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What is accounts payable turnover?

What is accounts payable turnover?

A company's accounts payable turnover rate is a a key measure of back-office efficiency and financial health. It measures how quickly a business makes payments to creditors and suppliers.

This article lays out what accounts payable turnover is, how to measure it, and why today’s metric-savvy accounting teams keep such a close eye on it.

What is accounts payable turnover?

Accounts payable turnover is an accounting metric that compares the payments you made on your accounts payable (AP) to your average AP balance during a given time period. It looks specifically at the AP account in your company’s accounts.

It has four primary uses:

  1. Companies can track their AP turnover rate to make sure they’re paying their bills on time. It’s a good measure of short-term liquidity and your company’s financial condition.
  2. Corporate finance teams can also use it as an early warning sign of cash flow problems, making sure they’ll have enough cash to meet their short-term obligations.
  3. Banks and credit card companies can use it to decide whether they’re willing to offer a line of credit, and on what terms.
  4. Large suppliers may also use it if they’re considering letting your business pay over time.

How do you calculate accounts payable turnover?

At first glance, it might sound like any company that’s paying its bills on time will have a one-to-one ratio between obligations and outflows — it’s paying as much as it owes. But AP turnover goes deeper than that.

By factoring in your average AP balance, not just your total payables, AP turnover measures whether you’re staying right on top of your payables or letting that total creep upward.

Specifically, your payable turnover ratio measures the number of times you pay out your average AP balance over a given time period.

Accounts payable turnover ratio formula

  1. Decide on the time period you want to look at
  2. Add up the payments you made on your accounts payable during that time
  3. Calculate your average AP balance over the same time period
  4. Divide the total payments by your average AP balance

You can find your AP balance on your balance sheet, a key financial statement for all companies. If you run a small business and you don’t have an internal finance team, your accountant can calculate your accounts receivable turnover ratio and other key financial ratios for you.

Companies that have busy AP departments with many bills and payments often start by looking at their AP turnover over a 5-day or 10-day period. That gives them a solid baseline.

The important thing is to make sure the time period you choose is as “typical” for your company as possible. If your AP balance changes a lot between the beginning and end of the month, don’t just look at the first 5 days or the last 5 days. Instead, look at your high and your low across the month.

To make this easier, many accounting software solutions will let you go back in time and see what your AP balance was at different points.

Accounts payable turnover examples

The best way to get a feel for AP turnover is to start with 2 simple examples — one company that pays all its outstanding bills the day after they come in, and one that pays all of its bills on the last day of each month.

Example 1: Paying every bill the day after it comes in

Let’s say your company is zealous about paying every bill the day after it comes in. If you have $1,000 in new AP bills each day, and you pay $1,000 every day, then your AP balance will stay right at $1,000 all the time. Here’s the AP turnover calculation for a 30-day month:

  1. 30 days
  2. Total payments: $30,000
  3. Average AP balance: $1,000
  4. AP turnover = $30,000 / $1,000 = 30

That’s a high AP turnover rate. Very few real-world companies will have an AP turnover rate of 30 because very few companies pay every bill the day after it comes in the door.

Example 2: paying all outstanding bills at the end of each month

Now let’s say your company waits until the end of each month and pays all its outstanding bills at once. If you have the same $1,000 in new AP bills each day, here’s the AP turnover calculation for that 30-day month:

  1. 30 days
  2. Total payments: $30,000
  3. Average AP balance = the average between $0 at the start of the month and $30,000 at the end of the month =  $15,000
  4. AP turnover = $30,000 / $15,000 = 2

What is an accounts payable turnover ratio?

Accounts payable turnover ratio is just another way of saying accounts payable turnover.

Because AP turnover is the ratio of your accounts payable payments to your average accounts payable balance over a given time period, the word “ratio” is technically redundant. The two terms are used interchangeably.

Do creditors look at your accounts payable turnover?

Creditors look at AP turnover because it’s a good indication of how quickly a company is paying its bills. A high ratio is a good sign that a company has a strong cash position and is both willing and able to meet its financial obligations. A low ratio could signal trouble in meeting short-term debts.

What is a good accounts payable turnover ratio?

Your AP turnover ratio changes based on the accounting period you’re considering, so the definition of a good ratio changes too. The best way to see why is with another example.

Monthly vs. quarterly AP turnover ratio

Let’s say your company’s average AP balance stays right around $15,000, and you pay about $30,000 in bills each month. Your AP turnover for one month is 2. Over the course of 3 months, you’d still have an average balance of $15,000, but you would pay $90,000 in bills. Your AP turnover for the quarter would be 6.

As a rule, vendors and other potential creditors will have different benchmarks for your monthly, quarterly, and annual AP turnover ratios.

AP turnover ratios by industry

AP turnover also depends on your industry. A good way to get a feel for AP turnover in your own industry is to look up industry leaders on a service like discoverci.com.

For example, if you were a car manufacturer, you might look up Ford and discover it has a 5.20 payable turnover for the most recent quarter.

If your AP turnover is above 5.2, that would look better to creditors. However, it might also mean that you’re paying your bills more quickly than you need to, tying up cash you could use in other ways.

If your ratio is below 5.2, creditors might be more concerned, but it could also mean that you’re deliberately slowing your payments to use your cash somewhere else.

Your specific number isn’t as important as whether you’re hitting your target. Metric-savvy AP teams decide strategically on the metrics they want to hit, then track those metrics, including their AP turnover ratio, to make sure they’re meeting their goals.

What other AP metrics do creditors consider?

When a vendor or supplier is considering whether to extend credit to your business, they may also look at your days payable outstanding, or DPO.

Your AP turnover ratio is generally more important than DPO in making business decisions, but DPO provides additional information to paint a more complete picture of your accounts payable.

What is days payable outstanding (DPO) and how is it different from AP turnover?

Days payable outstanding is a measure of how long bills sit in your payables queue before you pay them. It differs from AP turnover because it reports an average number of days, not a ratio.

DPO is especially important to your vendor relationships. It shows you how long your vendors have to wait before receiving payment.

How to analyze and improve your AP turnover ratio

In tracking your AP turnover, it’s important to understand not just where your ratio is today but how that number has been changing. Is your ratio higher or lower this month compared to last month? What about this year compared to the past year?

Tracking how your turnover changes can help you determine the health of your business’s cash flow. When your turnover ratio rises, that means you’re paying your bills more frequently. When it drops, you’re paying bills less frequently.

Many AP teams include their turnover ratio as a north star metric. Running a turnover ratio analysis on a regular basis helps you make strategic decisions for your cash flow and measure your success in achieving your objectives.

How can you improve your AP turnover ratio?

Step 1: Track your AP ratio over time

The first step in improving your AP turnover ratio is to start tracking it regularly. Ask your accountant or accounting department to report your accounts payable turnover ratio and other key performance indicators (KPIs) every month, quarter, and fiscal year. This gives you a constant picture of your company’s financial health, helping you manage your finances in a proactive way.

Step 2: Track the AP ratio of industry leaders

Because public companies have to report their financials, you can follow the AP turnover and other metrics of industry leaders to see how your own business compares. This can help you improve your company’s financial health and even identify strategic advantages you might be able to leverage for greater success.

Step 3: Decide strategically what you want your turnover to be

Maybe you want to raise your AP turnover to get more favorable credit terms. On the other hand, maybe it’s already quite high, and a lower ratio could help you increase your cash reserves. Consider the factors of your specific industry and your current financial position to set the right strategic target for your own business.

Step 4: Make tactical decisions to hit your target

If your AP turnover target is lower than your ratio today, you’ll need to pay your bills more slowly. It’s important to make those decisions carefully, putting a system in place to decide which bills you can afford to pay later and which you can’t.

Here are just a few of the many factors to consider:

  • Where can you take advantage of early payment discounts
  • Which payment terms give you longer to pay, such as Net 60 instead of Net 30
  • Which vendors might be open to negotiating new terms
  • Which vendor relationships are most critical to your business

If your target ratio is higher than your ratio today, you’ll need to reduce your current liabilities and pay your bills more quickly. Remember, a lower accounts payable balance will also raise your AP turnover ratio.

Here are some additional ideas to consider as you develop your own strategy for improving your AP turnover:

  • Pay some vendors by credit card to pay them quickly while deferring your cash outlay
  • See if you have enough inventory to slow any supplier orders temporarily
  • Streamline your accounts payable process with AP automation

Conduct financial analyses regularly

Nimble, high-growth companies rarely wait until the end of the year to conduct financial analyses. Instead, they make it a habit to track key metrics like cost of goods sold (COGS), liquidity ratios, high account balances, and more on a regular basis.

They also promote strong communications between business finance and operations, which need to work together to make both strategic and tactical decisions.

Remember that business processes and financials are a two-way street. Your operations create bills and other cash obligations that your business needs to cover, and your accountant or finance team can also help shape your business strategy, providing the right financial tools to help you grow.

Using AP automation software can help increase visibility

AP automation can help to ensure your company’s financial condition is in good standing. Create a more efficient AP process by avoiding duplicate payments and ensuring that money owed to suppliers is paid on time.

AP automation software from BILL simplifies the accounting process so your business can avoid late charges, stay on top of payments and improve overall financial visibility.

Start making vendor payments faster with AP automation from BILL today.

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