Accounts Payable Turnover Ratio

This video shows how to calculate the Accounts Payable Turnover Ratio.
The Accounts Payable Turnover Ratio is calculated by dividing the amount of credit purchases from suppliers by the average Accounts Payable (you compute the average Accounts Payable by adding the ending balance of Accounts Payable to the beginning balance of Accounts Payable and dividing the amount by two). In some textbooks you will see Cost of Goods Sold divided by the average Accounts Payable, but this is not correct.
The Accounts Payable Turnover Ratio tells you how many times the company paid its suppliers during the period (it ignores cash purchases from suppliers). A higher Accounts Payable Turnover Ratio means the company is paying its suppliers quickly. This means the company is paying its bills on time (and is perhaps getting a discount, depending on how fast it pays). However, what is considered a "good" ratio varies by industry; thus, you should compare a company's Accounts Payable Turnover Ratio to the ratios of the firm's competitors (and also look at the trend in the ratio over time).
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[@MyFinancialFocus]

Maximize days payable outstanding and minimize days sales outstanding. Name of the game when it comes to cash flow :)

[@francescociccone2224]

Good video. Tip: for the next ones, try to use a non-black background, because with any light beating down on the screen it makes it hard to see what is written there.

[@cpt6710]

Why dont we include purchases made from cash? Why only credit?

[@drewknox2261]

When calculating AP turnover ratio you are wanting to know: How quickly am I paying back my debts? We don't include cash transactions because they are paid for on the spot. It would skew your analysis.

[@jakubosobka4414]

Why does nobody ever explain where did those formulas actually come form? I mean you look at the BS and IS, sb tells you to find out the number of days the company pays its bills or collects its receivables - who comes up with exatcly those numbers. How did anyone come up with this - it's completely unintuitive. WHY would such ratios give you exatcly those meanings. I know you gotta have some accounting background and I got the basics, but the whole concept of all those conversion cycles formulas still seems completely unintuitive to me.. I've looked up multiple sources, books, youtube, articles and whenever this comes up there's NEVER an actual EXPLANATION on WHY these formulas are built like that and WHY we interpret the results of those, like everyone tells us to interpret them..

[@Edspira]

The accounts payable turnover ratio is used to calculate Days Payable Outstanding (DPO), which is how many days it takes the company to pay its bills. DPO is useful when it comes to working capital management. For example, if you add up a company's Days Sales Outstanding (DSO) and Days Sales in Inventory (DSI) and then subtract Days Payable Outstanding (DPO) you get something called the cash conversion cycle, or cash-to-cash cycle. DSO + DSI - DPO = C2C cycle. This is the amount of time the company must come up with capital (either from investors or lenders) to finance its inventory. Assume it takes a company 30 days to sell its inventory (DSI) and 40 days to collect payment from customers (DSO), and that the company pays its suppliers in 25 days. It takes the company 70 days to get cash for its inventory (30 days to sell it, then 40 days waiting to collect payment), but the company's suppliers are willing to wait 25 days for payment. Thus, the company needs to finance the inventory for 45 days (70 days -25 days). This is called the cash conversion cycle (45 days), and the shorter the cycle is, the better it is for the company. Some companies actually have a negative cash conversion cycle, which means they have sold their inventory and received cash for it before they even have to pay their suppliers for the inventory. The longer the cash conversion cycle, the worse it is for the company, because it means the company will have to borrow money or do something else to finance the inventory until they until receive cash for it. Thus, by reducing the length of the cash conversion cycle, a company can reduce its costs considerably. For a large company, we're talking about millions of dollars.

[@jakubosobka4414]

@@Edspira thank you for this. Acutally the CCC makes a lot more sense to me. I have a bigger problem understanding the concept of why would dividing e.g. receivables by daily revenues (assuming there's only credit sales in the company) would give me the number of days the company collects its receivables. Or dividing inventory or payables by daily COGS would give me the number of days the company has its inventory or payables as outstanding.

[@Edspira]

You asked about the intuition behind Days Sales Outstanding (DSO), so here is an example: a company makes $120,000 in credit sales each year and has an average accounts receivable balance of $10,000. The company's accounts receivable turnover would be 12 (which is $120,000 / $10,000); this means the company collects its receivables 12 times/year. Conceptually, you could think of the company selling $10,000 of product, then collecting it at the end of the month. Then it sells another $10,000 of product, and it collects it at the end of the next month. Another way to express the A/R turnover is DSO, which is 365 / accounts receivable turnover. In this case it would be 365/12, which is 30.4. This means that if the company makes a credit sale, it will collect the money from the customer 30 days later on average.

[@jakubosobka4414]

@@Edspira wow now all of this actually makes much more sense! thank you❤️