The accounts payable (A/P) turnover ratio is a liquidity measure that shows how fast a business pays its suppliers during a specific period. Bookkeepers should track it as part of their accounts payable management to identify payment issues. Creditors can use the A/P turnover ratio to evaluate a company’s payment history with vendors.
The A/P turnover ratio formula is:
Total Supplier Purchases / [(Beginning A/P + Ending A/P) / 2]
If you use accounting software like QuickBooks Online, it will only take you a few minutes to run the reports needed to calculate the A/P turnover ratio. If you’re still using Microsoft Word documents and Excel spreadsheets to do your bookkeeping, we recommend you upgrade to QuickBooks. For a limited time, you can save up to 50% off.
How To Calculate the Accounts Payable Turnover Ratio
Step 1: Calculate Average Accounts Payable
Take the A/P balance at the beginning of the period and add the A/P balance at the end of the period. Divide the result by two to get the average A/P.
Average A/P = (Beginning A/P + Ending A/P) / 2
Example: The A/P balances for a fictitious company are as follows:
- A/P balance as of January 1: $10,000
- A/P balance as of December 31: $30,000
The average A/P balance is calculated as follows:
($10,000 + $30,000) / 2 = $20,000
Step 2: Identify Total Supplier Purchases
Include all purchases made on credit, such as purchases of supplies, products for resale, and payments for overhead items like rent and utilities. If you use accounting software like QuickBooks, you can run a vendor purchases report easily to get the total supplier purchases.
Step 3: Divide Total Supplier Purchases by Average Accounts Payable
Once you have calculated the average A/P and obtained your total supplier purchases, you’re ready to calculate the A/P turnover ratio. Take the total supplier purchases and divide it by the average A/P.
A/P Turnover Ratio = Total Supplier Purchases / Average Accounts Payable
Example: A company’s total supplier purchases is $100,000. We’ll use the average A/P balance of $20,000, which we calculated in Step 1.
The A/P turnover ratio is calculated as follows:
$100,000 / $20,000 = 5
How To Interpret the Accounts Payable Turnover Ratio
The A/P turnover ratio is the number of times during the period, such as monthly, quarterly, or annually, you paid off your A/P balance. An increasing A/P turnover ratio indicates you’re paying your bills quicker than in previous periods while a decreasing A/P turnover ratio could mean you’re slower than in previous periods.
However, you cannot use the A/P turnover ratio on its own to make a determination about the ability of a business to pay its vendor suppliers. Instead, it should prompt you to investigate why your business has a high or low ratio. For example, a high ratio could be an indicator that you have very short payment terms with vendors because of negative payment history. Therefore, high doesn’t always mean good.
Another factor you should consider is the standard A/P turnover ratio for your industry. What might be acceptable for the fashion industry might not be acceptable for a grocery retail chain. Find out the average A/P ratio for your industry, and then compare yours to that standard.
Finally, keep an eye on how your A/P turnover ratio is trending over time. Are there certain times throughout the year where your A/P turnover ratio is consistently high vs other times when it’s consistently low? If so, investigate further. These are the types of questions lenders will ask when considering you for a loan or line of credit.
Accounts Payable Turnover Ratio Examples
To give you a better understanding of how to interpret the A/P turnover ratio, we have included a couple of examples using two fictitious companies.
Sample 1: Accounts Payable Turnover Ratio for ABC Company
ABC Company had the following results last year:
- Total supplier purchases: $100,000
- Beginning A/P: $25,000
- Ending A/P: $50,000
Average A/P for ABC Company is calculated as follows:
($25,000 Beginning A/P + $50,000 Ending A/P) / 2 = $37,500 Average A/P balance
A/P turnover for ABC Company is calculated as follows:
$100,000 Total Supplier Purchases / $37,500 Average A/P Balance = 2.67 A/P Turnover Ratio
A 2.67 A/P turnover ratio means the A/P balance was paid off 2.67 times during the year. By itself, this ratio doesn’t tell you anything about your business. However, if you compare it with the average A/P ratio for your industry and prior periods, you can identify patterns or trends. Then, you can do some research to identify what’s causing the trend and put together a plan to fix any issues or keep doing what’s working.
Sample 2: Accounts Payable Turnover Ratio for XYZ Company
XYZ Company had the following results last year:
- Total supplier purchases: $125,000
- Beginning A/P: $25,000
- Ending A/P: $35,000
Average A/P for XYZ Company is calculated as follows:
($25,000 Beginning A/P + $35,000 Ending A/P) / 2 = $30,000 Average A/P balance
A/P turnover ratio for XYZ Company is calculated as follows:
$125,000 Total Supplier Purchases / $30,000 Average A/P Balance = 4.17 A/P Turnover Ratio
A 4.17 A/P turnover ratio means the A/P balance was paid off 4.17 times during the year. When compared to ABC Company, XYZ Company has a higher A/P turnover, indicating it pays its vendor suppliers faster than ABC Company.
Ways To Improve Your Accounts Payable Turnover Ratio
Now that you know how to calculate your A/P turnover ratio, you can try to improve it by paying your bills on time and taking advantage of early payment discounts.
- Pay vendor supplier bills on time: A quick way to increase your A/P turnover ratio is to pay your bills on time consistently. To maintain positive cash flow, we don’t recommend you pay bills early unless you can take advantage of early payment discounts. In this case, you should schedule your payments to arrive one to two days before the due date.
- Take advantage of early payment discounts: Many vendor suppliers offer a discount for early payment. Generally, it’ll run 1% to 3% if payment is made within 7 to 10 days of the invoice date. If you take advantage of these discounts, you won’t only save money but also increase your A/P turnover ratio automatically because you’ll make your payments well before the standard due date.
Frequently Asked Questions (FAQs)
Do you want a high or low accounts payable turnover?
In general, you want a high accounts payable turnover because that indicates that you pay suppliers quickly. However, you should always investigate to see why your A/P turnover ratio is trending high or low. While a high A/P turnover can be positive, it could also mean that you pay bills too quickly, which could leave you without cash in an emergency.
What is the difference between accounts payable turnover ratio and days payable outstanding?
While the A/P turnover ratio quantifies the rate at which a company can pay off its suppliers, the days payable outstanding (DPO) ratio indicates the average time in days that a company takes to pay its bills. They essentially measure the same thing—how quickly are bills paid—but use different measurement units. The turnover ratio is measured in the number of times per year, whereas days outstanding is measured in days.
Here is the formula for days payable outstanding:
DPO = Accounts Payable x Number of Days / Cost of Goods Sold
An increasing A/P turnover ratio indicates that a company is paying off suppliers at a faster rate than in previous periods, which also means that the number of days payables are outstanding is less.
To calculate A/P turnover in days, use this formula:
(Average Accounts Payable / Cost of Goods Sold) / 365 days
Bottom Line
The accounts payable turnover ratio tells you how quickly you’re paying vendors that have extended credit to your business. The keys are to calculate the ratio on a periodic basis to identify trends and compare your ratio to the industry standard. It only takes a few minutes to run reports with the information required to compute the ratio if you use accounting software.
So, it’s time to upgrade if you don’t use accounting software like QuickBooks Online. It allows you to keep track of all of your income and expenses for your business. You can also run several reports that will help you not only calculate your A/P and A/R turnover ratios but also analyze cash flow and profitability.
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