Accounts Payable Turnover Ratio: Formula, Calculation, Example, How To Improve AP Turnover Ratio

Accounts payable (AP) turnover ratio is a liquidity ratio used to measure how quickly a company pays its bills to creditors in a certain period. It is also known as creditor’s turnover or payables turnover. Accounts payable are short-term debts for the firm for purchase of goods on credit basis, listed on the balance sheet under current liabilities.

Continue reading to find out its meaning, formula, and interpretation with examples. 

What is the Accounts Payable Turnover Ratio?

The accounts payable turnover ratio is a short-term liquidity measure which quantifies the rate at which a firm pays off its payables. Payables are the amount a firm owes to its creditors and suppliers for the purchases made. And the accounts payable turnover ratio shows how often a company pays off its creditors in a certain period.

What is the Formula for the Accounts Payable Turnover Ratio?

The accounts payable turnover ratio is calculated by dividing the company’s total purchases in a period by the average payables for that period. Following is the accounts payable turnover ratio: 

AP Turnover Ratio = Net credit purchases / Average accounts payable 

Here: 

• AP is accounts payable.
• Net credit purchases include the cost of goods sold (COGS) and any additional purchases a firm made during the period under consideration. 
• Average accounts payable is the average of beginning and ending accounts payable. Following is the accounts payable formula: 

Average accounts payable = (Beginning accounts payable + Ending accounts payable)/2

Accounts Payable Turnover Ratio in Days

While the accounts payable turnover ratio measures how often a company pays off its creditors, the accounts payable days formula measures how many days it takes to make the payment. The latter is calculated by dividing 365 by the accounts payable turnover ratio. 

Accounts payable days = 365/Accounts payable turnover ratio

A higher accounts payable turnover ratio means a lower accounts payable days. 

Accounts Payable (AP) Turnover Ratio Example

Here’s an interpretation of the accounts payable turnover ratio using an example:

Company XYZ reports its annual purchases on credit as Rs 200 million and pays off Rs 10 million during the March 31, 2023 quarter. Accounts payable at the beginning and end of the year were Rs 50 million and 90 million respectively. 

To calculate the accounts payable turnover ratio, we need to first calculate the net credit purchases and average accounts payable:

• Net credit purchases = Rs 200 million - Rs 10 million = Rs 190 million
• Average accounts payable = Rs 50 million + Rs 90 million2 = Rs 70 million

Therefore, as per the accounts payable turnover formula: 

Accounts payable turnover ratio = 190 million / 70 million = 2.71

Therefore, ABC’s accounts payable turned over approximately 2.7 times during the fiscal year. 

Interpretation of Accounts Payable Turnover Ratio

The accounts payable turnover ratio measures the speed at which the firm pays off its creditors and suppliers during an accounting period. One way to effectively measure AP turnover ratio is by comparing one firm’s ratio by another in the same industry.

Stakeholders and investors use this ratio to determine whether the company has enough revenue to meet its short-term debt obligations, showing them the firm’s financial conditions and helping them decide whether or not to extend a credit line. 

The accounts payable turnover ratio can increase or decrease compared to previous years. Investors typically compare an accounting period’s AP turnover ratio with other accounting periods to make a decision. 

Ideally, a company should generate enough revenue to meet its short-term debt obligations. But not so quickly that it misses growth opportunities.

Let’s see what an increasing or decreasing turnover ratio can suggest to investors. 

Increasing Accounts Payable Turnover Ratio

An increasing AP turnover ratio suggests the company is paying off its suppliers faster than it did in the previous accounting period. It means the firm has more cash than earlier — meaning its ability to pay off its creditors has increased. This could indicate that the company is effectively managing its cash flow.

However, if the ratio increases continuously, it could mean the firm is not reinvesting revenues. This could signal a lower growth rate in the long term. 

Decreasing Accounts Payable Turnover Ratio

A decreasing AP turnover ratio signals the company is taking longer than usual to pay off its debt obligations. It means the company has less cash than earlier assessment and might be distressed financially. 

However, a decreasing accounts payable turnover ratio is not always bad. It could also mean the company has negotiated different terms with its suppliers — such as low-interest rates or longer payment periods. This, in turn, could benefit a company's working capital management, reducing its financial costs.

Accounts Payable Turnover Ratio Industry Average

Every industry usually has a different accounts payable turnover ratio that can be kept as benchmark as each and every industry operates differently. However, an ideal AP turnover ratio ranges between 6-10. A ratio below this range indicates that a business is not generating enough revenue to pay its suppliers in a given time frame.

Importance and Limitations of Accounts Payables Turnover Ratio

AP turnover ratio indicates the efficiency of a company in managing its short-term debt obligations. It indicates the financial health and creditworthiness of the company. 

Here’s why this ratio is important: 

• AP turnover ratio can also help the company improve its cash flow management and operational efficiency by showing them how the competitors are performing. 
• It can help companies flag potential inefficiencies that could lead to underperforming or overspending. 
• It can also help companies negotiate better payment terms with suppliers. 

However, the AP turnover ratio could have some limitations as well, such as:

• It may not be accurate, or it may not be comparable across industries or even companies. This is because different industries have different payment cycles and terms, which impact their capital needs and growth rates differently. Plus, different companies within the same company could have different accounting policies, affecting their net credit purchases. 
• It seldom reflects the true cash flow situation of a company. It is because a company may have a high ratio due to suppliers demanding quick payments. Plus, this could also mean the company is leaving excess cash unused and that it could put that cash towards growth initiatives. 
• Again, the ratio may not show the reliability or quality of the suppliers. A company could have a low AP turnover ratio because it has favourable terms with its suppliers. 

Tips to Improve your Accounts Payable Turnover Ratio

Companies could have a chance to improve their AP turnover ratio by 

• Negotiating better terms with suppliers: You could try to get them to decrease interest rates or extend payment periods. 
• Automating the AP process: The technology could help you track and organize financial transactions to reduce errors, save time and money, and pay your invoices faster and accurately. 
• Using early payment discounts: Suppliers sometimes offer discounts on making early payments. This could help you save some money and also help improve relationships with the supplier. 
• Evaluating the AP ratio: You could try to determine the reason for delays and their impact on the ratio. You can also increase the speed at which you collect payment from your customers so that you can pay off yours quickly. One way to do this is by calculating your accounts receivable turnover ratio and seeing how improving it might help you pay your bills faster. 

Accounts Receivable Turnover Ratio vs Accounts Payable Turnover Ratio

The accounts receivable (AR) turnover ratio measures the number of times a company gets paid by its customers. It quantifies the company’s ability to collect payments from clients and customers. If the AR turnover ratio is high, the company efficiently collects payments and vice versa. 

As we’ve already discussed, the AP ratio tells us how many times the company pays off its creditors and suppliers. Having a higher AP ratio than competitors is beneficial because it means the company is doing better financially than competitors; however, a continuously increasing ratio can also spell trouble.