What Is A Good Accounts Payable Turnover Ratio?

An efficient instrument for financial research that lets one evaluate AP management efficiency is the accounts payable turnover ratio. This ratio gauges an average accounts payable turnover for a corporation over a certain period.

If high, the accounts payable turnover ratio shows that a company is efficiently managing working capital, paying off supplier credit fast, and securing payment terms discounts. While a low ratio indicates inefficiencies in paying its suppliers or suggests cash flow issues, a high ratio might be an indication of effective management and the capacity to pay its suppliers. Still, in the context of the accounts payable turnover ratio, what does the word "good" mean? Do not overlook any of the material this article still has to provide.

Calculated as the number of times accounts payable are paid or cleared in a particular period, is the accounts payable turnover ratio.

The accounts payable turnover ratio determines how often a company settles its average accounts payable in a given period. Formula—that is, total annual buy divided by average accounts payable—helps one to compute it.

Turnover Ratio of Total Credit Purchases for the Period / Average Accounts Payable

A company's accounts payable turnover ratio would be $500,000 if it made $2 million in total purchases last year and had an average unpaid supplier balance throughout the year. The accounts payable turnover ratio of a corporation would be: $2 million in total purchases last year and an average unpaid supplier balance of $500,000 would translate into:

Divide total funds by acquired funding to get the leverage ratio: $2,000,000 / $500,000 = 4.

For this company, the average payable balance turned over four times during the year. Stated differently, it regularly released its responsibilities to its suppliers every quarter on average.

At last, one wonders what a proper ratio is based on.

For example, a normal account payable turnover ranging from 12 to 18 is regarded as good. A corporation so pays an average supplier payment of $X almost once a month or every three weeks. While a figure below 6 may suggest inefficiency or perhaps financial difficulty, the working capital turnover ratios range and are deemed suitable from 6 to 12.

Still, the appropriate turnover level described above greatly relies on the type of industry one works in. Those with tight billing and payment cycles claim that monthly billing and payment will result in better turnover ratios—that is, for food retailers. Businesses impacted by sectors with lengthier product and credit cycles, such as aircraft manufacture, would also have reduced turnover at the same time.

Regarding the accounts payable turnover rate, one should either match the given ratio to the average of industry competitors or the ratios of past years. Variations in the year-on-year statistics or numbers outside the industry average also call greater attention.

Usually, a higher ratio has advantages.

Although a relatively high turnover ratio indicates not always favorable results, successful working capital management usually depends on solid accounts payable efficiency. Usually, advantages include:

• Getting early payment discounts: Early payment discounts are a regular occurrence among suppliers within the first ten days. A corporation can reduce its buying expenses when it wants to pay its suppliers within the quickest possible period since it indicates that it can maximize its resources.

• Reducing late fees and interest charges: This is so because timely invoice payment guarantees that one is not charged with any penalties or interest on outstanding accounts not paid on time.

• Maintaining excellent relations with suppliers depends on timely payment, which always helps to preserve positive supplier relationships and raises the possibility of obtaining the best credit facilities and pricing going forward.

• Freeing capital: Effective supply chain management is, therefore, more important since the earlier businesses can accomplish this, the sooner they will have cash to engage in other operations. this raises general liquidity.

Some of the drawbacks of a too-high turnover ratio

An excessively high accounts payable turnover percentage in comparison to industry standards could also point to some negative aspects, such: Another indication of certain negative aspects could be an accounts payable turnover ratio that seems abnormally high in comparison to industry standards:

• If it affects cash flows, paying suppliers too early and obtaining price concessions using early payment discounts also constitute mistakes.

Having an above-average accounts receivable turnover makes it challenging to collect from consumers even if the cash may be used for more appealing purposes in the near run. Invoices should be paid before their due date.

Look at the cash management strategies, terms of payments with the suppliers, or frequency of bills that were sent to the company if there are some variations in accounts payable turnover or if it grew significantly over some period.

This paper focuses on strategies one may use to raise their accounts payable turnover.

There are a few techniques you can use to increase efficiency if your accounts payable turnover seems below rivals or your past trends:

• If at all possible, extend credit terms for payments to enable you to pay your suppliers later.
• Relish presents supplier early payment discounts.
• One can apply dynamic discounting schemes of the main supply chain partners or supply chain financing.
To guarantee the most efficient and successful accounts payable, centralize suppliers and accounts payable/billing.
• Should float be a possibility, one could want to consider long grace period company credit cards.
• Find the underlying reasons for late payments and streamline invoice handling to improve rates of timely payments.

While doing this, the cash conversion cycle and account payable turnover combined with days payable outstanding provide the general working capital efficiency picture. Please call your accounting advisor if you need help identifying areas where you might be missing or highlighting opportunities for improvement.