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What is '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.

Formula for Accounts Payable Turnover Ratio

BREAKING DOWN 'Accounts Payable Turnover Ratio'

The measure shows investors how many times per period the company pays its accounts payable. Accounts payable, also known as payables, represents short-term debt obligations listed under the balance sheet's current liabilities.  Accounts payable is not exclusive to businesses; it also extends to individuals with short-term debt obligations, such as credit card payments.

Interpretation

A decreasing turnover ratio indicates that a company is taking longer to pay off its suppliers than in previous periods.  When the turnover ratio is increasing, the company is paying off suppliers at a faster rate than in previous periods.  The rate at which a company pays its debts could indicate the financial condition of the firm.  A decreasing ratio could signal that a company is in financial distress; alternatively, it could reflect that the company has negotiated different payment arrangements with its suppliers.

Example

Company A purchased $100 million of supplies from suppliers in the previous year, and, throughout the year, it held an average accounts payable of $20 million. The accounts payable turnover ratio for the previous accounting period was $5 million ($100 million / $20 million). Assume that during the current year, company A had a 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.

The average accounts payable for the year equals the sum of the accounts payable divided by the number of accounts payable periods. The average accounts payable was $40 million (($30 million for the start of the accounting period + $50 million for the end of the accounting period) / 2 accounting periods). The accounts payable turnover ratio was 3, or $120 million / $40 million.

Assume that during the current year, Company B, a competitor of Company A, had a COGS of $110 million, accounts payable of $20 million for the end of the accounting period, and accounts payable of $15 million for the start of the accounting period. Company B had an average accounts payable of $17.50 million (($15 million for the start of the accounting period + $20 million for the end of the accounting period) / 2 accounting periods). 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 suppliers at a faster rate.

In addition to COGS, administrative expenses may need to be included to give a more accurate picture of how quickly a company pays its suppliers.  

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