Accounts Payable Turnover Ratio: Definition, Formula and Example

Accounts Payable Turnover Ratio: Definition, Formula and Example

It simply measures the quickness or quantifies the time in which a business makes payments to the suppliers. The accounts payable turnover ratio indicates a company's liquidity and defines how the cash flow has been managed throughout the company.

It is generally calculated by dividing the total purchases of a business by the average of the total payable accounts by the company during that period of time.

Formula

AP turnover ratio= tsp/[(bap+eap)/2]

Where,

Tsp=total supply purchases

Bsp=beginning accounts payable

Eap=ending accounts payable

Decreasing AP Turnover ratio:

The decrease in the graph of the AP turnover ratio means that the company is currently taking longer than usual to pay off its suppliers than its previous records.

Increasing AP Turnover ratio:

The increase in the graph of the AP turnover ratio means that the company has made all the payments to the suppliers either at the correct time or at a shorter period of time as compared to its previous records in paying off.

Examples of AP turnover ratio:

Suppose the purchases were 50 million for a year for a  company

Accounts payable were 10 million at the start of the year, but it came out to be 30 million at the end of the year.

So, according to the formula, the average of the accounts at the beginning and at the end of the year is (10+30) /2 = 20 million.

So, the AP turnover ratio comes out to be: 50/20 million 

=2.5 million

Therefore, the company has paid off the accounts payable a total of 2.5 times during that particular year. 

Now, let’s assume any other company whose purchases were 200 million at the start of the year.

The accounts payable amount was 50 million at the start of the year, but at the end of the year, it turned out to be 90 million.

Therefore, in accordance with the above-given formula, the average of the accounts payable at the beginning and at the end of the year is (50+90)/2

=70 million

So, the AP turnover ratio comes out to be:200/70

=2.85 million

Hence, the company has paid off the accounts payable a total of 2.85 times during that particular year.

In comparing both examples, we observe that in the second example, the accounts payable ratio is higher, so the company in the second example has paid off its suppliers at a faster rate.

Activity for students: purchases=800 million

Accounts payable amount at the start of the year = 200 million

Accounts payable amount at the end of the year = 250 million

Calculate the AP Turnover ratio.

Procurement: 

The act of purchasing goods or services, typically for business purposes, is called procurement.

There are 3 stages involved in the process of procurement 

1. SOURCING STAGE:

  • Identify needs
  • Create purchase requests
  • Assess vendors

2. PURCHASING STAGE:

  • Negotiate terms
  • Create orders
  • Receive and inspect goods and services

3. PAYMENT STAGE

  • Conduct three-way matching
  • Approve invoices and arrange and manage payments
  • Keep records

Assets meaning in accounting:

In accounting, an asset is any resource a business owns or controls. It could be anything that could be sold for money. For example, cars, furniture, buildings, cash, investments, machinery etc

Classification of Assets

1. Convertibility 

  • Current Assets 
  • Fixed Assets 

2. Physical Existence 

  • Tangible assets
  • Intangible assets

3. Usage

  • Operating assets
  • Non operating assets

Importantly, tangible and intangible assets are classified in a way that the tangible assets can be touched by hand (equipment, machinery, buildings, vehicles, land, cash)

On the other hand, we have intangible assets which we cannot touch by hand (trademarks, franchises, copyrights, licenses, goodwill, patents, brands)

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Accounting journal entries:

An accounting journal entry is a method used to keep a record of accounting transactions in the accounting records of a business for a company. This information can then be used to construct financial statements for businesses for various purposes. These are also helpful for the record of AP turnover ratios we discussed in the initial document.

JOURNAL ENTRY RULES: the total of debit and credit transactions must be equal to each other. This is to create a balance in the entries, and therefore a record is properly established for each entry.

A journal entry of two lines is called a simple journal entry, while a journal entry of more than two lines is called a compound journal entry.

There are two special types of journal entries:

  1. Reversing journal entry- a journal entry either manually or by accounting software in the following reporting period is called a reversing journal entry.
  2. Recurring journal entry- a journal entry which repeats itself in a fixed period of time in successive reporting periods till the date of termination is called a recurring journal entry. 

Example: a corporation sells a product for $1000 to a customer in cash. This, in turn, generates revenue of $1000 as well as cash of $1000.

The entry is:

 

Debit

Credit 

Cash

$1000

 

Revenue

 

$1000

It also buys a machine for $12000 on credit. It then results in addition to the machinery fixed assets in the account with debit, thus increasing the accounts payable with a credit

The entry is:

 

Debit

Credit

Machinery fixed assets

$12000

 

Accounts payable

 

$12000

Conclusion and key takeaways:

The accounting payable turnover ratio has been understood how it helps keep the company's finances for a particular year. It also explains the necessity of the accounts paid off to the company's suppliers within the given period of a particular time.

We have also learned about purchases, i.e. procurement, how it is possible, i.e. by the help of assets, and how we can keep a balanced record for a non-deceiving financial statement, i.e. by the help of accounting journal entries. 

All these key points are very necessary to put light on to help maintain a clear record and save your company from financial troubles by keeping liquidity in your records.

The AP turnover ratio is the main component to determine a company's short-term liquidity, i.e. how easily a company is paying off their liabilities. A healthy accounts payable turnover ratio differs from industry to industry, but the companies are typically expected to maintain a ratio between eight to ten (8-10).

Students are instructed to think open-mindedly about the factors that can affect the AP turnover ratio as well the consequences of the increase or decrease in the graph of the AP turnover ratio that a company has to face.

FAQ’s

1. What is AP turnover ratio?

The accounts payable turnover ratio indicates a company's liquidity and defines how the cash flow has been managed throughout the company.

2. What factors lead to an increase or decrease in the AP turnover ratio?

The decrease in the graph of the AP turnover ratio means that the company is currently taking longer than usual to pay off its suppliers than its previous records.

The increase in the graph of the AP turnover ratio means that the company has made all the payments to the suppliers either at the correct time or at a shorter period of time as compared to its previous records in paying off.

3. What steps can a company take to increase its AP turnover ratio?

Maintaining a healthy cash flow and completing all the payments on time can increase the AP Turnover ratio.

4. What causes AP turnover ratio to decrease?

When a company can't make payments back on time and the cash flow isn't healthy, it can decrease the AP turnover ratio.

5. NUMERICAL based on AP turnover ratio.

Refer 2 questions discussed in the later part.

At the end of the document, the AP TURNOVER RATIO, PROCUREMENT, ASSETS, and ACCOUNTING JOURNAL ENTRIES have been properly studied and understood. 

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