Accounts Payable Turnover Ratio Defined: What You Need to Know

The accounts payable turnover ratio is a financial calculation used to measure how quickly a company pays money owed to its creditors, such as suppliers, over a given accounting period. This ratio provides a crucial metric for businesses that helps to track their liquidity, as it indicates the organisation’s ability to manage and fulfil its accounts payable obligations.

Accounts Payable Turnover Ratio Definition & Calculation

The accounts payable (AP) turnover ratio, sometimes also referred to as payables turnover or creditors turnover, is a figure that shows how many times a business pays its creditors over a certain period. As noted by the Australian Securities and Investments Commission (opens in new tab) (ASIC), creditors may be any individual, organisation or institution that has provided goods, services, or loans to the business.

In Australia, managing creditor obligations is not just a liquidity issue; it also affects GST reporting, compliance with ATO payment reporting rules, and credit rating with local vendors. Many Australian businesses rely on financial software tools, like NetSuite, to track accounts payable and cash flow trends in line with the local tax year cycle, which runs from July to June.

The AP turnover ratio itself is usually a fairly straightforward calculation that provides insights into the short-term liquidity of a business, and how efficiently it is managing its payables. Since it shows how fast or slowly a company is paying its bills, it can help to cast a light on the financial health of the business. For instance, if the ratio noticeably declines between one period and another, it could mean that the organisation’s finances are in trouble.

To calculate the AP turnover ratio, you need to begin with two figures: the total cost paid for purchases—or cost of goods sold (COGS)—on lines of credit from suppliers, and the average accounts payable over a particular period, in this case a calendar year.

The formula looks like this:

Total supplier purchases on credit / average accounts payable = accounts payable turnover ratio

The average accounts payable figure should equal the sum of the accounts payable at the beginning of the year in question and at the end of the year, divided by two.

Accounts payable at beginning of period + accounts payable at end of period / 2 = average accounts payable

For example, if the costs of goods sold over the year is $500,000, and the accounts payable at the beginning of the year in question is $40,000 while the accounts payable at the end of the year is $60,000, the accounts payable turnover ratio would be 10 — meaning the company has paid off its accounts payable 10 times during the period.

Below is the two-step calculation process:

• Step 1: $40,000 + $60,000 / 2 = $50,000
• Step 2: $500,000 / $50,000 = 10

From this calculation, it’s possible to work out the accounts payable days, which is the average number of days it takes the company to pay its suppliers over the course of the year in question, since we have the AP turnover ratio value for the year and the number of days in the year (365).

365 / accounts payable turnover ratio = accounts payable days

Using the figures in the example above, the accounts payable days would be 36.5 days — meaning it takes the business an average of 36.5 days to pay its suppliers .

Using the figures in the example, this is the calculation:

365 / 10 = 36.5 days (accounts payable days)

Importance of the Accounts Payable Turnover Ratio

The accounts payable turnover ratio provides visibility into a business’s ongoing financial health and performance, helping to uncover a range of critical financial insights such as how well the business is managing its cash flow, its short-term liquidity status, and the state of its vendor relationships. The ratio also helps to assess the organisation’s financial risk posture, as it reveals how capable the business is of managing its payables on an ongoing manner.

Benchmarking AP turnover ratio against averages in a given industry, which are typically published by the Australian Industry and Skills Committee or IBISWorld, can provide business decision-makers with valuable insights. It’s important to consider industry-specific benchmarks to make accurate assessments, because industries with lots of small transactions, such as retail and hospitality, have tighter accounts payable cycles than those with less frequent but larger transactions, such as construction or manufacturing.

Understanding the Implications of the Ratio

Because the AP turnover ratio provides visibility into an organisation’s liquidity and financial risk profile, it is of particular interest to investors who want to ensure their investments are sound and are likely to result in an expected return. Likewise, the AP turnover ratio can play a big role in supplier relationships, as it is used to gauge an organisation's creditworthiness, determining not only whether a supplier is likely to do business with an organisation, but also helping to work out how much credit a supplier is likely to extend to the organisation.

Some of the key areas where the AP turnover ratio can provide important business insight include:

• Business benchmarking: As noted earlier, you can benchmark your AP turnover ratio against other businesses within your market sector to determine how you compare to your competitors.
• Vendor relationship management: The promptness of your supplier payments, as defined by the AP turnover ratio, can build and secure warm relationships with your suppliers, often leading to better terms.
• Cash flow management: Accounts payable play a big role in cash flow. The AP turnover ratio can reveal whether early payments are putting a strain on cash reserves or cash shortages are delaying payments.
• Liquidity status: Because the AP turnover ratio provides insight into cash flow management, it can also offer insight into liquidity. For instance, a higher ratio can indicate robust liquidity, in some cases.

Analysing the AP Turnover Ratio

At its core, the accounts payable turnover ratio helps businesses understand their ability to pay creditors on time. As explored above, this can be used to shed light on any number of broader financial questions business leaders, suppliers, investors and other stakeholders may have about the business. However, one of the most immediate outcomes of the AP turnover ratio is its value in helping businesses understand how effectively they are servicing their lines of credit with suppliers.

As noted by Business Queensland (opens in new tab), the lower the number of AP turnover ratio days, the better. Likewise, a higher number of days is typically viewed negatively, as it indicates slow payments to suppliers, which could damage supplier relationships. Comparing these figures to industry benchmarks can help to determine areas of financial strength or weakness within the business, informing options for improvement over time or helping to convince investors of the organisation’s financial health.

Likewise, analysing AP turnover ratios over time, when tracked and compared from one accounting period to another, can indicate important trends within the business. For instance, a declining AP turnover ratio may suggest financial trouble and lead to lower lines of credit with suppliers. Conversely, an increasing AP turnover ratio could suggest efficient cash management and result in longer lines of credit with vendors.

However, it should be noted that the AP turnover ratio, while a valuable tool, typically doesn’t provide the full financial picture. Rather, it offers a critical portion of the whole. That’s why it’s important for the AP turnover ratio to be assessed in combination with other financial ratios and metrics. From the creditors’ perspective, for instance, a high AP turnover ratio is typically viewed in a positive light. But if the ratio is high because the business is paying its creditors too much, too soon, that could drain the company’s cash reserves.

High vs. Low AP Turnover Ratio

As discussed previously, a high accounts payable ratio typically indicates that a company is paying its creditors and suppliers quickly. A low ratio, on the other hand, suggests the business is slower in paying its bills. High and low AP turnover rates can reveal critical insights into the following areas:

How to Optimise the Accounts Payable Turnover Ratio

Given the different ways the accounts payable turnover ratio can be used as a bellwether of business and financial stability, optimising it has the potential to enhance key financial health measures. Doing so can help businesses to secure more favourable credit terms with vendors or suppliers, improve supplier relationships, streamline cash flow management, and shore up investors’ confidence in the business and its financial performance.

Some of the key strategies aimed at optimising the AP turnover ratio are:

• Negotiate longer terms: A simple way to make the AP turnover ratio optimal for the business is to negotiate longer payment periods to provide more flexibility in managing invoices and payment planning.
• Pursue payment incentives: Likewise, working with creditors to negotiate payment incentives, such as discounts for early payment, can help reduce costs.
• Optimise accounts receivable: Amending accounts receivable collection to ensure debtor payments are made on time or early can help to generate the cash flow to meet creditor obligations sooner.
• Identify receivable payment delays: Evaluating your accounts receivables could highlight instances of slow or late payment from debtors, which could be restricting cash flow for creditor payments.
• Tweak cash flow management: Have a close look at how the business is managing cash flow to determine how reducing days payable outstanding may have on the organisation as a whole.
• Review COGS: Work out exactly how much you’re spending on the products and services you sell to see if there’s any room for improvement in terms of profit margin, which can free up cash.

Best Practices

Getting your accounts payable turnover ratio right for your business is not a one-step process. For many businesses, it can take time and incremental adjustments to find the optimal AP turnover ratio for your business and its broader financial settings. It’s worth remembering, too, that for some businesses, the AP turnover ratio can change over time naturally, as a result of influences such as seasonal sales fluctuations. Regardless, certain best practices can help to strike the right balance for your business’s AP turnover ratio.

Here are some key best practices to make your AP turnover ratio work for your business:

• Streamline AP processes: Streamlining AP processes with specialised software can simplify workflows and make it easier to pay bills on time and more efficiently, helping to avoid late payment penalties.
• Leverage AP automation: When looking for AP turnover solutions to improve your processes, make sure it has tools to automate things like processing, payment approvals, and supplier communication.
• Regularly audit AP: Establish an ongoing accounts payable audit process to identify and rectify inefficiencies, overpayments, and errors that may arise from one period to the next.
• Maintain close supplier relationships: The closer you are to your suppliers, the better your credit terms are likely to be, so it’s worth building strong relationships for lasting trust on both sides.
• Communicate with suppliers: Part of fostering close creditor relationships is keeping suppliers informed about payment schedules and addressing any issues promptly. Open communications are critical.
• Prioritise invoices: A constant focus on prioritising invoices and staying on top of them with the help of appropriate AP software can ensure timely payments and avoid delays, making for a better ratio.
• Consider Australian tax deadlines and BAS cycles: Optimise your AP processes around quarterly Business Activity Statement (BAS) lodgement timelines to maintain strong compliance and avoid cash flow issues.

How NetSuite Helps You Automate Your Accounts Payable Processes

NetSuite’s Accounts Payable Software, part of NetSuite ERP, gives businesses the ability to automate the review, approval, and payment of supplier invoices, leaving you greater control over the full procure-to-pay process. NetSuite Accounts Payable helps to maintain detailed vendor records, create and manage purchase requests, and improve data accuracy by automatically matching invoices to the correct vendor and purchase order. Automated journal entries eliminate the need to manually enter debits and credits, saving time and ensuring payments are recorded accurately.

Accounts Payable Turnover Ratio FAQs

How do you calculate the accounts payable turnover ratio?

The accounts payable turnover ratio is calculated by taking the total cost paid for purchases on lines of credit from suppliers and dividing it by the average accounts payable over a particular period.

Is a higher or lower accounts payable turnover better?

It depends on your company’s financial situation. But a higher accounts payable turnover ratio is usually deemed better than a lower one, since it indicates a greater ability to pay creditors.

How to improve accounts payable turnover ratio?

Some of the steps you can take to improve your accounts payable turnover ratio include:

• Audit your company’s cash flow management
• Improve credit lines with suppliers
• Review costs of goods sold

What is a good accounts payable turnover for Australian businesses?

A good accounts payable turnover ratio depends on the industry and payment frequency. For instance, a ratio of 12 indicates that a business pays its invoices within an average of 30 days throughout the year, and is considered healthy.