In order for businesses to maintain a good cash flow, it is important to keep track of the amount of money that they owe to their suppliers.
This metric, also known as the Accounts Payable Turnover Ratio, measures the number of times in a given period that a business pays off its payables.
It gives businesses an indication of how effectively they are managing their accounts payable and helps them to identify areas of improvement.
Even investors and lenders would use the Accounts Payable Turnover Ratio to measure a company’s creditworthiness and ability to pay off its suppliers.
What is the Accounts Payable Turnover Ratio?
The Accounts Payable Turnover ratio is a financial measure used to assess the liquidity of a company.
It enables investors and financial analysts to determine how well the company is managing its accounts payable, which are short-term debts that must be paid within one year’s time.
These short-term debts are mostly accumulated from the suppliers who provide goods and services to the company.
The accounts Payable Turnover Ratio portrays how many times a company is able to pay off its payable accounts within a period of time.
A good accounts payable turnover ratio implies that the company is able to pay off its suppliers’ debts on time and in full, which indicates satisfactory liquidity.
On the other hand, a low accounts payable turnover ratio suggests that the company may be having trouble paying off its suppliers and may not have enough cash reserves.
Formula of the Accounts Payable Turnover Ratio
The formula for the Accounts Payable Turnover Ratio is:
Accounts Payable Turnover Ratio = Net Credit Purchases / Average Accounts Payables
Ned Credit Purchases: To find net credit purchases, subtract the cost of goods sold from the total purchases.
Average Accounts Payables: To get the average accounts payables, add the beginning and ending balance of accounts payable and divide it by 2.
By using this formula investors can easily determine how well a company is managing its short-term debts.
Examples of Accounts Payable Turnover Ratio
Here is an example of the Accounts Payable Turnover Ratio.
Let’s assume that a company has total purchases of $10,000, a cost of goods sold of $5,000, and beginning and ending accounts payable of $2,000.
Therefore: Net Credit Purchases = 10,000 – 5,000 = $5,000
Average Accounts Payable = (2,000 + 2,000)/2 = $2,000
Accounts Payable Turnover Ratio = 5,000/2,000 = 2.5
This indicates that the company is able to pay its suppliers two and a half times in a period of time. By looking at this Accounts Payable Turnover Ratio, investors can have a better idea of the company’s liquidity and its ability to pay off its short-term debts.
A 2.5 Accounts Payable Turnover Ratio is considered good and implies that the company is able to pay its debtors in a timely manner.
Conclusion
The Accounts Payable Turnover Ratio is an important financial metric used to measure the liquidity of a company. This ratio helps investors, lenders, and analysts know how efficiently a company is managing its accounts payable. By looking at the ratio companies can identify areas of improvement and strive to pay off their suppliers in a timely manner.
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