The accounts payable turnover ratio measures your company's efficiency in paying suppliers for purchases. The basic formula for measuring payable turnover is total purchases or costs of goods sold in a given period, divided by the average balance in accounts payable during that time.
Assume your company acquired $100,000 in goods from suppliers during a given period. Accounts payable at the start of the period was $10,000. Accounts payable at the end of the period was $14,000. Therefore, the average was $10,000 plus $14,000, divided by two, which equals $12,000. Thus, accounts payable turnover is $100,000 divided by $12,000, which equals 8.33. This ratio means the business turns over or pays off its accounts payable balance 8.33 times a year.
Convert to Days
Companies also like to evaluate their accounts payable turnover in terms of the number of days to payoff. The conversion formula is 365 days divided by the number of turns. With 8.33 turns, you divide 365 by 8.33. The result is 43.82 days. Therefore, the company turns over or pays off its average accounts payable balance every 43.82 days.
Turnover versus Terms
Business leaders monitor accounts payable to determine how efficiently the company manages its cash position. In general, companies benefit from longer payable turnover periods. Longer turnover times mean the business holds onto its cash for longer. Companies typically want to have a payable turnover ratio that is near the payment terms issued by creditors. If a creditor allows 60 days for payment without penalty, for instance, an ideal payable turnover ratio is 59 or 60 days. A much lower ratio means the company pays debts sooner than is required, giving up its optimum cash position.
Payable versus Receivable
Comparing accounts payable turnover to accounts receivable is useful as well. Accounts receivable is the time it takes for a business to collect payments from its own customer accounts. Collecting payments on account more efficiently than you pay debts is preferred. This scenario leads to an optimum cash position, and it also allows the business to generate more interest on bank holdings than it pays in debt interest.