Accounts Payable Turnover Ratio

The Account Payable Turnover Ratio (or APT ratio) is used to measure the length of time that is needed for a company to repay (liquidity of the company) its suppliers. The suppliers of a company are simply companies that produce different parts that the company could assemble together. For example a glass manufacturer is a window supplier for a car manufacturer, as the car manufacturer gives orders of windows of specific sizes and shapes to the glass manufacturer.

The APT ratio’s main purpose is to measure short term liquidity, as suppliers allow short a payment period, usually withing 30-90 business days, however this preriod is dependent on many factors, such as the industry norm, relative size of the supplier to that of the company, and the financial condition of the supplier.

The formula for the Account Payable Turnover ratio is

Accounts Payable Turnover Ratio = Cost of Goods sold/Accounts Payable

To fully understand this formula, first, we need to define the terms in the numerator and the denominator of the formula.

Cost of goods sold

Cost of goods sold is simply the money a company spends to manufacture the given product. The cost of goods take many things into consideration, such as the cost of raw materials and different parts from suppliers, the total cost of labor per good (divide total wages with number of goods sold on the market), electric bill per sold good, and many other types of costs. In the above formula this refers to the total costs of all of the goods produced in a set period of time.

Accounts payable

Accounts payable are the short term credits that the company has to pay within a set period of time, usually within less then one year, but more often than not this period is a few months.

Now let us see an example of the Accounts Payable Turnover ratio. Lets say that a company had total cost of production $10 million in its full fiscal year. Its total short term credits in the same period was $5 million. Applying the formula, we get an APT ratio of 2. This figure of 2 means that the company repays (turns over) its creditors 2 times a year, that is, every 182 days.

Advantages of using the Accounts Payable Turnover ratio

When valuing a company based on the APT ratio, one advantage is that only the performance of the company is taken into consideration, and no outside factors, like the current stock market sentiment, that determines the price of the share of the company.

This ratio determines the financial stability of the company with a good accuracy. A high Account Payable Turnover ratio signals that the company in question produces cash fast. If this figure is low, it suggests that the company is in serious cash flow trouble.

Disadvantages of using the Accounts Payable Turnover ratio

Low ratio results can be misleading. Many companies extend the period of credit turnover (rapayments) for financial efficiency reasons. For example, a company has income of $1 million. If the company is in a powerful position compared to its suppliers, it can invest that amount of money, for say 3 months (when the creditor payment is due). If the company receives 12% annual interest, that means, that for the 3 months it receives 3%, or $30, 000 minus the interest of the credit (if there is any).

Disputes with the suppliers also extends this turnover period, thus decreasing the Accounts Payable Turnover ratio.

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Comments 5 comments

forlan profile image

forlan 6 years ago

This is a good indicator to value the company. Thanks for your explanation.


Csanad profile image

Csanad 6 years ago from Budapest, Hungary Author

bi: Assuming that a customer of the company bought products/services of the company on credit in the past, it is reasonable to assume that that customer will continue to do so in the future. If all other clients' payable to the company remains the same, more and more purchases on credit will result in an increase in trade receivables. Of course, there is a certain limit the company can allow this: it needs cash flow too, not just balances.


bi 6 years ago

do you knw the reason why the trade receiveable increase from one year to anotehr year?


Csanad profile image

Csanad 7 years ago from Budapest, Hungary Author

Yep, you're right.


EasyLearn profile image

EasyLearn 7 years ago from Washington State

Thank you for making the point that accounts payable can be a good thing, not just a liability. The opposite is also considered true where accounts recievable is an asset.

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