What Is Accounts Payable Turnover?: What It Tells You About a Company’s Financial Health

Before we dive into the turnover ratio, let’s quickly define the “accounts payable” part of the equation. Accounts Payable (AP) represents the money a company owes to its suppliers and vendors for goods or services purchased on credit. Think of it as the company’s short-term debt, a line item on the balance sheet that shows the outstanding bills that must be paid soon.

For example, if a car manufacturer buys steel from a supplier on a 30-day credit term, the value of that steel is recorded as an accounts payable until the manufacturer pays the invoice. AP is a normal and necessary part of business operations, but how a company manages this liability is a key indicator of its financial health.

The Accounts Payable Turnover ratio measures how many times a company pays off its average accounts payable during a period, typically a year. The formula is straightforward, but it requires two key pieces of information from the company’s financial statements: its Cost of Goods Sold (COGS) and its average Accounts Payable.

Accounts Payable Turnover = Cost of Goods Sold / Average Accounts Payable

In this formula:

• Cost of Goods Sold (COGS): This is the direct cost of producing the goods sold by a company. It includes the cost of the materials and labor directly used to create the product. You’ll find COGS on a company’s income statement. It’s used here because most accounts payable are tied to the raw materials and services needed to produce a company’s core product.
• Average Accounts Payable: To get a more accurate picture over the period, we use an average of the beginning and ending accounts payable balances. You can find these figures on the company’s balance sheet at the start and end of the period.

Average Accounts Payable = (Beginning Accounts Payable + Ending Accounts Payable) / 2

Let’s imagine a company, “TechGadget Inc.,” had a COGS of $50 million last year. At the start of the year, its accounts payable was $4 million, and at the end of the year, it was $6 million.

First, we calculate the average accounts payable:

(4 million+6 million) / 2 = 5 million

Now, we calculate the turnover ratio:

Accounts Payable Turnover = 50 million / 5 million ​= 10

So, TechGadget Inc. paid off its average accounts payable about 10 times over the year.

The Accounts Payable Turnover ratio isn’t a standalone metric; its meaning is found in comparison. It’s most insightful when you compare a company’s ratio to its own historical performance, to industry benchmarks, and to its competitors.

A high Accounts Payable Turnover ratio (meaning a company pays its suppliers quickly) can suggest several things:

• Strong Liquidity: A company with a high turnover ratio is likely flush with cash and has the financial resources to pay its bills without delay. This is a sign of financial strength and efficient cash flow management.
• Lost Opportunity: A turnover ratio that is too high, however, could indicate that a company isn’t taking full advantage of its credit terms. By paying too quickly, it might be missing out on using its suppliers’ capital interest-free for a longer period, which could be used for other investments or operations.
• Limited Negotiating Power: In some cases, a company might have to pay quickly because it lacks the bargaining power to negotiate more favorable credit terms with its suppliers.

A low Accounts Payable Turnover ratio (meaning a company pays its suppliers slowly) also has a dual interpretation:

• Strategic Cash Management: A company might be intentionally extending its payment period to improve its working capital. By holding onto cash longer, it can use that money for short-term investments, operational expenses, or to fund growth. This is a common strategy in industries where cash is king.
• Financial Distress: On the other hand, a low turnover ratio could be a major red flag. If a company is paying its bills slowly because it simply can’t afford to pay on time, it could be a sign of a looming cash flow crisis or poor financial health.
• Strained Supplier Relationships: Consistently slow payments can damage a company’s relationships with its suppliers, potentially leading to a loss of key suppliers, less favorable credit terms, or even a disruption in the supply chain.

The ideal accounts payable turnover ratio is a delicate balancing act. It’s not about being the fastest or the slowest, but about being optimal. The “sweet spot” is a ratio that allows a company to take full advantage of its credit terms without straining supplier relationships or risking its reputation. This often translates to a ratio that is in line with or slightly below industry averages, suggesting a company is effectively using its financial leverage.

So, how do you use this information to make better investment decisions?

• Look for Trends: Don’t just look at one year’s number. Track a company’s Accounts Payable Turnover ratio over several years. Is it stable, or is it trending up or down? A sudden, significant drop could signal financial trouble, while a consistently managed ratio shows stability.
• Benchmark Against Competitors: Compare the ratio of a potential investment to its direct competitors. If Company A has a ratio of 10 and its main competitor, Company B, has a ratio of 6, it could mean Company B is more effectively leveraging its credit terms—or it could mean Company B is struggling to pay its bills. You need to dig deeper into their cash flow statements to find the answer.
• Cross-Reference with Other Ratios: A single ratio is never enough. Combine Accounts Payable Turnover with other metrics like the Accounts Receivable Turnover (how quickly a company collects money from its customers) and the Inventory Turnover (how quickly it sells its goods). Together, these ratios provide a powerful picture of a company’s entire cash conversion cycle—the time it takes to convert its investments in inventory and other resources into cash.

Accounts Payable Turnover is more than just a number—it’s a window into a company’s operational efficiency, liquidity, and even its strategic relationship management. While a high number can suggest strong financial health, a low number isn’t always a negative; it could be a sign of a company strategically managing its cash.

As an investor, you should use this ratio as a detective’s tool. Don’t simply accept a number as good or bad. Instead, use it as a starting point to ask smarter questions. Why is the ratio what it is? How does it compare to the past and to competitors? 

By doing so, you’ll gain a deeper, more nuanced understanding of a company’s true financial standing and move closer to making well-informed investment decisions.