Accounts Payable Turnover Ratio - Definition - Formula - Example - Analysis - Importance

Here we discuss about Accounts Payable Turnover Ratio. Previously we discuss about Accounts Receivable Turnover Ratio.

You may also be interested in Accounts Payable Questions And Answers

Accounts Payable Turnover Ratio Definition What is Accounts Payable Turnover Ratio

Account Payable Turnover is the ratio of Net Credit Purchases To Average Accounts Payable. This ratio shows how much efficient a company is to pay its bills to Suppliers within the Current Accounting Period. The more ratio is, the more the ability of company is to pay off its bills within the specified Accounting Period. Whether this ratio is good or not it totally depends upon particular type of industry in which the company is operating its business. If the Ratio is decreasing From One Accounting Period to another, then it is a sign that the company fail to make prompt payment to suppliers due to lack of Cash. So, Investors and Creditors hesitate to invest or give credit to such company.

This ratio is also known as Creditors Turnover Ratio.

Accounts Payable Turnover Formula

Credit Purchases / Average Accounts Payable or Cost of Sales / Average Accounts Payable

Example

If a company has Credit Purchases For the Current Accounting Period Rs. 500000 and Opening Accounts Payable From Previous Accounting Period Rs. 250000 and Closing Accounts Payable Rs. 150000, then by applying the above formula we have:

500000 / 200000 = 2.5

Here Average Accounts Payable is calculated as:

Beginning Accounts Payable + Ending Accounts Payable / 2 = 250000 + 150000 / 2 = 200000

Analysis / Interpretations

So, Accounts Payable Turnover Ratio is good. It means that the company pay its bills 2.5 times in a Accounting Period.

The more ratio is, the more the company’ ability to pay it short-term obligations. However, too much ratio can decrease the Cash of the company in hand and the company fails to meet its working conditions. So, there must be a balance in the ratio to maintain the Working Capital of the business.

Importance / Significance of Accounts Payable Ratio

1. By knowing this ratio, the investors and Creditors judge the ability of company in paying its short term debts. If the ratio is good, then the investors invest in the company to get return of their investments in future. Similarly, the creditors give credits as they have confidence in getting their payments from company.

2. If the ratio is good, then the company can easily maintain its working capital and hence meet daily running expenses of the business.

So, Accounts Payable Turnover Ratio measures the ability of the company in paying off its Short Term Debts To its Suppliers and encourage investors and creditors to invest or give credit to company as the company is efficiently meeting its short-term obligations.