Company buys products and services from outside parties either on cash and credit. Mostly, the companies purchase these products and services on credit terms with its suppliers. In order to manage working capital cycle, this is of great importance to manage accounts payable payment terms effectively. Here comes the role of Accounts Payable Turnover Ratio which is an important efficiency ratio.
Accounts Payable Turnover Ratio Formula
Accounts Payable Turnover ratio shows how many times company paid to its supplier in an accounting period. It is also called Creditor Turnover Ratio and simply written as A/Payable Turnover ratio. It is calculated by dividing net credit purchases divided by the average accounts payable figure.
Accounts Payable Turnover Ratio = Net Credit Purchases / Average Accounts Payables
Where:
Net Credit Purchases = Gross Purchases – Purchase Returns
Average Accounts Payables = (Accounts Payable Opening Balance + Accounts Payables Closing Balance) / 2
Higher Accounts Payable Turnover Ratio means that company is repaying its customers very quickly which are not a good indication because it is against good working cycle management principle. On the other hand, a lower Accounts Payable Turnover Ratio means that company is taking too much time to repay its creditors.
Before going to decide anything on the basis of Accounts Payable Turnover Ratio, make sure you compare your ratio with the competitors in the industry.
Example:
Company A purchases various raw materials from its suppliers. The total credit purchases for the year are $700,000. The opening balance of A/Payable is $60,000 while closing balance is $75,000. Calculate Accounts Payable Turnover ratio. The purchase return figure for the same year is $100,000.
Solution
Net Credit Purchase = Gross Purchases – Purchase Return
Net Credit Purchase = 700,000 – 100,000 = $600,000
Average Accounts Payable = (Opening Accounts Payable + Closing Accounts Payable) / 2
Average Accounts Payable = (60,000 + 75,000) / 2
Average Accounts Payable = $67,500
Now, we will calculate Accounts Payable Turnover Ratio:
Accounts Payable Turnover Ratio = Net Credit Purchases / Average Accounts Payables
Accounts Payable Turnover Ratio = 600,000 / 67,500 = 8.89 times
Point to Focus: Students can use Cost of Goods Sold figure instead of credit purchase figure (if missing) to calculate Accounts Payable Turnover ratio in the examination. Normally, exam papers carry simple question for the calculation of various types of ratios that carry marks around 20 marks.
Example Question Examination Based
Following is the data available for two big companies involved in the home textile products manufacturing.
| J Plc | M Plc | |
| Accounts Payable Opening balance | 45,666 | 53,576 |
| Accounts Payable Closing balance | 51,763 | 48,984 |
| Sales revenue | 150,000 | 163,000 |
| Gross profit on sale | 25 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} | 22 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} |
Required:
You are required to calculate Creditor’s turnover ratio
Average Accounts Payable
| J Plc | M Plc | |
| Accounts Payable Opening balance | 45,666 | 53,576 |
| Accounts Payable Closing balance | 51,763 | 48,984 |
| Total | 97,429 | 102,560 |
| Average Accounts Payables | 48,715 | 51,280 |
Cost of Goods Sold (COGS)
| J Plc | M Plc | |
| Sales revenue | 150,000 | 163,000 |
| Gross profit on sale | 25 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} | 22 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} |
| COGS | 150,000X75/100 = 112,500 | 163,000X78/100 = 127,140 |
As credit purchases are not given in the question, we will use COGS instead to compute Creditor’s turnover ratio as follows:
| A/Payable Turnover Ratio = COGS / Average Accounts Payable | ||
| J Plc | M Plc | |
| J Plc | 112,500/48,715 = 2.31 | |
| M Plc | 127,140/51,280 = 2.48 |
As you can see from the above computation that the ratio of both companies are identical, so we can assume that both are utilizing good control over supplier’s payment.