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 |
| |
|
|
|
