Ratios: Accounts Payable Turnover - Online Tutor, Practice Problems & Exam Prep

The accounts payable turnover ratio measures how efficiently a company pays off its debts, calculated by dividing the cost of goods sold (COGS) by the average accounts payable. The formula for average accounts payable is $\frac{\mathrm{Beginning}+\mathrm{Ending}}{2}$. A higher ratio indicates quicker debt repayment, and benchmarking against industry standards is essential for analysis. Understanding this ratio is crucial for assessing a company's liquidity and operational efficiency.

Ratios: Accounts Payable Turnover

Alright, here we go with another ratio, the accounts payable turnover ratio. So accounts payable turnover, well, this is going to relate the amount of generally, I'm going to say COGS. Most of the time in your class, you're going to use COGS as the numerator, but the technically correct term is purchases, but we're going to go with COGS is generally what we're going to use here. And we're going to relate that to our average accounts payable level. Okay? That's the accounts payable turnover. And this is a common efficiency ratio. How efficiently are we? How efficient are we at paying off our debts? Paying off our accounts payable. Okay? So the account payable turnover, notice in this formula here, I've got purchases or COGS in the numerator. You're going to want to check with your professor or see his questions, see how he generally how he generally tackles these questions, but generally, like I said, you're gonna we're gonna use COGS in this class, because it's a little less complicated. And we're gonna divide that by our average AP. So remember, every time we do an average, it's gonna be the beginning balance plus the ending balance divided by 2. So let me put that in here. This is always how we're gonna do it. Beginning balance plus ending balance divided by 2. Okay? So you've got an interesting way to calculate our purchases. We can back into it. If we're given an inventory account, so if we see a balance sheet and we're given 2 years. If we're given last year's balance sheet, this year's balance sheet, and we have an income statement. Well, we can back into our purchases, or get a pretty good estimate of it. All right? So our inventory T account, right? We're gonna have some beginning balances of debit, and then we're gonna have purchases. We're gonna buy more inventory, and then what's gonna lower the inventory account? Well, when we sell inventory. Right? COGS. COGS is going to lower the account and we'll be left with an ending balance. So if we rearrange those algebraically and solve for purchases, what we're going to see is that it equals the COGS plus the ending inventory minus beginning inventory, that's equal to our purchases. So we could get purchases for our numerator with that amount of information. But like I said, you're generally not gonna do that. You're just gonna have a COGS amount divided by average AP. Easy peasy, alright? So how do we analyze an AP turnover? Well, the AP turnover let me leave it on screen there. The AP turnover, it tells us how many times we're able to pay our AP during the year. How many times we are able to pay our AP during the year. So if you think about it, right? We're gonna have some accounts payable balance and every time we purchase, it's gonna increase that balance. But it's not gonna keep increasing and increasing. No. We're gonna have to pay it off, right? So we're gonna have some average balance, but those purchases keep increasing as we purchase and purchase. So you can imagine that the numerator is going to be bigger than the denominator, right? Because we're going to have to be paying off those AP and keep them at some average balance that we have for our company. Right? So how do we compare AP turnover? Well, like most ratios, we use benchmarking, right? Because we have to know in our industry, what's a reasonable amount. So we check with our competitors, we check with the industry average, and we see how our AP turnover compares to them. All right? And last but not least, I want to just mention here that a higher AP turnover, the higher your AP turnover, well, it implies you pay off your debts more quickly, right? You're able to pay them off more quickly as the ratio goes higher. Higher. Alright? So in general, this is a pretty easy formula. Let's go ahead and jump into some practice problems.

XYZ Company had net sales of $500,000 and COGS of $320,000. If the beginning balance of AP was $60,000 and the ending balance in AP was $100,000, what is the AP Turnover ratio?

• A. 1.8
• B. 3.2
• C. 4.0
• D. 5.0

ABC Company had $200,000 in Net Sales and Gross Profit of $80,000. If AP had a balance of $60,000, what is the AP Turnover ratio?

• A. 1.33
• B. 2.00
• C. 3.33
• D. Not enough information

Here’s what students ask on this topic:

What is the accounts payable turnover ratio and how is it calculated?

The accounts payable turnover ratio measures how efficiently a company pays off its debts. It is calculated by dividing the cost of goods sold (COGS) by the average accounts payable. The formula is:

$\frac{\mathrm{COGS}}{\frac{\mathrm{Beginning\; Accounts\; Payable\; +\; Ending\; Accounts\; Payable}}{2}}$

A higher ratio indicates quicker debt repayment, reflecting better liquidity and operational efficiency.

Why is the accounts payable turnover ratio important for a company?

The accounts payable turnover ratio is important because it indicates how efficiently a company is managing its short-term liabilities. A higher ratio suggests that the company is paying off its suppliers quickly, which can improve relationships with suppliers and potentially lead to better credit terms. It also reflects the company's liquidity and operational efficiency, which are crucial for financial health and stability.

How do you interpret a high accounts payable turnover ratio?

A high accounts payable turnover ratio implies that a company is paying off its debts more quickly. This can be a positive sign, indicating strong liquidity and efficient management of payables. However, it could also mean that the company is not taking full advantage of credit terms offered by suppliers, potentially missing out on opportunities to use cash for other investments. It's important to compare the ratio with industry benchmarks to get a clearer picture.

What is the formula for calculating average accounts payable?

The formula for calculating average accounts payable is:

$\frac{\mathrm{Beginning\; Accounts\; Payable\; +\; Ending\; Accounts\; Payable}}{2}$

This average is used in the accounts payable turnover ratio to provide a more accurate measure of the company's efficiency in paying off its debts over a period.

How can you use the accounts payable turnover ratio to compare companies?

To compare companies using the accounts payable turnover ratio, you should benchmark the ratio against industry standards and competitors. This helps determine if a company is managing its payables efficiently relative to others in the same industry. A higher ratio compared to peers may indicate better liquidity and operational efficiency, while a lower ratio could suggest potential issues in managing short-term liabilities.