Financial Ratios to Manage Accounts Payable

 Managers need information to make informed decisions. This data includes financial ratios. There are three types of financial ratios: liquidity, solvency, or profitability. This discussion will focus on liquidity ratios. A ratio can be used to evaluate results in balance sheets, income statements, and other financial statements.

Ratios can be used by businesses to help them make decisions on a variety of issues, including accounts payable. The accounts payable impact cash flow, your business operations and your relationships to vendors. Stampli's MTN cheap data allows you to have full control over your corporate spending and helps you manage accounts.

Let's say Premier Furniture is a company that produces custom furniture pieces and sells them to the residential market. This would be an example. The average time taken to calculate ratios is one year. Different industries will produce different ratios.

Managers should first address liquidity needs. Liquidity is a short-term concern.

Work with Liquidity Ratios

liquidity is the ability to generate sufficient current assets to cover all current liabilities. Borrowing money is an option for businesses that are unable to produce sufficient current assets. However, these options have their drawbacks. Borrowing money means the debtor must pay interest. Selling equity gives the new shareholders ownership rights to the business.

You must review your accounts to determine if you can use liquidity ratios.

Understanding your current assets and liabilities

The term "current" is a term that covers 12 months or less. This term is used to identify if assets or liabilities are current.

Current assets are cash and assets that can be converted into cash in 12 months. This includes accounts receivables and inventory. You can understand current assets by looking at transactions that require cash.

• Inventory is items that have been purchased or produced and are held for sale. You don't get back the money you spent on inventory until you sell it.
• The balance of accounts receivables is the dollar amount of credit sales not paid in cash.

Within a year, the inventory and accounts receivable balances will be converted to cash. These balances can be reduced by improving inventory management and collecting account receivables.

Current liabilities include accounts due and any other obligations that must be paid within one year. This current portion of long-term debt, which is $50,000, will be due within the next twelve months.

These are important liquidity ratios many managers use for financial analysis.

Revision of liquidity ratios

These are the most popular liquidity ratios.

Current ratio

Current ratio is the ratio of current assets to current liabilities. Businesses want to keep a current ratio greater than 1. Premier Furniture's current assets are $1,200,000. Current liabilities are $980,000. The current ratio is $1,200,000 divided by $980,000, or 1.2.

The company has enough current assets to cover current liabilities. Businesses adjust the current ratio formula by subtracting the inventory balance.

Ratio quick (acid test).

The quick ratio, also known as the acid test ratio, subtracts inventory from current assets and divides it by current liabilities.

Current assets, as mentioned above, are Vtu top up  that can be converted into cash in less than a year. Businesses believe inventory is the hardest asset to convert into cash. The quick ratio, however, is more convenient and provides a better view of liquidity.

If Premier Furniture has a $300,000 inventory balance, the quick ratio would be:

($1,200,000 total current assets less inventory $300,000.) / $980,000 total current liabilities = 0.9

Premier doesn't have enough assets to cover all its current liabilities if inventory is subtracted. To determine if additional cash is needed to pay current liabilities, the business owner must analyze customer payments and inventory sales.

Use turnover ratios

To estimate the speed at which sales can be converted into cash, managers use turnover ratios. A business might sell inventory on credit and then collect the receivable balances of customers. If a business sells inventory on credit but doesn't immediately collect cash, the balances receivable increases.

Ratio of accounts receivable turnover

The ratio of accounts receivable to credit sales measures the amount of accounts receivable.

(Net annual credit sales) / Average accounts receivable

Credit sales refers to sales to customers who do not pay immediately. The net credit sales balance subtracts receivable balances which are not collectable (bad loans). The average accounts receivable balance is equal to the beginning year balance and ending year balance divided by 2.

Let's say that Premier Furniture's receivable turnover ratios are:

($1,900,000.00 net annual credit sales) / ($280,000 Average Accounts Receivable) = 6.8

Premier sells 6.8 times per annum the average amount of accounts receivable. This means that the inventory balance of the company is sold and completely replaced 6.8 times per year.

A higher ratio indicates that a business VTpass faster from sales and doesn't need as much inventory to generate revenue. The turnover ratio would increase to 13.6 if the average receivables were $140,000 with the same annual sales. Premier can therefore operate with less inventory and cash.

Ratio of inventory turnover

The inventory turnover ratio is the cost of goods sold divided by (average inventory), and the average inventory is (beginning inventory ending inventories) divided by 2.

The inventory asset account is depleted when inventory is sold. The balance is then reclassified into the cost-of-goods sold account. The Premier turnover ratio is:

($1,680,000 cost per unit of goods sold) divided ($320,000 average inventory) = 5.

Managers should be aware of these two points:

• The cost of goods sold includes both credit sales as well as sales that were paid immediately in cash. Only credit sales are used in the accounts receivable turnover ratio.
• The inventory turnover formula calculates the average inventory.

High turnover is desirable by businesses. A higher sales volume means a higher cost per unit of goods sold. The goal is to have fewer inventories and a higher price for goods sold. As with accounts receivables, inventory can tie up cash. Lowering the average inventory balance will free up cash for other purposes.

If sales (and the cost of goods sold) fall or if average inventory rises, a lower ratio will be achieved.