Creditor Turnover Ratio: Definition & Interpretation

What is Creditors Turnover Ratio?

The creditors turnover ratio is also known as 'accounts payable' turnover ratio is liquidity ratio that measures the number of times a company pays off its creditors in a year. The creditors turnover ratio is a short term liquidity.

      

The creditor payable ratio shows how efficiently a company is paying the creditors and short term debts.

Creditors Turnover Ratio Formula

The creditors turnover ratio is calculated by net credit purchases by average trade payables.

       

creditor Turnover Ratio=(Net credit purchases/Average Trade Payables)

In Some cases, net purchases is used in numerator instead of net credit purchases.

          

Average trade payables=(Creditors at the beginning of the year + Creditors at the end of the year)/2, if opening balance is not given, the closing balance can be used.

Creditors Turnover Ratio Example

             

It is ABC company. Here is some information about the ABC company.   

Particular                   Amount(Rs)

Net credit purchases  10,00,000

Opening creditors         2,00,000

Closing creditors           2,50,000

 So, average trade payables=(2,00,000+2,50,000)/2= Rs 2,25,000

           Therefore, creditor turnover ratio= 10,00,000/2,25,000= 4.44 times

It means ABC company has paid off its creditors around 4.44 times.

What is Account Payable/creditor Days? 

It tell us the number of days in which the company repays its creditors.

Creditors Days Formula & Example

It is calculated the following way,

       

Creditors Days=(365/Creditors Turnover Ratio)

       Therefore,  Creditors Days=(365/4.44)=82.20 days

It means ABC company takes around 82.20 days to pay off its creditors.

        As a rule of thumb, higher the number of days taken for the company to pay off creditors, better it is for the company.

Creditors Turnover Ratio Interpretation

Creditors Turnover Ratio measures the efficiency of the company regarding timely payment to the suppliers & short term debt obligations. 

Always a higher ratio is better than lower ratio. It is good for the company if creditors allow them a long credit period. It is also advantageous for the company if it pays before time to take advantage of early payment discounts.

      

A higher payable ratio(the company is paying up creditors faster than the industry average) relative to industry reflects that company is not utilizing the credit facilities properly and management is not able to negotiate well with suppliers, for a reasonable credit period.

      

A lower payable ratio reflects that company is not able to pay its creditors on time or company is requiring a higher number of days to pay back its creditors than the industry average(assuming that the company has a lot of debt obligations).

      

As a rule of thumb, the lower the creditor turnover ratio, the better it is for the company. This ratio depends on industry standards. This ratio is used to compare companies within same sector.