Guide to Accounts Payable Turnover Ratio Formula & Examples

To get the most information out of your AP turnover ratio, complete a full financial analysis. You’ll see how your AP turnover ratio impacts other metrics in the business, and vice versa, giving you a clear picture of the business’s financial condition. Look for opportunities to negotiate with vendors for better payment terms and discounts. When you take early payment discounts, your inventory costs less, and your cost of goods sold decreases, improving profitability. Your cash flow improves because less cash is required to pay the vendor invoices.

Seasonal Businesses Impact

Meals and window cleaning were not credit purchases posted to accounts payable, and so they are excluded from the total purchases calculation. The inventory paid for at the time of purchase is also excluded, because it was never booked to accounts payable. The formula can be modified to exclude cash payments to suppliers, since the numerator should include only purchases on credit from suppliers.

Strong supplier relationships can lead to more favorable payment terms, affecting the ratio independently of financial considerations. Comparing average ratios helps assess a company’s payables management relative to others in the same industry, keeping in mind that industry norms can vary. A high ratio suggests that a company is collecting payments from customers quickly, indicating effective credit management and strong sales.

Then, divide how to add a payment link to a xero invoice the total supplier purchases for the period by the average accounts payable for the period. A one-month period will have a lower AP turnover ratio than a three-month period, assuming your accounts payable process doesn’t change drastically between the two. If your AP turnover for the same quarter is above 5.2, that would look better to creditors. However, it might also mean that your company pays its bills more quickly than you need to, tying up cash you could use in other ways.

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This speed not only improves efficiency but also enhances supplier relationships through timely payments. To optimize the AP turnover ratio, companies can leverage technology and AP automation to improve the efficiency of their accounts payable processes. Automated AP systems can streamline invoice processing, reduce errors, and provide real-time visibility into payment status. Generally, a higher AP turnover ratio and a lower AR turnover ratio are seen as favorable.

1. Meals and window cleaning were not credit purchases posted to accounts payable, and so they are excluded from the total purchases calculation.
2. In some instances, a lower ratio might be a deliberate strategy to leverage longer payment terms for better cash flow management.
3. In today’s digital era, leveraging technology can significantly enhance your accounts payable processes and positively impact your AP turnover ratio.
4. The ratio is a measure of short-term liquidity, with a higher payable turnover ratio being more favorable.
5. The basic formula for the AP turnover ratio considers the total dollar amount of supplier purchases divided by the average accounts payable balance over a given period.

Limitation of the AP Turnover Ratio

Such efficiency is indicative of healthy cash flow, showing that the company has sufficient liquidity to meet its short-term obligations. Furthermore, a high ratio is often linked to strong supplier relationships, as consistent and timely payments can lead to more favorable terms and cooperation. We don’t think that this approach is comprehensive enough to get a handle on cash flow. Therefore, we suggest using all credit purchases in the formula, not just inventory and cost of sales that focus on inventory turnover.

Step 1: Track your AP ratio over time

Conversely, in a booming economy, companies might pay faster due to better cash flow, increasing the ratio. For example, a company might deliberately extend its payment cycles to suppliers to maintain higher cash reserves, thus lowering the turnover ratio. This strategic decision may not necessarily reflect poor financial health but rather a cash management tactic. A higher turnover ratio might suggest good liquidity, implying the company is efficiently managing its payables.

In simple terms, the AP turnover ratio measures how quickly a company can pay off its suppliers within a certain period, typically a month or a year. As such, it is an essential tool for managers, investors, and creditors to evaluate a company’s performance and financial stability. A high AP turnover ratio typically reflects positively on a company’s financial health. High ratio suggests that the company manages its payables efficiently, often paying suppliers on time or even early to take advantage of discounts.

Barbara is a financial writer for Tipalti and other successful B2B businesses, including SaaS and financial companies. She is a former CFO for fast-growing tech companies with Deloitte audit experience. When she’s not writing, Barbara likes to research public companies and play Pickleball, Texas Hold ‘em poker, bridge, and Mah Jongg. Our partners cannot pay us to guarantee favorable reviews of their products or services. If you start with an AP balance of $0 and end with an AP balance of $2,000, your average AP balance is $1,000. And, if you start with an AP balance of $2,000 and end with an callable preferred stock AP balance of $0, your average is still $1,000.