Reading Financial Reports For Dummies
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A company's reputation for paying its bills is just as important to financial report readers as its ability to collect from its own customers. If a company develops the reputation of being a slow payer, it can have a hard time buying on credit.

The situation can get even more serious if a company is late paying on its loans. In that case, the business can end up with increased interest rates while its credit rating drops lower and lower.

You can test a company's bill-paying record with the accounts payable turnover ratio. In addition, you can check how many days a company takes to pay its bills by using the days in accounts payable ratio. Keep reading to find out how to calculate these ratios.

How to calculate the ratio

The accounts payable turnover ratio measures how quickly a company pays its bills. You calculate this ratio by dividing the cost of goods sold (you find this figure on the income statement) by the average accounts payable (you find the accounts payable figures on the balance sheet).

Here's the formula for the accounts payable turnover ratio:

Cost of goods sold ÷ Average accounts payable = Accounts payable  turnover ratio

You can use Mattel's and Hasbro's income statements and balance sheets for 2012 to compare their accounts payable turnover ratios.

Mattel

  1. Find the average accounts payable:

    $334,999,000 (2011 accounts payable) + $385,375,000 (2012 accounts payable) ÷2 = $360,187,000 (Average accounts payable)

  2. Use that number to calculate Mattel's accounts payable turnover ratio:

    $3,011,684 (Cost of goods sold) ÷$360,187,000 (Average accounts payable) = 8.4 times

Mattel turns over its accounts payable 8.4 times per year.

Hasbro

  1. Find the average accounts payable:

    $134,864,000 (2011 accounts payable) + $139,906,000 (2012 accounts payable) ÷2 = $137,385,000 (Average accounts payable)

  2. Calculate Hasbro's accounts payable turnover ratio:

    $1,671,980 (Cost of goods sold) ÷$137,385,000 (Average accounts payable) = 12.7 times

Hasbro turns over its accounts payable 12.7 times per year, which is faster than Mattel.

What do the numbers mean?

The higher the accounts payable turnover ratio, the shorter the time between purchase and payment. A low turnover ratio may indicate that a company has a cash-flow problem. Hasbro is paying its bills more rapidly than Mattel.

Each industry has its own set of ratios. The only way to accurately judge how a company is doing paying its bills is to compare it with similar companies and the industry.

About This Article

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About the book author:

Lita Epstein, who earned her MBA from Emory University’s Goizueta Business School, enjoys helping people develop good financial, investing and tax-planning skills.
While getting her MBA, Lita worked as a teaching assistant for the financial accounting department and ran the accounting lab. After completing her MBA, she managed finances for a small nonprofit organization and for the facilities management section of a large medical clinic.
She designs and teaches online courses on topics such as investing for retirement, getting ready for tax time and finance and investing for women. She’s written over 20 books including Reading Financial Reports For Dummies and Trading For Dummies.
Lita was the content director for a financial services Web site, MostChoice.com, and managed the Web site, Investing for Women. As a Congressional press secretary, Lita gained firsthand knowledge about how to work within and around the Federal bureaucracy, which gives her great insight into how government programs work. In the past, Lita has been a daily newspaper reporter, magazine editor, and fundraiser for the international activities of former President Jimmy Carter through The Carter Center.

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