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What is the Accounts Payable Turnover Ratio?
Accounts payable turnover ratio, otherwise known as the turnover ratio or creditors turnover ratio is a measure of how many times a business is able to repay its creditors in a period of time. It quantifies short term liquidity and cash flow of the business.
For example, if a business has an AP turnover ratio of 9, it means it is able to pay its suppliers back 9 times in the year.
A higher turnover ratio indicates that the business is able to repay its creditors more number of times within a period due to healthy cash flow and optimised financial planning. It may also indicate that the business’s creditors demand payments with a quick turnaround or that the business is making use of early payment discounts.
Calculating Accounts Payable Turnover Ratio
The formula to calculate the turnover ratio is:
Payable turnover ratio = Net credit purchases / Average accounts payable
- Net credit purchases includes all goods and services purchased by a company on credit within a period of time.
- Net credit purchases = Total purchases – cash purchases – purchases returns
- Average accounts payable is the average amount of money owed by a business to its creditors within a period of time.
- Average accounts payable = (Opening AP balance + Closing AP balance)/2
COGS or Cost of Goods Sold can be used in place of Net Credit Purchases in the formula to calculate AP Turnover Ratio.
Days Payable Outstanding (DPO) & AP Turnover Ratio in Days
DPO, or Days Payable Outstanding is a measure of the average number of days it takes to repay creditors. A high DPO means a business takes a longer time to repay creditors. Ideally, DPO should be lower, signifying quicker payments and more healthy cash flow.
The difference between DPO and the AP turnover ratio is that DPO measures the average number of days it takes to pay a supplier, but the AP turnover ratio measures how many times a business pays suppliers in a period.
Days Payable Outstanding and AP turnover ratio have an inverse relationship. If a business takes more time to pay suppliers, the DPO ends up being high – this means that the business is making fewer payments to its suppliers, meaning the AP turnover ratio is low.
DPO can be calculated from the AP turnover ratio using the following formula:
DPO for one year = 365 / Accounts Payable Turnover Ratio
DPO for one quarter = 90 / Accounts Payable Turnover Ratio
DPO for one month = 30 / Accounts Payable Turnover Ratio
Understanding Accounts Payable Turnover Ratio
AP turnover ratio is a good way for creditors to measure the creditworthiness of a business by indicating short term liquidity and turn around time of invoices.
A low ratio indicates slow payments. This could be due to cash flow issues, delays due to slow processing, poor financial conditions, etc. Whichever the reason – a low AP turnover ratio may cause suppliers to shy away from offering goods and services on credit.
This is why its very important to efficiently manage invoices, vendors and your AP processes. Manual processes are the main culprit. Complex workflows like Accounts Payable are prone to errors and delays due to mishandling of paper invoices, missed deadlines, wrong payments, and more.
Automated AP processes are significantly more efficient, time-saving and accurate. Automate your AP processes with RazorpayX and never miss a payment deadline again.
What is a Good AP Turnover Ratio?
The “ideal” AP turnover ratio differs across industries.
- Retail or consumer businesses require frequent inventory purchases and so may have a higher turnover ratio since they work on quick turnover and short repayment terms.
- Manufacturing or construction businesses make large purchases with longer repayment terms and so may have lower AP turnover ratios.
- Most businesses should aim to have an AP turnover ratio between 8 and 12. Comparing your AP turnover ratio to businesses in the same industry and regularly checking in with experts and analysts will help you understand the ideal place to be.
- A turnover ratio that is too high indicates rigid repayment terms and quick repayment of invoices. This may not always be a good thing – it means the business may not have cash available for other needs.
- A very low turnover ratio is also not healthy – it means the business tends to extend deadlines frequently, and may strain supplier relationships. It may also indicate cash flow and financial management issues.
How to Improve AP Turnover Ratio
Here are some tips on how to improve your AP turnover ratio.
Optimize cash flow
Cash management involves managing cash inflows and outflows and allocating available cash to different business processes.
Good cash management means the business has the right amount of liquid cash at hand – not too little, which may endanger the business’s ability to repay creditors; and not too much, which may indicate underutilisation of funds.
When cash flows are optimised, businesses should have no problem meeting creditor obligations, which in turn results in a healthy turnover ratio.
Maintain healthy supplier relationships
When your supplier is assured of your ability to repay, you may be given more flexible repayment terms. This can help you use your liquid cash for other important processes and maintain operational flexibility.
Additionally, when suppliers trust your business, they are more likely to offer favourable terms, such as discounts for early payments or extended payment periods, which can further enhance your cash flow management.
Automate your AP processes
This is the best way to improve your AP turnover ratio – automated processes result in almost 100% accurate payments, 0 missed deadlines and a much more streamlined process.
Tools like RazorpayX offer one single place for AP and finance managers manage invoices, vendors and the entire procurement process in one single place.
FAQs
How do you calculate accounts payable turnover ratio?
Accounts payable turnover ratio is calculated by dividing business's total credit purchases by its average accounts payable balance in that time period.
Is a high or low accounts payable turnover ratio better?
Ideal AP turnover ratios differ across industries and businesses. Its important to benchmark your ratio against your peers and competitors in the industry to understand what is best. Generally, a higher turnover ratio - between 6 and 10 is considered ideal and indicates efficient management of accounts payables.
How to improve accounts payable turnover ratio?
Efficient management of accounts payables process, vendors and invoices can help businesses repay their vendors on time and improve AP turnover ratio. Automating the procurement process is the best way to improve this ratio.
What is DPO in accounts payable?
DPO stands for Days Payable Outstanding, which indicates the average number of days it takes for a business to repay its vendors.