Accounts Payable Turnover Ratio
Accounts payable turnover ratio is the liquidity ratio which is used to measure the ability of the company to pay off its account payable by comparing the net credit purchase to average account payable balance during the period.
It measures the ability of the company to pay off its suppliers and vendor due to which analyzers analyze the liquidity of any business.
Those companies which can easily payoff supplies throughout the year are good for investors and creditors. Because such types of companies easily make the principal amount and regular interest.
Accounts payable turnover ratio formula can be calculated by dividing the total purchases by average accounts payable for the year.
Account Payable Turnover Ratio = Total purchases/Average Accounts Payable
On the financial statement, total purchases number not available, so we can calculate this by adding the ending inventory to cost of goods sold and subtract the beginning inventory from it.
Most of the companies have no need for this calculation because these companies have the record of the supplier purchases.
As account payable vary throughout the year because of which in the above formula average accounts payable used.
It can be calculated by the sum of beginning and ending account payable and divide the result by two.
The high ratio of accounts payable turnover is better the low ratio. Because a high ratio indicates that the efficiency of the business is good to pay off its vendors.
Creditors and suppliers from the high ratio analyze that the company frequently pay off its bills.
From such type of companies, the new vendor can get paid back quickly.
For the comparison of the different companies in the same industries, this ratio is used. Because every industry has a different standard.
Lee is the building supplier which buy equipment of construction and material from a wholesaler.
Lee resells this inventory in its retail store to the general public.
From his vendors, Lee purchases 1,000,000 dollars of construction material.
At the balance sheet, Lee has 55,000 dollars beginning account payable and 958,000 dollars ending account payable.
The payable ratio of Lee will be calculated as
1.97 = 1,000,000/506,000
506,000 is the average account payable for Lee which is calculated by the sum of beginning and ending payable amount and divide by 2.
From the above result, it is clear that Lee pays his vendor back on every six month period.
The payable turnover ratio of Lee is not good enough but it can be compared with other companies in the industry.
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