Accounts Payable Turnover = Cost of Goods Sold
The Accounts Payable Turnover Ratio represents the average number of times per year that payables “turn over” or get paid with cash. A higher (more rapid) turnover is generally favorable, since accounts payable are being paid more quickly.
But, paying debts too quickly uses up needed cash. Many businesses extend these payments as much as possible to make the best use of their cash. Businesses that manage their payables in this way or which receive extended payment terms from suppliers will, therefore, have lower (less rapid) accounts payable turnover.
At the same, businesses experiencing cash flow crunches or disputed invoices with their suppliers will also exhibit slower payables turnover. Additional research is often necessary to determine the cause of slow or slowing accounts payable turnover. Is it a sign of trouble or a result of good cash flow management? To learn more, compare payables turnover to the industry average and to the payment terms of vendors. Explore payables turnover from previous periods, and look for trends.
Like the other turnover ratios, this one compares cost of goods sold over a period of time with the accounts payable balance at a single point in time. Perhaps the payables balance is inflated due to a seasonal buildup or a big discount from a supplier. An analyst may compare purchases (as opposed to Cost of Goods Sold) to average accounts payable balances to obtain more meaningful ratios.
Days Payables Outstanding = 365
Accounts Payable Turnover Ratio
“Days Payables Outstanding” expresses turnover as the average length of time in days between purchases and their payment. Although, this ratio has the same limitations as the Accounts Payable Turnover Ratio, it may be more intuitive to look at payables turnover in terms of days rather than in number of times per period.
The payables of Smith Heating and Cooling, Inc. turn over 2.33 times per year or every 157 days. This represents extraordinarily slow payables turnover. The company’s accounts payable are certainly due in less than an average of 157 days. An analyst would explore whether the company is experiencing cash flow problems that are resulting in very slow payments.