The term accounts payable days refers to a calculation that allows an investor-analyst to understand the number of times a company pays off its purchases in a given timeframe. As is the case with accounts payable days, this metric is useful when trying to determine how quickly a company is able to pay for the materials and services it purchases.
Accounts Payable Turnover = Total Purchases / Accounts Payable Balance
Liquidity measures allow the investor-analyst to understand the company's long term viability in terms of fiscal health. This is usually assessed by examining balance sheet items such as accounts receivable, use of inventory, accounts payable, and short-term liabilities. One of the ways to understand how quickly a company is paying their bills is by calculating their accounts payable turnover.
Fast payments (high ratio values) are typically indicative of sufficient cash flow and / or companies taking advantage of discounts offered by its vendors. While the value can be tracked over time to understand if the company's financial position is changing, the accounts payable turnover is also a useful benchmark to understand a company's position relative to its competitors. Analysts looking for a more refined metric should consider substituting accounts payable days for this metric.
The manager of a large mutual fund would like to assess the ability of Company ABC to pay its bills. He believes this measure would provide a good understanding of the company's cash flow strength. He asked his analytical team to calculate accounts payable turnover value based on Company ABC's most recent SEC filing. The following information was taken from the company's 10-K. Accounts payable at the end of the period was $7,430,000. Total purchases in the same timeframe were $325,419,000, including payroll expenses of $175,322,000 and depreciation of $64,951,000. Using this information to calculate the accounts payable turnover:
= ($325,419,000 - $175,322,000 - $64,951,000) / $7,430,000
= $85,146,000 / $7,430,000, or 11.5 times
Using the derived value of 11.5, the mutual fund manager concluded Company ABC was paying its bills approximately 365 / 11.5, or 31.8 calendar days, indicating not only was the company paying bills quickly, but taking advantage of vendor discounts too.