Title: Accounts Payable Turnover Ratio — what it measures, how to calculate it, and how to use it
Definition
– The accounts payable (AP) turnover ratio measures how many times a company pays off its supplier obligations during a period (typically a year). It is a short‑term liquidity indicator that shows the speed at which the business satisfies trade payables.
Why it matters
– Creditors and investors use the ratio to judge whether a firm is able to meet short‑term supplier obligations and how it manages working capital. Comparisons over time and against peers reveal changes in payment behavior and potential cash‑flow issues.
Formula and calculation
– Average accounts payable = (Beginning AP + Ending AP) / 2
– AP turnover = Total supplier purchases during the period ÷ Average accounts payable
Notes:
– “Total supplier purchases” means purchases on credit from suppliers for the period. If a company does not disclose purchases, analysts sometimes use Cost of Goods Sold (COGS) as a rough proxy, but this introduces approximation error.
– To convert to days payable outstanding (DPO): DPO = 365 ÷ AP turnover (assumes a 365‑day year).
Step‑by‑step checklist (quick)
1. Get beginning and ending accounts payable balances from the balance sheet.
2. Compute average AP = (BAP + EAP) / 2.
3. Obtain total supplier purchases for the period (or use COGS only with caution).
4. Compute AP turnover = Purchases ÷ Average AP.
5. Optionally compute DPO = 365 ÷ AP turnover.
6. Compare the result to (a) the company’s prior periods, (b) industry peers, and (c) any payment‑term changes disclosed in notes.
7. Interpret together with other working‑capital metrics (inventory turnover, receivables turnover, cash conversion cycle).
Worked numeric example
– Inputs: Beginning AP = $50,000; Ending AP = $70,000; Total supplier purchases = $480,000.
– Average AP = (50,000 + 70,000) / 2 = $60,000.
– AP turnover = 480,000 ÷ 60,000 = 8.0 times per year.
– DPO = 365 ÷ 8.0 ≈ 45.6 days.
Interpretation: The company pays suppliers an average of about every 46 days. A turnover of 8 is within a common rule‑of‑thumb range (see below) but should be judged against peers and past trends.
What changes in the ratio can indicate
– Decreasing AP turnover (fewer turns): the company is taking longer to pay suppliers. Possible causes: cash strain, deliberate stretching of payables, or renegotiated longer payment terms.
– Increasing AP turnover (more turns): the company is paying suppliers faster. Possible causes: strong cash position, tighter payment policies, or a strategic decision to secure early‑payment discounts. Persistently high turnover may also signal underinvestment if the firm pays too quickly and hoards cash rather than deploy it into growth.
AP turnover vs. AR (accounts receivable) turnover
– AP turnover measures how quickly a firm pays its suppliers (outflows).
– AR turnover measures how quickly a firm collects from customers (inflows).
– Use both to gauge working capital management and to compute the cash conversion cycle.
What is a “good” AP turnover ratio?
– There is no universal target. A commonly cited guideline places a typical range around 6–10 turns per year, but acceptable values vary strongly by industry, supplier terms, and seasonality.
– Higher is not automatically better. Very high turnover may mean the company is not taking available credit terms and may be tying up cash unnecessarily. Very low turnover may indicate cash problems or advantageous long payment terms.
How to improve AP turnover (practical steps)
1. Negotiate better payment terms (either shorter if you want higher turnover, or longer if you need cash).
2. Improve cash‑flow forecasting to pay on schedule without overpaying early.
3. Consolidate or centralize payables processing to avoid late payments.
4. Take early‑payment discounts where the economics are favorable.
5. Manage inventory levels and purchasing timing to smooth payables.
6. Reconcile supplier statements regularly to avoid overpayments and disputes.
Limitations and caveats
– Purchases data may not be disclosed separately; using COGS as a proxy can distort the ratio (COGS excludes purchase returns, changes in inventory, and non‑trade purchases).
– Industry norms and payment practices differ; cross‑industry comparisons can mislead.
– Seasonality and one‑off events (large purchases, acquisitions) can skew a single‑period ratio.
– Accounting policy differences (timing of recognition, cutoffs) affect comparability.
– The ratio tells you “what” (payment speed) but not automatically the “why” (good liquidity vs. supplier pressure).
Quick interpretation checklist before drawing conclusions
– Did purchases get used or approximated by COGS?
– Are payment terms disclosed and have they changed?
– How does the ratio compare to recent years and to peers in the same industry?
– Are there seasonal or one‑time items affecting AP or purchases?
– Complement the ratio with cash flow statements and other working‑capital ratios.
Sources for further reading
– Investopedia — Accounts Payable Turnover Ratio: https://www.investopedia.com/terms/a/accountspayableturnoverratio.asp
– Corporate Finance Institute — Accounts Payable Turnover Ratio: https://corporatefinanceinstitute.com/resources/knowledge/finance/accounts-payable-turnover/
– U.S. Securities and Exchange Commission — How to Read a Financial Report / Financial Statements guide: https://www.investor.gov/introduction-investing/investing-basics/how-read-financials
– Financial Accounting Standards Board (FASB): https://www.fasb.org/
Educational disclaimer
This explainer is for educational purposes only. It is not individualized investment advice or a recommendation to buy or sell securities. Before making investment or credit decisions consult qualified financial, tax, or accounting professionals and review company disclosures.