The accounts payable turnover rate is an indicator that should be measured periodically and recorded in your business plan to check, with investors or financial entities, how your liquidity is operating.
In this article, we will explain everything you need to know about this metric and how you can calculate it in your company. Let’s start with the basics. Accounts payable are invoices in the form of debt, which companies must make in a specified period of time to a specific supplier.
These documents can be found on the balance sheet in the liabilities section, although they are usually short-term liabilities since they are debts that must be paid quickly. Paying accounts payable on time is very important to avoid late fees.
What is the Accounts Payable Turnover Rate?
The accounts payable turnover ratio (known in English as accounts payable turnover ratio) is a KPI that indicates the number of times, during a certain time, that your company has paid the debts contracted with suppliers.
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AP Automation purchase management software that has an accounts payable section, which allows you and your team involved in the purchasing process, to know in real time and remotely, which are the invoices that are pending to be paid, until when there is time and what are the provider’s details that correspond to making the payment.
What is this Metric for?
For investors, this metric is used to determine if a company has enough income or cash to meet its short-term payment obligations, which is key to deciding whether to invest in it or not. Companies can use this metric to know if they should extend a line of credit contracted with suppliers or, failing that, request it.
How is the Accounts Payable Turnover Calculated?
The formula to calculate this indicator is: Turnover of accounts payable = Total purchases from suppliers / average of accounts payable. The average accounts payable is used because these can vary throughout the year. The ending balance may not be representative of the total year, therefore an average is used.
To better understand this calculation, let’s imagine that a company buys $ 1 million in parts to make automobiles for an entire year. Of that purchase, half, that is to say 500 thousand dollars, was on credit and the rest in cash.
This means that the company has half a million in its accounts payable balance. Using the formula together with the information above, we can calculate the accounts payable turnover.
Accounts payable turnover = $ 500,000 / $ 50,000 = 10. The result indicates that the company rotates its accounts receivable 10.
How is the Turnover of Accounts Payable in Days Calculated?
The accounts payable turnover in days shows the average number of days it takes a business to make a payment. To calculate this indicator, you simply divide the number of days in a year by the rotation. Using the previous example, if we divide 365/10 it is approximately 36 days
Why is Accounts Payable Turnover Important?
Accounts payable turnover is an indicator that tells you how well your business pays its outstanding invoices. If this index is too low, it can be interpreted as that the company is having problems paying its bills or that it has very attractive credit terms.
On the other hand, when turnover increases, it means that the company is paying suppliers at a faster rate than in previous periods. This means that you have enough cash on hand to pay off short-term debt in a timely manner, managing your debts effectively.
As it can also mean that the company may be paying its bills very quickly and not be taking full advantage of the credit terms offered by its suppliers, decreasing its cash flow available for reinvestment, resulting in a lower growth rate and lower profits in the long run.
When you want to benchmark this indicator, it is essential to do it with companies that are part of the same industry, since different industries have different operating models and standards on business volume and payment terms. What may appear low in one industry may appear high in another.