Efficiency Ratio:

Creditors/Payables Turnover Ratio:

Payable turnover establishes relationship between net credit annual purchases and average accounts payable.Account payable includes trade creditors and bills payables.

 

Payable Turnover Ratio= Average net credit purchases

                                               Average Account Payable

 

Account Payable= Trade Creditors + Bills Payable

 

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

 

=Average Account 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 account payable*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 cosequently enjoys better credit standing in the market or business credit rating among suppliers is not good and therefore they don't allow reasonable period of credit.The above two alternative conclusions are contradictory of eachother therefore the ratio should be interpreted with caution.

 

Example:

Calculate average age of creditors and creditor turnover ratio:

                                                     $

Creditors(closing)                                                                                               54,200

Bill Payable(closing)                                                                                              5800

Total Purchases                                                                                               3,38,000

Cash Purchases                                                                                                   28,500

Purchases Returns                                                                                                 9500

Days of years                                                                                                             365

 

Solution:

 

Average age of creditors= Average account Payable * Days of Year

                      Net credit purchases

 

                                           = 60,000*365  =73 days

                                                 3,00,000

 

Creditors turnover ratio= net credit purchase 

                                                Average Account Payable

 

                 =3,00,000 =5 times

                                               60,000

 

Average Creditors:

opening creditors are not given so average creditors will be considered as ending creditors +ending bills payable

i.e.,     =54,200+ 5800=GBP 60,000

 

Days of year= 365

 

Net Credit Purchases: 

                                              $                      $

Total Purchases                                                                                                                                      3,38,000

less: Cash Purchases                                                                        28500

          Returns Outwards                                                                    9500                                             38,000

                                                                                                                                                                    3,00,000