How to Calculate Trade Payables Turnover Ratio with Example
The Trade Payables Turnover Ratio is a crucial accounting metric that tells us how quickly a business pays its suppliers during an accounting period. Understanding this ratio helps students excel in Class 12 Accountancy exams, competitive tests, and also assists business owners in assessing their supplier payment efficiency.
| Term | Meaning | Also Known As |
|---|---|---|
| Trade Payables | Money owed to suppliers for credit purchases | Accounts Payable, Creditors |
| Trade Payables Turnover Ratio | Number of times payables are paid off in a period | Accounts Payable Turnover Ratio, Creditors Turnover Ratio |
Trade Payables Turnover Ratio – Meaning and Importance
The trade payables turnover ratio shows how efficiently a business pays its suppliers or creditors. It indicates the number of times the company settles its accounts payable within a set period, usually a year. This ratio is vital for students and business owners to evaluate company liquidity and supplier trustworthiness.
Trade Payables Turnover Ratio Formula and Steps
To calculate the trade payables turnover ratio, use the following formula:
- Trade Payables Turnover Ratio = Net Credit Purchases ÷ Average Trade Payables
Here is how to calculate each component:
- Net Credit Purchases = Total Credit Purchases – Purchase Returns
- Average Trade Payables = (Opening Trade Payables + Closing Trade Payables) ÷ 2
This ratio tells you how many times, on average, your business pays off its suppliers in a year.
Trade Payables Turnover Ratio Calculation Example
| Particulars | Amount (₹) |
|---|---|
| Total Annual Credit Purchases | 2,50,000 |
| Purchase Returns | 40,000 |
| Opening Trade Payables | 20,000 |
| Closing Trade Payables | 30,000 |
- Net Credit Purchases = 2,50,000 – 40,000 = 2,10,000
- Average Trade Payables = (20,000 + 30,000) ÷ 2 = 25,000
- Trade Payables Turnover Ratio = 2,10,000 ÷ 25,000 = 8.4 times
This means the business paid its suppliers 8.4 times during the year.
Significance and Interpretation of the Trade Payables Turnover Ratio
The trade payables turnover ratio helps assess payment discipline and supplier relationship strength. Here’s how to interpret the results:
- High Ratio: Company pays suppliers quickly, signaling good liquidity and strong supplier relationships.
- Low Ratio: Payments are delayed, which may indicate poor cash flow or financial problems.
- Ideal Ratio: Depends on industry terms but typically ranges between 6–12.
Calculation of Trade Payables Turnover Ratio in Days
To express the ratio in days (also called "Days Payable Outstanding"), divide 365 by the turnover ratio:
- Trade Payables Turnover in Days = 365 ÷ Trade Payables Turnover Ratio
For the earlier example: 365 ÷ 8.4 ≈ 43 days. This means, on average, payments are made every 43 days.
Comparison with Related Ratios
| Ratio Name | What It Measures | Main Formula |
|---|---|---|
| Trade Payables Turnover | How often payables are paid off | Net Credit Purchases ÷ Average Trade Payables |
| Trade Receivables Turnover | How often receivables are collected | Net Credit Sales ÷ Average Trade Receivables |
| Current Ratio | Firm’s overall liquidity | Current Assets ÷ Current Liabilities |
| Quick Ratio | Short-term liquidity (excluding stock) | (Current Assets – Inventories) ÷ Current Liabilities |
Unlike the current and quick ratios, which check overall liquidity, the trade payables turnover ratio focuses specifically on payments to suppliers. Do not confuse it with trade receivables turnover ratio, which relates to money collected from customers.
Why Trade Payables Turnover Ratio Matters to Students
Mastering the concept of trade payables turnover ratio prepares students for Board and competitive exams, including typical MCQs and numerical questions. It also supports understanding of working capital management and how efficient supplier payments strengthen a firm's creditworthiness.
Related Commerce Topics for Deeper Study
- Accounting Ratios – Learn about various ratios for broader financial analysis.
- Ratio Analysis – Explore how ratios reveal business health and performance.
- Current Liabilities – Understand what forms a company’s short-term debt.
- Solvency Ratio – See how businesses analyze their long-term solvency.
- Final Accounts – Connect ratios to overall financial statement preparation.
At Vedantu, we make complex accountancy topics easier to understand through clear examples and practice-based learning resources.
In summary, the trade payables turnover ratio is vital for checking how efficiently a business pays off its suppliers. It aids exam preparation, improves working capital management skills, and builds practical financial awareness for students and future business managers.
FAQs on Trade Payables Turnover Ratio Explained for Students
1. How do you calculate the trade payables turnover ratio?
The trade payables turnover ratio shows how efficiently a company pays its suppliers. It's calculated by dividing net credit purchases by the average trade payables over a period.
2. What is a good payables turnover ratio?
A 'good' payables turnover ratio varies by industry. Generally, a higher ratio (indicating faster payments) is better, showing strong supplier relationships and efficient cash management. However, an extremely high ratio might indicate lost credit advantages. Benchmark against industry averages for a better interpretation.
3. How to calculate trade receivable turnover ratio?
The trade receivables turnover ratio is different from the trade payables turnover ratio. It measures how quickly a business collects payments from its customers. The formula is: Net Credit Sales / Average Accounts Receivable. This ratio focuses on cash inflows, unlike the payables ratio which looks at cash outflows.
4. Is a higher or lower trade payable turnover ratio better?
Generally, a higher trade payables turnover ratio is preferred, as it suggests prompt payments to suppliers. However, an excessively high ratio might indicate that a company is forgoing potential discounts or benefits from extended payment terms. The ideal ratio depends on industry benchmarks and company-specific circumstances. A lower ratio might indicate cash flow issues or strained supplier relationships.
5. What is the trade payables turnover ratio formula with example?
The trade payables turnover ratio is calculated as: Net Credit Purchases / Average Trade Payables. For example: If Net Credit Purchases are ₹2,00,000 and Average Trade Payables are ₹25,000, then the ratio is 8. This means the company pays its suppliers 8 times during the period.
6. What does a high trade payables turnover ratio indicate?
A high trade payables turnover ratio generally indicates that a company is paying its suppliers quickly. This suggests efficient working capital management and positive relationships with vendors. However, it's important to consider industry norms and the company's overall financial health.
7. Can this ratio be calculated in days?
Yes, you can express the payables turnover ratio in days. This is often called Days Payable Outstanding (DPO). To calculate DPO, divide 365 days by the payables turnover ratio. A lower DPO indicates faster payment cycles.
8. How do industry norms influence the ideal trade payables turnover ratio?
Industry norms significantly impact the interpretation of the trade payables turnover ratio. Industries with longer payment terms (e.g., construction) will naturally have lower ratios than those with shorter payment cycles (e.g., retail). Benchmarking against competitors within the same industry is crucial for a meaningful analysis.
9. Why is purchase returns subtracted from total purchases in the formula?
Purchase returns are subtracted from total purchases to arrive at net credit purchases. This is because returns represent goods not actually received or used, and thus, do not contribute to the amount outstanding to suppliers. Using net credit purchases provides a more accurate reflection of the company's actual payment obligations.
10. How can manipulation in accounts payable affect ratio interpretation?
Manipulating accounts payable can distort the trade payables turnover ratio. Deliberately delaying payments inflates the ratio, masking underlying cash flow problems. Conversely, artificially accelerating payments reduces the ratio, potentially giving a false impression of financial strength. This highlights the importance of accurate and transparent accounting practices.
11. What is the link between this ratio and the company's cash flow?
The trade payables turnover ratio is directly linked to a company's cash flow. A low ratio might indicate that the company is delaying payments to preserve cash in the short term. However, this strategy can damage supplier relationships and even lead to supply chain disruptions, ultimately affecting long-term cash flow. Conversely, a high ratio indicates efficient management of cash outflows.
12. How can trade payables turnover ratio help during credit negotiations?
A high trade payables turnover ratio demonstrates reliability and efficient payment practices to potential suppliers. This can significantly improve a company's negotiating position when seeking credit, potentially leading to better terms, higher credit limits, or extended payment periods.
