Days Purchases in Accounts Payable
Accounts payable activity ratios indicate the speed with which the company pays its suppliers.
The days’ purchases in accounts payable represents the average number of days the company takes to pay its payables.
The days’ purchases in accounts payable is calculated as follows:
| Days’ Purchases in Payables = | 365 |
| Accounts Payable Turnover Ratio
(Annual Credit Purchases ÷ Average Accounts Payable) |
Or, a variation on A, because to divide by a fraction, invert the fraction and multiply:
| Days’ Purchases in Payables = | Average Accounts Payable | × | 365 |
| Annual Credit Purchases |
Or
| Days’ Purchases in Payables = | Average Accounts Payable |
| Average Daily Credit Purchases (Annual Credit Purchases ÷ 365) |
The annual credit purchases figure is rarely reported in a company’s financial statements, and this fact creates difficulty for an analyst outside the company in calculating both the accounts payable turnover ratio and the days’ purchases in payables. Limited information on credit purchases can be calculated from published financial statements, but it is not complete.
1- Assuming that all purchases of inventory are made on credit, a rough estimate of annual credit purchases of inventory can be obtained for a merchandising company by adjusting cost of goods sold by the amount of change in inventories during the period, as follows
| Purchases = | Cost of sales + Ending inventory – Beginning inventory |
The above calculation is meaningful only for a nonmanufacturing company, in other words, a reseller. A manufacturing company’s cost of sales includes many costs that are not purchases made on credit, such as direct labor (paid through payroll) and depreciation on production equipment (recorded in the accounting system). Therefore, the above calculation is not meaningful for a manufacturing company.
2- For a manufacturing company, a similar calculation can be performed using raw materials inventory, and it will result in the amount of credit purchases made of raw materials (only). However, purchases of raw materials represents only a part of a manufacturing company’s purchases on credit, so that is not a useful method of obtaining a figure for purchases.
Furthermore, neither of these “purchases” amounts includes selling, general and administrative items purchased on credit; and some of the inventory purchases included may not have been made on credit.
Because of these difficulties, truly accurate accounts payable turnover and days’ purchases in payables can be calculated only by an analyst inside the company who has access to full information on credit purchases. Analysts outside the company must use estimates, so the resulting ratios are also only estimates. Cost of Goods Sold is usually used as a proxy for Purchases.
However, if the estimated purchases are determined in a consistent manner, trends in the ratios can be observed. An increase in the number of days’ purchases in payables indicates that the company is paying its payables more slowly, which could mean the company is having liquidity problems.