Accounts Payable Turnover = Cost of Goods Sold
Accounts Payable
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.
No comments:
Post a Comment