A creditor's turnover ratio is a reflection of how quickly a company pays its creditors. This is also known as a payable turnover ratio. Low turnover means it takes longer for a company to pay off creditors, while high turnover reflects rapid processing of credit accounts. Changes in the creditor's turnover ratio can provide information about a company's financial circumstances.
Credit purchases are the underpinning of many industries. Companies rely on credit to buy goods and services, and repay the credit when they are able to sell products or move forward with economic activities as a result of the services they receive. Many companies offer credit on variable terms, and the ability to keep up with creditors and control debt is important for the long-term financial success of a company. Internal accounting can determine the creditor's turnover ratio and flag changes that may be of concern.
If the ratio falls, it means a company is taking longer to repay creditors. This may be the result of poor liquidity, low sales, or other issues. A continued drop may be a cause for concern as it suggests the company cannot control its debt and may be at risk of bankruptcy. When the ratio rises, a company is retiring debt more quickly. A consistent ratio indicates balanced financial planning to keep repayments consistent, although if that ratio is low, it may indicate that a company could be headed for financial trouble.
There are a number of ways to calculate the creditor's turnover ratio. One option is to divide the annual net credit transactions by the average accounts payable. Companies can also do the reverse, and look at what percentage of total credit over the year is represented by the average accounts payable. For example, if a company does $100,00 United States Dollars (USD) in credit transactions each year and carries an average debt of $20,000 USD, the creditor's turnover ratio might be 5, or 1/5 (20%), depending on how the company calculates it.
In this example, the company turns its debts over five times a year, and keeps up with creditors. If the company starts carrying $50,000 USD in debt at any given time, the creditor's turnover ratio drops to 2 or 1/2 (50%), which is a cause for concern. Conversely, the company might start only maintaining $10,000 in accounts payable. This would cause the ratio to rise to 10 or 1/10 (10%), a positive sign.
