Friday, June 17, 2011

Creditors Turnover Ratio or Payables Turnover Ratio:

 Definition and Explanation:

It is a ratio of net credit purchases to average trade creditors. Creditors turnover ratio is also know as payables turnover ratio.

It is on the pattern of debtors turnover ratio. It indicates the speed with which the payments are made to the trade creditors. It establishes relationship between net credit annual purchases and average accounts payables. Accounts payables include trade creditors and bills payables. Average means opening plus closing balance divided by two. In this case also accounts payables' figure should be considered at gross value i.e. before deducting provision for discount on creditors (if any).

Payable turnover ratio = Annual net credit purchases / Average accounts payable

Accounts payable = Trade creditors + Bills payable

The above ratio is usually complemented with average payment period which may be calculated as follows:

Average accounts payable / Average daily credit purchases

Where average daily credit purchases
= Net annual credit purchases / No. of days in the year

Alternatively average payment period can also be calculated with the following formulae.

(Average accounts payable x No. of days in the year) / Annual net credit purchases

or

No. of days in the year / Payable turnover ratio
Interpretation:

Shorter average payment period or higher payable turnover ratio may indicate less period of credit enjoyed by the business it may be due to the fact that either business has better liquidity position; believe in availing cash discount and consequently enjoys better credit standing in the market or business credit rating among suppliers is not good and therefore they do not allow reasonable period of credit. The above two alternative conclusions are contradictory of each other therefore the ratio should be interpreted with caution.

Regards
G.Srinivas

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