Many buyers purchase goods from suppliers or vendors on credit in a trade transaction.

Credit purchase is extended by creditors to increase their customer base by providing them with a benefit allowing the buyer to use the product, and simultaneously, the money for various operations.

However, credit is extended if the seller sees that the buyer has a good credit history and pays their dues on time. This is determined through a buyer’s accounts payable turnover ratio.

Meaning of Accounts Payable Turnover Ratio

The accounts payable turnover ratio is one of the liquidity ratios that help to calculate how quickly a business pays back its suppliers or creditors and completes its outstanding payments.

Accounts payable is a short-term debt the company must pay its creditors for credit purchases.

The ratio helps indicate a business's efficiency in fulfilling its short-term obligations to the supplier.

Calculation of Accounts Payable Performance/KPI

Depending on the type of metric used to calculate accounts payable, several ways can help indicate its performance.

1. Cost Incurred for Processing a Single Invoice The average cost of processing a single invoice helps to understand the company’s complete efficiency. It can be calculated by:

Total Accounts Payable Costs/Total No.of Invoices This insight can help businesses determine personnel salaries, managerial costs, etc. Based on this, unnecessary costs can be cut down.

2. Time Taken for Processing a Single Invoice The time taken to process every invoice helps to measure a company’s productivity, early discount availability and vendor relationships.

The time taken is calculated by:

Total No. of invoices Paid (for a Fixed Period)/All Costs Incurred to Pay the Invoices(for that Same Period)

This leads to lower average costs and time taken, surrounding which companies can make decisions accordingly.

3. Days Payable Outstanding The number of days taken to pay back the supplier can be calculated by:

Accounts Payable x No.of Days/ COGS This helps to provide an answer for the number of days the company has taken to pay back its supplier.

A high DPO signifies that the company has extra cash for its working capital but isn't paying its suppliers on time.

That can result in a negative relationship and make the company's situation of buying on credit worse.

4. Rate of Errors The number of payment errors a company makes is crucial for them to track. It is calculated by:

No. of Incorrect Payments/No. of Invoices Paid = Rate of Error

It allows one to understand the rate of overpayments or duplicate and incorrect payments made, which can cause instability in their finances over the long term.

Calculation of Accounts Payable Turnover Ratio

Here’s the formula to understand how quickly a company pays back its supplier:

Payable Turnover Ratio = Net Credit Purchases/Average Accounts Payable Average Accounts Payable = (Accounts payable at the beginning + end)/2

Example Hind Pvt. Ltd. reported their net annual credit purchases of ₹12,00,000. Their accounts payable at the start of the year were at ₹2,00,000, and at the end of the year at ₹4,00,000. Now, Hind Pvt. Ltd. wants to calculate how many times they repay their creditors in a financial year.

The calculation for Hind Pvt. Ltd. is: Average Accounts Payable - (₹2,00,000 + ₹6,00,000)/2 = ₹4,00,000 Accounts Payable Turnover Ratio = Total Net Credit Purchases/Average Accounts Payable = ₹12,00,000/₹4,00,000 = 3

Therefore Hind Pvt. Ltd. paid its creditors three times in one financial year. This is a low account payable turnover ratio.

Ways to Increase Accounts Payable Turnover Ratio

The higher the accounts payable turnover ratio, the faster a company pays back its suppliers.

This helps to showcase the company as a good customer in the eyes of the supplier or creditors, and the company can enjoy the benefits that come with having a credit purchase.

Therefore, to have a higher account payable turnover ratio, a business should:

  • Pay their creditors on time or on the due date.
  • Pay invoices earlier than the due date. Buyers can bank on early payment discounts and show creditors that they are creditworthy clients.
  • Generate cash flow through accounts receivable collection to pay off their outstanding payments to the suppliers.

Cause of Accounts Payable to Decrease

When accounts payable decrease, it means that the company is paying off its supplier quicker than they are purchasing more products.

Incorrectly logged data can also cause accounts payable to be understated or decreased because accurate information is missing.

FAQs

Is a Higher Turnover Better or Worse? A company with a higher accounts payable turnover ratio signifies that it has enough cash flow to pay off its suppliers or creditors quickly. A low ratio implies that the company doesn’t have enough cash or is behind on supplier payments.

Why Would a Company Have High Accounts Payable? The reason why companies can have high accounts payable is that they have purchased inventory on credit. If a business has an already existing credit account with the supplier, they can simply place an order with them. Buying new inventory on credit increases the accounts payable section of a company’s balance sheet.

What Is a Good Average Payable Period Ratio? Mostly, 90 days is considered an ideal or reasonable average payment period by many industries or companies.

If a business takes more than 90 days, then it is perceived as them dragging the payment longer.

What Is an Ideal Accounts Payable Turnover Ratio? Generally, a healthy or ideal payable turnover ratio should be around 8-10. Anything below the value of 6 is considered low and showcases the company as increasing or stretching the payable period to fund its cash flow.