Trade payables turnover (days)

6.1 Analysis & Interpretation – Accounting Ratios (Cambridge IGCSE 0452)

Why Ratios Matter

• Turn raw figures into meaningful information about profitability, efficiency and liquidity.
• Allow comparison with the company’s own past performance (trend analysis).
• Enable benchmarking against industry averages or competitors (inter‑firm comparison).
• Provide the evidence required for AO3 evaluation in exam questions.

Quick Reference: The Eight Required Ratios

Key Definitions (for AO3 evaluation)

• Credit Purchases: Purchases of stock or services made on credit during the period (cash purchases are excluded).
• Trade Payables: Amounts owed to suppliers for credit purchases.
• Average Trade Payables: (Opening balance + Closing balance) ÷ 2. Use a quarterly or monthly average when the business has strong seasonal fluctuations.
• Capital Employed (for ROCE): Issued share capital + Reserves + Non‑current liabilities (as defined in the syllabus).

AO3 Evaluation Checklist (use for every ratio)

1. Industry Benchmark – How does the figure compare with the typical range for the sector?
2. Trend Over Time – Is the ratio improving, deteriorating or stable compared with previous years?
3. Cash‑Flow Implications – What does the ratio say about the business’s ability to generate or conserve cash?
4. Impact on Stakeholders – Consider owners, banks, suppliers and customers.
5. Limitations of the Ratio – Historic‑cost basis, seasonality, one‑off items, differences in accounting policies.

Inter‑Firm Comparison (AO3)

When comparing two or more companies, examine each ratio side‑by‑side and discuss:

• Which firm shows stronger profitability, liquidity or efficiency?
• Possible reasons for differences (size, market position, credit terms, inventory policy).
• How the differences might affect future performance or financing decisions.

Trade Payables Turnover (Days)

Definition

The trade‑payables turnover ratio indicates how many times a business pays its suppliers in a year. Expressed in days, it shows the average number of days taken to settle trade payables.

Formulas

1. Turnover Ratio (times per year)

Turnover Ratio = Credit Purchases ÷ Average Trade Payables

LaTeX: $$\text{Turnover Ratio} = \frac{\text{Credit Purchases}}{\text{Average Trade Payables}}$$

2. Turnover (Days)

Turnover (Days) = 365 ÷ Turnover Ratio

LaTeX: $$\text{Turnover (Days)} = \frac{365}{\text{Turnover Ratio}}$$

When to Use a Refined Average

• For businesses with large seasonal swings, calculate a more representative average:

  Average Payables = (Opening + Q1 + Q2 + Q3 + Closing) ÷ 5

• Monthly averages can be used where quarterly data are unavailable.

Step‑by‑Step Calculation

1. Obtain **total credit purchases** for the period (income statement or purchase ledger).
2. Identify the **opening** and **closing** trade‑payables balances (statement of financial position).
3. Calculate **average trade payables** (simple mean or refined average as appropriate).
4. Compute the **turnover ratio** using Formula 1.
5. Convert the ratio to **days** using Formula 2.

Worked Example

ABC Ltd. – Year ended 31 December 2024

1. Average Trade Payables:

   (15,000 + 25,000) ÷ 2 = 20,000

2. Turnover Ratio:

   120,000 ÷ 20,000 = 6 times per year

3. Turnover (Days):

   365 ÷ 6 ≈ 60.8 days

Interpretation & Evaluation (AO3)

• What the figure tells you: ABC Ltd. takes about 61 days on average to pay its suppliers.
• Evaluation using the checklist:
  1. Industry benchmark – If the sector average is 45 days, ABC is slower, which may indicate weaker cash‑flow management.
  2. Trend – Compare with the previous year (e.g., 45 days). A rise suggests cash is being retained longer, but could also signal deteriorating supplier relations.
  3. Cash‑flow implications – Longer payment periods free up cash in the short term (positive for working capital).
  4. Stakeholder impact – Suppliers may demand tighter credit terms or charge interest, affecting profitability.
  5. Limitations – The ratio is based on historic‑cost figures; large one‑off purchases or seasonal spikes can distort the average.

Common Mistakes to Avoid

• Using **total purchases** (cash + credit) instead of **credit purchases**.
• Failing to average opening and closing balances; using only the closing balance gives a misleading result.
• Dividing 365 directly by the average payables – the denominator must be the **turnover ratio**, not the payables amount.
• Using 360 days unless the question explicitly states a 360‑day year.
• Mixing currencies or periods (e.g., monthly purchases with yearly payables).
• Ignoring seasonality – for highly seasonal firms, adopt a quarterly or monthly average.

Exam Tip – How the Question May Appear

Practice Questions

1. XYZ Co. recorded credit purchases of £250,000 for the year. Opening trade payables were £30,000 and closing trade payables were £50,000. Calculate the trade‑payables turnover (days) and comment on the result.
2. A company’s trade‑payables turnover ratio is 8 times per year. What is the average number of days taken to pay suppliers? Explain what this indicates about the company’s cash‑flow management.
3. Explain why a very low trade‑payables turnover (e.g., 2 days) might not always be desirable for a business.
4. ABC Ltd. has seasonal sales. Its trade‑payables balances at the end of each quarter are £12,000, £18,000, £22,000 and £16,000. Credit purchases for the year total £180,000. Calculate the turnover (days) using a quarterly average.