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the inventory turnover ratio. This formula is used to determine how quickly a company is
converting their inventory into sales. A slower turnaround on sales may be a warning
sign that there are problems internally, such as brand image or the product, or
externally, such as an industry downturn or the overall economy.
The numerator of the days in inventory formula is shown at the top of this page as 365
to denote 365 days in a year. However, it is important to match the period in the
numerator with the period for the inventory turnover used. For example, suppose that a
company is calculating the days in inventory held based on a inventory turnover of 4.32
for one year. This can be divided into 365 days of the year for an average days in
inventory of 84.49. If the same company has an inventory turnover of 2.31 for 180 days,
the average days in inventory would be 77.92.
It is important to remember that the average inventory for the period is used. From
here, the days in inventory formula can be rewritten as the numerator multiplied by the
inverse of the denominator.
The 2nd portion of this formula is essentially the % of goods left to be sold, in terms of
cost. This % of goods left to be sold can be used to estimate the % of time it is held
prior to sale. The % of time products are held prior to sale can be converted into actual
days by multiplying by 365 days in a year, or in a period.
Accounts payable turnover ratio (also known as creditors turnover ratio or creditors velocity) is
computed by dividing the net credit purchases by average accounts payable. It measures the number
of times, on average, the accounts payable are paid during a period. Like receivables turnover ratio, it
is expressed in times.
Formula:
In above formula, numerator includes only credit purchases. But if credit purchases are not known,
the total net purchases should be used.
Average accounts payable are computed by adding opening and closing balances of accounts
payable (including notes payable) and dividing by two. If opening balance of accounts payable is not
given, the closing balance (including notes payable) should be used.
Example:
P&G trading company has good relations with suppliers and makes all the purchases on credit. The
following data has been extracted from the financial statements of P&G for the year 2012 and 2011:
Purchases during 2012
220,000
20,000
40,000
20,000
8,000
12,000
Solution:
= $200,000* / $40,000**
= 5 times
It means, on average, P&G company pays its creditors 5 times in a year.
* 220,000 20,000
** [(40,000 + 8,000) + (20,000 + 12,000)] / 2
Average payment period means the average period taken by the company in making payments to its
creditors. It is computed by dividing the number of working days in a year by creditors turnover ratio.
Some other formulas for its computation are give below:
Formula:
This ratio may be computed in a number of ways:
Any of the above formulas may be used to compute average payment period. If credit purchases are
unknown, the total purchases may be used.
Example:
Metro trading company makes most of its purchases on credit. The extracted data for the year 2012 is
given below:
Total purchases
$ 600,000
Cash purchases
150,000
Purchases returns
30,000
65,000
40,000
20,000
15,000
Solution:
When complete information about credit purchases and opening and closing balances of accounts
payable is given, the proper method to compute average payment period is to compute accounts
payable turnover ratio first and then divide the number of working days in a year by accounts payable
turnover ratio.
= $420,000* / $70,000**
= 6 times
Average payment period = 360 days /6 times
60 days
The average payment period of Metro trading company is 60 days. It means, on average, the
company takes 60 days to pay its creditors.
*Computation of net credit purchases:
Total gross purchases
Less purchases returns
600,000
30,000
Net purchases
570,000
150,000
420,000