What Is Accounts Payable Turnover?
The AP turnover is an important figure that indicates how effectively the company fulfills its payment obligations as short-term liabilities or bills. The accounts payable turnover ratio shows how often a company can pay off the average accounts payable during a particular period.
Understanding Accounts Payable Turnover
Accounts payable turnover is the amount of total purchases that a company makes in a given period divided by the amount of accounts payable in the same period.
For instance, if a firm bought $2 million of goods in the previous year, and had on average $500,000 of accounts payable, then the accounts payable cycle would be 4 ($2,000,000/$500,000). This means the company settled an average value of payables four times in the year.
Higher turnover of AP implies that a company is clearing its bills faster than they build up, meaning they do not allow for payables to pile up. In this respect, it symbolizes effectiveness in the handling of cash in business organizations. A high turnover ratio or extremely high might signal that the company is paying for items too fast and it loses opportunities to take advantage of early payment discounts.
On the other hand, a lower turnover of AP implies that the company is paying off its vendor bills and liabilities at a slower rate. This could lead to the conclusion that the company was facing problems with its cash reserves. But it could also mean that the company has been able to negotiate comfortable credit terms with the suppliers.
Why Accounts Payable Turnover Counts?
The AP turnover ratio is valuable assistance in understanding the effectiveness of the financial administration in a particular company as well as cash management. This, in conjunction with other working capital ratios such as DPO (Days Payable Outstanding), offers an insight into the bill payment behavior and solvency.
Where the AP turnover is trending downwards over successive accounting periods, then this is a pointer to constraining liquidity and vulnerability to delayed payments. However, it warrants further analysis of why the change is occurring – perhaps business volumes are growing at a faster pace than cash flows or the business is unprofitable with cash deficiencies.
Comparing AP turnover with other rivals in the same industry also gives an insight into its position in working capital management. Does it pay its vendors faster or extend its pay to them much more than its competitors? The turnover is helped by the context that determines its reasonableness.
A rising AP turnover means that there is a reduction in the company’s control over the payments to the vendors. This one suggests that the condition under which the financial manager is paid implies that the bills are paid on time, but not earlier. A company has to manage AP turnover – it should be relatively high but not too low, meaning that the firm does not want a very high proportion of early payments.
Factors which affect the Accounts Payable Turnover include the following;
Many factors influence the accounts payable turnover achieved by a company:
- Payment terms negotiated with suppliers: They entail incurring expenses in a more extended period and therefore take longer to pay the bills hence a low turnover.
- Inventory management policies: Just-in-time inventory requires the AP to be paid at the earliest, which makes the turnover ratio for AP higher.
- Discounts for early payment: Taking discounts to pay bills sooner increases AP turnover because of the additional cash received from customers.
- Extending the payment period: The management of cash flows to reduce the amount of cash paid out thereby reducing AP turnover.
- Credit rating and financing terms: Credit and rate policies ensure that suppliers provide better credit terms and thus help a company retain enough liquidities as it strives to achieve a healthy turnover on AP.
- Industry conventions: Some industries have tended to give longer periods when it comes to payments. They should compare normal AP terms or what is commonly understood as AP terms by everyone.
In general, accounts payable turnover enables the assessment of the efficiency of payment of bills from the organization’s finance department. By managing trends, one can identify issues that may occur about the ability to pay suppliers and manage working capital.