How to Use Financial Reports to Calculate the Accounts Payable Ratio - dummies

How to Use Financial Reports to Calculate the Accounts Payable Ratio

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.