheet. Accounts payable are also part of households because people may be subject to pay off their short-term debt provided by creditors, such as credit card companies.
If the turnover ratio is falling from one period to another, this is a sign that the company is taking longer to pay off its suppliers than it was in previous time periods. The opposite is true when the turnover ratio is increasing, which means that the company is paying off suppliers at a faster rate.
For example, if company A made $100 million in purchases from suppliers during the previous year, and at any given point it held an average accounts payable of $20 million, the accounts payable turnover ratio for the previous accounting period was 5, or $100 million / $20 million. Assume that during the current year, company A had cost of goods sold (COGS) of $120 million, accounts payable of $30 million for the start of the accounting period, and accounts payable of $50 million for the end of the period.
To calculate the average accounts payable for the fiscal year, sum the two accounts payable amounts, and divide by two. Therefore, the average accounts payable was $40 million, or ($30 million + $50 million) / 2, for the current year. Consequently, the accounts payable turnover ratio was 3, or $120 million / $40 million.
Assume that during the current year, company B, which is in the same industry as company A, had COGS of $110 million, accounts payable of $20 million for the end of the accounting period, and payables of $15 million for the start of the accounting period. This means that company B had an average accounts payable of $17.50 million, or ($15 million + $20 million) / 2. Company B had an accounts payable turnover ratio of 6.29, or $110 million / $17.50 million. Therefore, when compared to company A, company B is paying off its short-term debt at a faster rate.