The accounts payable(AP) turnover ratio measures how quickly a business makes payments to creditors and suppliers that extend lines of credit.
Account Payable Turnover Ratio is gotten by calculating the average number of times the company pays its AP balances during a specified time period.
The account payable turnover ratio indicates a company's liquidity and how it is managing cash flow.
Categories of Account Payable Turnover Ratio
A higher AP ratio shows that a company pays its bills in a shorter period of time than those with a lower AP ratio. A high ratio may be due to suppliers demanding fast payments or the company taking advantage of early payment discounts.
Low AP ratios could mean that a company is struggling to pay its bills and its financial conditions are worsening, but it could also mean that the company is using its cash strategically.
Bargaining power plays a significant role in AP rato which means that companies with strong bargaining power are given longer credit terms and will therefore, report a lower accounts payable turnover ratio.
It is important to note that a higher AP ratio indicates creditworthiness and it is sought after by creditors.
How to calculate Account Payable Turnover Ratio
AP turnover ratio is calculated by dividing a business' total purchases by its average accounts payable balance during the same period.
AP Turnover=(BAP + EAP)
2TSP
where:AP = Accounts payable
TSP = Total supply purchases
BAP = Beginning accounts payable
EAP = Ending accounts payable
What Account Payable Turnover Ratio means to Investors
The accounts payable turnover ratio indicates to creditors the short-term liquidity and the creditworthiness of a company. A high AP ratio shows that payments are made promptly to suppliers for purchases made on credit.
A low AP ratio indicates slow payments to suppliers for purchases made on credit. This may be due to favourable credit terms such as strong bargaining power, or it may signal cash flow problems which are worrisome to creditors and investors. A decreasing AP ratio might indicate that a company is in financial distress or it could mean that the company has successfully managed to negotiate better payment terms with its suppliers and this allows said company to make payments less often without sanctions.
A company's turnover ratio should be examined and compared with similar companies in that particular industry.
This tells the investors and creditors what to expect and how to move forward from there.
Importance of AP Turnover Ratio
The accounts payable turnover ratio communicates a variety of useful information to a company. The ratio indicates:
1)How well a company is collecting credit sales. As a company processes receivables balances faster, it gets its hand on capital faster.
2)How it is performing compared to its competitors. When analysing similar companies in an industry, the AP turnover ratio helps to understand if a company is at the top or failing behind.
3)How it is performing over time
4)How satisfactorily a company is evaluating. If the AP turnover ratio is low, it means that the creditworthiness is low.
How to improve AP Turnover Ratio
1)Audit how your company is managing its cash flow and determine what impact reducing days payable outstanding might have.
2)Evaluate the accounts receivable turnover ratio and determine if delays in collections are having an impact on your ability to pay your bills.
3)Determine if you can renegotiate and improve your line of credit terms with suppliers.
4)Measure the cost of goods sold and look for room for improvement.
5)Consider outsourcing. You cannot do it all on your own so outsourcing is a good way to make sure that everything you need to do gets done on time.
Invoice financing is one good way to outsource. You get financing for your invoices and invoice financing companies also follow up on debtors and ensure you get paid. This is another great benefit of outsourcing. Link up with Bridger to get your invoices sorted!