Accounts Payable Turnover Ratio
An accounting equation that tells you how fast a company pays its bills. The ratio is: total purchases from suppliers divided by average accounts payable.
The number alone tells you little. Look at it compared to prior periods. Is it falling? The company is taking longer to pay its bills. Rising? They’re paying faster. Let’s say Tesla places an order from Goodyear for one million tires that cost $200 a piece. The order is payable in 90 days. Tesla now shows accounts payable of $200 million. That, along with all the other supplies Elon Musk needs to build his space cars, adds up to Tesla’s accounts payable...call it $5 billion.
To tell whether Tesla is doing better or worse with paying suppliers, we’d divide all those supply purchases over a period of time by Tesla’s average accounts payable balance. If Tesla has bought $5 billion in supplies over the last 90 days and has an average accounts payable balance over that period of $1 billion, its AP turnover ratio is 5.
Let’s say it was 10 in the previous 90 days. So Musk cut his turnover in half, but that’s bad. Very bad. Instead of keeping his suppliers paid and his accounts payable low, he’s relying more on credit and taking longer to pay. Although his cars are quiet, suppliers won’t be if he keeps this up.
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Finance: What are Accounts Payable and A...111 Views
Finance- a la shmoop what are accounts payable and accounts receivable? easy. they're
accounts. they live on the balance sheet right here and here. accounts payable [balance sheet shown]
refers to bills you owe for stuff you bought or committed to buy. accounts
receivable refers to stuff you sold, and are you know waiting to be paid for.
you're the CEO of Shmesla. you make flying electric cars. you've built a
thousand of these units and they're ready to sell. the machine takes five
grand worth of aluminum ,eight grand worth of computers, three grand for the
blades, and so on. so flying schmess la in total costs 50 grand to build then sells [equations]
for about 80 grand each. only problem with your build of inventory you didn't
have the money to pay for all of the equipment that goes into the Shmesla
up front. so you cut a deal with your suppliers to pay them six months after [forklift]
they've shipped you that construction materials. by building a thousand units
you'll spend 50 million bucks on raw materials ordered on credit, which shows
up on your balance sheet as a short-term liability, in the accounts payable slot [balance sheet]
right there 50 million. well as sales come in, yeah cha-ching, cha-ching, cha-ching,
you feel ready to pay off at least one of your suppliers, and send them a check
for a million bucks .and that cool million shows up as an expense on your [hands exchange check]
income statement, and your accounts payable figure declines by a million
bucks .your sales end up being solid you quickly sell 500 units you built for 80
grand each and that's half your stock. unfortunately the buyers can't pay you
right away they promise to pay you in writing within 120 days of taking [hand signs document]
possession of the Schmesla. so that's 500 Schmeslas for 80 grand each
giving you 40 million bucks worth of accounts receivable that you show on
your books right there. well a few months go by and you start to collect. some
buyers pay early a quick 500k comes in as buyers pay off their Schmeslas, and [men in suits]
that 40 million in accounts receivable is now 35 million, and that five million
plops right in your cash account at the old Bank of America. you feel good [bank of America logo]
about the business and hate having accounts payable, so you take 4 million
of that 5 million bucks in cash, and well you pay some bills you pay down the 49
million you owed ,you now be 45 million in accounts payable.the contracted for
payments of the Shmeslas all come in and another 35 million dollars comes in [men stand by stacks of cash]
the door, taking away all of the remaining thirty five million dollars in
accounts receivable so that account now goes to zero, and that thirty five
million bucks well it gets dumped into your cash account, which now has 36
million dollars in it. why well because you had a million dollars sitting there
from the first set of payments remember? you still owe 45 million bucks in your
accounts payable but you can bring that obligation down fast by paying 30 [hands exchange check]
million down immediately and make your suppliers dance. so what are the key
factors of your balance sheet at this point? well you have five million in cash
nice asset that cash there. you have five hundred cars yet unsold you think you
can get 80 grand each for them or 40 million dollars in revenues to you. you
hold them as inventory on the asset side of the balance sheet right here. you are
no longer owed anything because all the buyers who bought your first 500 cars [car flies through the air]
have now paid you. and while you owe another 15 million bucks to your
suppliers to clean them up so don't start strutting around like you're Elon
Musk just yet you've still got a ways to go before Schmesla Galactic can found
its first colony on Mars. schmooping in space yeah it's a dream come [man in space suit meets alien]
true.
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