The accounts payable turnover ratio treats net credit purchases as equal to cost of goods sold (COGS) plus ending inventory, less beginning inventory. This figure, otherwise called total purchases, serves as the numerator in the accounts payable turnover ratio.
Most general purpose financial statements do not include total net purchases as a figure, but its components can be found separately in the statements.
Net Credit Purchases
The specific calculation for net credit purchases – sometimes referred to as total net payables – might vary from company to company. Much also depends on the nature of the business; a business with many types of credit accounts and many types of operations has a more complex calculation for net credit purchases.
A baseline equation can be written as: Purchases = COGS + Ending Inventory - Starting Inventory
Payment requirements also vary among suppliers. It is not always the case that lower net credit purchases – which relates to a lower accounts payable turnover ratio – is a sign of poor debtor practices by the firm.
Purpose of the Accounts Payable Turnover Ratio
Analysts use the accounts payable turnover ratio and its cousin, the accounts receivable turnover ratio, to measure the liquidity and operational efficiency of a company. In a vacuum, a higher ratio is a sign of speedy payment for creditor services.
This formula is very similar to the better-known accounts payable days formula. Lenders and suppliers are most interested in quality accounts payable practices, since they have to assume counterparty risk when fronting cash or materials to the firm.