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Creditors Turnover Ratio or Payables Turnover Ratio:

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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.

Example.

From the following figures calculate average age of creditors and creditor turn over ratio:

  $
Creditor (closing) 54200
Bills payable (closing) 5800
Total purchases 338000
Cash purchases 28500
Purchases returns 9500
Days of year 365

SOLUTION:

Average age of creditors = Average account payable x Days of year / Net credit purchases

= 60,000 x 365 / 300,000

= 73 days


Creditors turn over ratio = Net credit purchase / Average accounts payable

= 300,000 / 60,000

= 5 times

Working:

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

i.e., = 54200 + 5800 = $60,000

No. of days in a year = 365

Net Credit Purchases:

Total purchases   $3,38,000
Less: Cash purchases 28500  
Less: Return outwards 9500 38,000
 

    3,00,000
   
More study material from this to
 

More study material from this topic:

Meanings, Nature and Usefulness of Ratios Analysis
Interpretation of Ratios
Important Factors for Understanding Ratios Analysis
Significance and Usefulness Ratios Analysis
Classification of Ratios
Analysis of Short Term Financial Position or Test of Liquidity
Current Ratio
Quick/Acid Test/Liquid Ratio
Absolute Liquid Ratio
Inventory/Stock Turnover Ratio
Debtors / Receivable Turnover Ratio
Creditors / Payables Turnover Ratio
Working Capital Turnover Ratio
Profitability Ratios
Gross Profit Ratio (GP Ratio)
Operating Profit Ratio
Net profit ratio (NP ratio)
Earnings Per Share Ratio
Operating ratio
Expense ratio
Solvency ratios - Test of Long Term Solvency
Debt-equity Ratio
Debt Service Ratio or Interest Coverage Ratio
Fixed Assets Ratio
Debts to Total Funds or Solvency Ratio
Reserves to Capital Ratio
Capital Gearing Ratio
Proprietary Ratio
Accounting Ratios Formulas
Limitations of Ratios Analysis

 

 
 

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Financial Accounting Topics


  Introduction to Accounting
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  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Final Accounts
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  Work Sheet
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  Capital and Revenue Items
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  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
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  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
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  Accounting Dictionary
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  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
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  Materials and Inventory Cost Control
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  Activity Based Costing System
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  Standard Costing and Variance Analysis
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  Balanced Scorecard
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  Capital Investment Analysis/Capital Budgeting
 
 

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