Managers use financial ratios to evaluate the performance of a company. At their essence, financial ratios compare two numbers in a company's budget or financial results. It's a quick and easy method to tell whether certain departments or budget items are rising faster than others. Financial analysts, investors, regulators and lenders also use financial ratios to identify trouble spots in firms. Evaluating the ratio of accounts payable to sales growth is a way to evaluate a firm's relationship to its suppliers.
Accounts payable is money a company owes. There is always a cost to doing business, so a reasonable analyst should note that when sales increase, accounts payable should increase with it. This could reflect, for example, increased materials bought, but not paid for, to manufacture goods. The problem is when accounts payable rises much faster than sales. This could be an indication that a company is delaying payment of bills.
To calculate the ratio, you will need a calculator and several years or quarters of a company's financial results. Divide the firm's accounts payable by its sales. Repeat this calculation for several years or quarters. Evaluate whether the ratio is growing. The ratio is usually expressed as a percentage.
Because accounts payable is an amount of money a company owes its suppliers, and because those suppliers often don't charge interest on money owed, the calculation can tell lenders how reliant a firm is on its suppliers as a source of credit. A low ratio can indicate that a firm's suppliers are not offering the company good terms. A high ratio can indicate that a firm is delaying payment to suppliers. Highs and lows do differ for many industries. In the plastics industry, the median ratio is 8 percent, and the upper 25 percent have a ratio above 10 percent. In pharmaceuticals, the median ratio is 12 percent, but 25 percent of companies have ratios higher than 47 percent.
Growth to Accounts Payable
Once you have calculated the ratio for several years, refer back to the firm's financial statements. If sales are growing and the sales to accounts payable ratio is growing, it means a firm is funding some of its growth with cheap credit from suppliers. But remember, those bills are going to come due. If sales falter when the economy slips, the firm's profitability may slip as it struggles to pay back suppliers in a tough environment.