Payables turnover formula is a method of determining approximately how long it takes a business to pay back those suppliers from whom it purchases goods. Since most suppliers are paid using some method of credit, there is generally a period between when the business receives its supplies and when it pays the suppliers for them. The payables turnover formula is performed by dividing the cost of goods sold during a certain time period by the average accounts payable for that time period. This number can then be divided by the amount of days in the period to determine the days payable, which is the approximate length of time in days it takes a company to pay back suppliers.
The relationship between a business and its suppliers is a crucial one. A company that keeps up a solid payment schedule can usually depend upon having the necessary inventory to smoothly conduct business. If a company struggles to make payments to its suppliers, that relationship can be put in jeopardy, which in turn can jeopardize the company itself. For that reason, the payables turnover formula is an important calculation for business managers to make.
For example, imagine that a company has amassed a total of $400,000 US Dollars (USD) for the cost of goods sold in a single year. In that same time period, the average amount of the accounts payable it owed was $20,000 USD. The payables turnover formula requires that the $400,000 USD be divided by the $20,000 USD. As it turns out, the company's accounts payable turnover is 20.
This amount gained from the payables turnover formula can then be used to calculate the length of time that the company, on average, needs to pay back its suppliers, also known as days payable. It can be done by taking the 365 days in the year and dividing that number by the payable turnover of 20. The division shows that the company needs about 18.25 days to pay back its suppliers.
It is important to note that there are a few considerations that must be made before the final payables turnover formula can be calculated. For the cost of goods sold, inventory amounts must also be considered, since the inventory not sold still was purchased from suppliers. In addition, calculating the average accounts payable requires taking the different accounts payable totals amassed during the whole time period and dividing them by the amount of totals being collected.