What is Accounts Payable Turnover? What is the formula and why it is important

Are you looking to make your accounts payable process easier and more efficient? If so, then you’re in the right place. In this blog post, we will provide you with actionable steps that can help you streamline your accounts payable turnover. Whether it’s a complex vendor network or an increasing level of invoices that have become difficult to keep up with; these tips will prove helpful as you work towards creating a more streamlined and manageable AP system. Read on to discover our best advice for optimizing your account payables!

What Is Accounts Payable Turnover?

Accounts Payable Turnover is an important indicator of a business’s financial health. It measures the number of times during a reporting period that a company pays off its creditors from whom it has purchased goods or services on credit.

Put simply, this metric shows how often and efficiently a business pays off its creditors in order to generate cash for future operations. Paying vendors promptly helps create positive relationships with them and may even help to secure better terms or discounts on purchases. It also ensures smart utilization of profits within the company’s budget cycle and allows businesses to reinvest in their success by taking advantage of new opportunities.

Why Is It Important For Businesses To Track Their Accounts Payable Turnover?

Good cash flow is essential for any business, and tracking accounts payable turnover rates can help gauge how well a company is doing. A business significantly reduces its risk when it monitors how much money it spends on liabilities in a timely manner, as this allows them to control their spending habits and ensure they stay in the black.

Accounts payable turnover rates also provide insight into a company’s liquidity; if the rate is too low, then cash might be tied up due to slow payments, while a high rate indicates that the business is efficiently paying all of its creditors. Additionally, monitoring these rates gives business owners an overview of the number of times they paid suppliers over a certain period of time – giving a deep understanding of their finances at any given moment.

Overall, tracking accounts payable turnover is an important part of developing sound cash flow management strategies, which can ultimately increase success and sustainability within a business.

How Do You Calculate Accounts Payable Turnover?

Calculating Accounts Payable Turnover is an important part of financial accounting, helping businesses manage how quickly payments are made to suppliers. This calculation is simple and straightforward; the Accounts Payable Turnover Ratio is achieved by dividing the total amount spent on supplier credit purchases over a period by the average accounts payable balance for that period.

As an example, if your business has credit purchases for $24,000 over three months with an average account payable of $2,000, then the Accounts Payable Turnover Ratio= 12x. Analyzing this ratio can help your business identify any risk associated with cash flow management or identify areas where too much money could be tied up in long outstanding payments.

What Factors Affect Accounts Payable Turnover?

The accounts payable turnover ratio can be affected by several factors, some of which include:

Credit terms:

The terms of payment extended to suppliers and vendors can have an effect on accounts payable turnover, with longer payment periods resulting in slower payments, and vice versa.

Cost of goods sold:

If the cost of goods sold increases, then companies may need to pay their suppliers sooner in order to keep their cash flow healthy.

Inventory levels:

Companies that have higher levels of inventory may be able to delay payment to suppliers until they sell the items and free up their cash reserves.

Vendor management:

Companies that manage their vendors well will be able to negotiate better terms, leading to increased accounts payable turnover.

Payment methods:

Companies that make use of electronic payment methods may be able to pay their suppliers faster, leading to higher accounts payable turnover.

By understanding these factors and how they affect the accounts payable turnover ratio, companies can better manage their cash flow and ensure that their business remains financially healthy.

What Is A Good Accounts Payable Turnover?

A good accounts payable turnover ratio is essential to running a successful business. It tells you how quickly your company can pay its suppliers or vendors, and it is one of the most important indicators of financial health. Higher ratios imply that your business has high liquidity, which means you can easily meet your obligations.

A strong accounts payable turnover also suggests that you are able to take advantage of discounts offered by suppliers for paying early, a great way to maximize profits. There are many benefits associated with a good accounts payable turnover ratio, so understanding how your company’s ratio measures up is crucial for any business owner.

Examples Of Accounts Payable Turnover

Example 1

To calculate the accounts payable turnover ratio of a company with total purchases of $200 million and accounts payable at the start and at the end of the year of $70 million and $80 million respectively.

We can use the following formula:  Average Accounts Payable = (Opening Accounts Payable + Closing Accounts Payable) / 2.

In this case, Average Accounts Payable is equal to ($70 million + $80 million) / 2 = $75 million.

Accounts Payable Turnover Ratio can then be calculated using the formula Total Purchases / Average Accounts Payable and for this example, APT Ratio = $200 million / $75 million = 2.67.

This shows that the company managed to pay off its trade payable 2.67 times during the year.

Example 2

Let’s take a look at Apple Inc.’s Accounts Payable Turnover Ratio (APT) for 2018. According to the company’s annual report, the cost of sales was $163,756 million, and the opening inventory was $4,855 million while closing inventory was $3,956 million. The opening accounts payable was $44,242 million and closing accounts payable at the end of the year was $55,888 million.

To calculate APT Ratio for 2018, we can use the following formula:

Total Purchases = Closing Inventory + Cost of Goods Sold – Opening Inventory

Total Purchases = $3,956 million + $163,756 million – $4,855 million

Total Purchases = $162,857 million

Average Accounts Payable is calculated by using the formula given below:

Average Accounts Payable = (Opening Accounts Payable + Closing Accounts Payable) / 2

Average Accounts Payable = ($44,242 million + $55,888 million) / 2

Average Accounts Payable = $50,065 million

Accounts Payable Turnover Ratio is calculated by using the formula given below:

Accounts Payable Turnover Ratio = Total Purchases / Average Accounts Payable

APT Ratio = $162,857 million / $50,065 million

APT Ratio = 3.25

From this calculation, Apple Inc.’s APT for 2018 was 3.25 times, indicating that the company had paid off its liabilities effectively during the year.

Strategies To Improve Accounts Payable Turnover

Automate Accounts Payable:

Automation of accounts payable processes can help to streamline the entire process and make it more efficient, reducing the amount of time it takes for payments to be made and received. This can also help improve accuracy in tracking invoices and payments.

Negotiate Better Payment Terms:

Speak to vendors and suppliers about better payment terms, such as extended due dates or discounts for early payments. This can help your organization maintain a positive relationship with its suppliers while also improving cash flow.

Monitor Outstanding Invoices:

Proper monitoring of outstanding invoices can help ensure that all bills are paid on time and reduce the risk of late payments. This can be done manually or through automated software that tracks and manages invoices.

Improve Vendor Relations:

Good vendor relations are essential for accounts payable processes and lead to smoother transactions, quicker turnaround times, and better discounts. Make sure to communicate regularly with vendors about payment due dates and any other potential issues.

Reduce Data Entry Errors:

Data entry errors can be a major cause of delays in the accounts payable process. By automating data entry processes and implementing quality control measures, you can reduce the risk of incorrect information being entered and help ensure that payments are processed quickly and accurately.

Review Credit Terms Regularly:

Reviewing your credit terms regularly can help ensure that you’re taking advantage of the most favorable payment terms and discounts available. This will help improve cash flow and reduce the amount of time it takes for payments to be processed.

Implement an Audit Process:

Regularly auditing accounts payable processes can help identify any potential issues and ensure that payments are being made in a timely manner. By implementing an audit process, you can reduce the risk of late payments and ensure that all invoices are being processed correctly.

Set Up Automated Payment Reminders:

Automating payment reminders can help to ensure that vendors and suppliers receive their payments on time. This can help both parties maintain a good relationship and reduce the risk of late payments.

Pay E-Invoices:

Electronic invoicing can help to speed up the accounts payable process by reducing the amount of paperwork involved. Paying e-invoices in a timely manner can also help improve cash flow.

Centralize Accounts Payable:

Centralizing accounts payable processes can help to ensure that all payments are being tracked and managed in a single system. This will reduce the risk of duplicate payments or incorrect data entry and make it easier for your organization to monitor payment status.

Improve Visibility of Accounts Payable:

In order to ensure that all payments are being made on time, organizations need to have visibility into their accounts payable processes. Automation and analytics can be used to provide real-time insight into payment status, helping to reduce the risk of late payments.

By implementing these strategies, you can help improve the efficiency of your accounts payable process and reduce the risk of late payments.

Conclusion

Accounts payable turnover is a measure of how quickly a company pays its invoices and is used to assess the efficiency of a company’s AP department. There are several ways to streamline your AP turnover, from automating your AP process to improving communication between departments. By taking these steps, you can improve your accounts payable turnover and make your AP department more efficient.