All businesses must manage their short-term liquidity effectively, both to track available resources and the data by which lenders view it. Lenders and suppliers will gauge any perceived difficulties a company may be navigating and how well it manages cash flow through an important metric known as accounts payable turnover ratio.

Utilized by lenders and accounts payable teams alike, the accounts payable turnover ratio highlights how quickly a business pays its creditors and lenders. This data helps reveal the health of an organization over a time period, most commonly from year to year. Although undervalued as a key performance indicator, the AP turnover ratio indicates the likely status of their vendor relations and how the business is maximizing its short- and long-term resources. 

Calculated by way of a straightforward formula, if an organization’s ratio indicates alarm, suppliers and creditors will be increasingly hesitant to extend additional lines of credit, hampering both stability and potential growth. 

How the accounts payable turnover ratio is measured 

AP professionals calculate a company’s accounts payable turnover ratio by dividing the total purchases by the average levels of accounts payable available throughout a specific time period.

Accounts Payable Turnover Ratio = Total Purchases / Average Accounts Payable

Two factors stand out when determining this formula::

1. Average accounts payables

2. Net vs. gross purchases 

Average accounts payables are utilized due to fluctuations throughout any given year. By relying on an average, the ratio is taking into account a broader dataset, resulting in more comprehensive data. The average accounts payable is calculated by adding the beginning and ending accounts payables and dividing the total by two.

Accounts Payables = Beginning + Ending Balances / 2

To utilize net AP balances, take the total purchase cost and subtract all applicable returns and cancellations.

What is a good accounts payable turnover ratio

Determining whether an accounts payable turnover ratio is ‘good’ or ‘bad’ requires interpreting results through the lens of a business’s particular industry. Generally, however, a higher accounts payable turnover ratio will ensure more available and favorable terms with lenders and suppliers. It conveys how promptly a company’s bills are paid, while a lower ratio indicates slow and potentially unreliable bill payment processes and inconsistent credit terms policies. A lower ratio will cause hesitation, potentially reflecting ineffective cash management, resulting in limited lines of credit and more restrictive terms.

As with the ratio itself, several factors must be considered to best interpret the data. 

1. Historical APTR trends for the company

2. Competitor/peer ratios (similar size and industry)

Historical accounts payable turnover ratios for a company

Integrating long-term trends for an individual company and its industry provides a crucial context. Is a company’s accounts payable turnover ratio an outlier, reflecting uniquely favorable credit/supplier terms?

Industry-specific accounts payable turnover ratios

Similarly, desirable ratios can differ depending on the specific industry and the size and scope of a business. Do industry-specific suppliers expect payment upon delivery (goods or services)?

Any perception of a ‘good’ ratio must evaluate this data if it is going to assess a business’ accounts payable health comprehensively.  

Limitations to accounts payable turnover ratio

As with the factors that help determine whether or not a given ratio is ‘good’ when considering accounts payable turnover ratios, it is important to remember the limited data being delivered. 

Ratios will not readily reflect unique situations that can occur, such as one-time, significant purchases. If an industry has high purchase volume and low purchase amounts, this will distort ratios.

An accounts payable turnover ratio is an effective tool for assessing a company’s cash flow and trustworthiness. Still, valuing the context within which the ratio occurred is critical. 

Ways to increase a company’s accounts payable turnover ratio

When determining a company’s stability and viability, current and potential creditors and investors will weigh, among many factors, its accounts payable turnover ratio. Does it reflect timely payments? Are supplier relationships in a positive place? Is the company reliable in the long term?

Once limiting factors have been noted, a low AP turnover ratio will indicate the likelihood of missed payments and damaged or frayed supplier relationships, and the potential for undesirable debt loads.

A company can take various actions to improve its accounts payable turnover ratio, with effectiveness reliant upon the company, its unique situation, and the capabilities or limitations of its AP department. Improved cash flow management can be achieved with directed efforts and enhanced resources.

1. Evaluate and simplify internal accounts payable workflows where feasible

1. Focus on reducing human error

2. Minimize labor requirements

3. Improve supplier experience

2. Assess current terms with all creditors and suppliers

1. Identify all early payment discounts

2. Renegotiate negative terms

3. Adhere to payment due dates without fail

4. Integrate accounts payable automation solutions to potentially achieve:

1. Lower average cost per invoice

2. Shorter average time to payment

3. Fewer late payments

4. Reduction in time-intensive disputes

5. Streamlined approval processes

How to decrease a company’s accounts payable turnover ratio

An accounts payable turnover ratio on the lower end of the spectrum may cause suppliers and creditors to believe that a business has not performed successfully over a specific time period.

Measures to decrease this ratio must be handled carefully and with a specific strategy.

• Extend payment terms when feasible

• Disregard early payment discounts (if the tradeoff is reasonable)

Any steps taken must weigh any potential impact on supplier/creditor relationships, which isn’t always a straightforward answer. 

Written By: Daniel Redding
Date: February 2023