Trade Payable Turnover Ratio: Meaning, Formula, Significance and Examples

Last Updated : 16 Mar, 2023

What is Trade Payable Turnover Ratio?

Trade Payable Turnover Ratio is a financial ratio that measures how efficiently a company pays its suppliers for the goods and services it has purchased on credit. It is calculated by comparing the cost of goods sold to the average accounts payable during a particular period. This ratio helps in evaluating a company’s credit management practices and its relationship with suppliers. A higher trade payable turnover ratio is considered better as it indicates that a company is efficiently managing its payable. Trade payable turnover ratio cannot be negative. However, a low ratio may indicate that a company is not effectively managing its payable. A company can improve its trade payable turnover ratio by negotiating better payment terms with its suppliers, improving its inventory management, and reducing its accounts payable days.

The terms cost of goods sold and average trade payable can be defined as:

Cost of Goods Sold: In practical cases, it might be hard to ascertain the net sales made by the firm. In such cases, the trade payable turnover ratio is calculated using the cost of goods sold i.e. the cost of all the goods and services that are sold.

Average Trade Payables: The average trade payables are calculated by taking the sum of the opening and closing trade payables and dividing by 2.

Formula of Trade Payable Turnover Ratio

Where,

Cost of Goods Sold = Opening Stock + Purchases – Closing Stock or,

Cost of Goods Sold = Net Sales â€“ Gross Profit

The numerator of the formula, cost of goods sold, represents the total cost of all goods sold during the accounting period. The denominator of the formula, average trade payables, represents the average amount owed to suppliers for the goods and services purchased on credit during the period.

The average trade payables are calculated by taking the sum of the opening and closing trade payables and dividing by 2. This is done to get a more accurate representation of the trade payables during the period, as trade payables can fluctuate throughout the accounting period.

Significance of Trade Payable Turnover Ratio

The Trade Payable Turnover Ratio is significant because it helps companies in assessing how efficiently they are managing their trade payables. A higher ratio indicates that the company is paying its suppliers promptly, which means it has good credit management practices and maintains healthy relationships with its suppliers. On the other hand, a lower ratio may indicate that the company is having difficulty paying its bills.

Illustration 1:

ABC Limited is a manufacturing company that produces various products. During the year 2021-22, the company had a cost of goods sold of â‚¹10,00,000. The opening trade payables were â‚¹ 50,000, and the closing trade payables were â‚¹ 75,000.

Solution:

= â‚¹62,500

=

= 16

The Trade Payable Turnover Ratio of ABC Limited is 16, which indicates that the company is paying its suppliers promptly and has good credit management practices.

Illustration 2:

XYZ Limited is a retail company that sells various products. During the year 2021-22, the company had a cost of goods sold of â‚¹50,00,000. The opening trade payables were â‚¹1,00,000, and the closing trade payables were â‚¹2,00,000.

Solution:

=

= â‚¹1,50,000

= 33.34

The Trade Payable Turnover Ratio of XYZ Limited is 33.34, which indicates that the company is paying its suppliers promptly and has good credit management practices.

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