The Significance of Creditors Turnover: What You Need to Know
In order for businesses to succeed when trading goods and services internationally, it’s critical to have as much business information as possible about their trading partners. Of particular importance is whether a trade partner has a good record of paying its suppliers, and how these payments are paid with respect to timeliness. If a business has a poor record of paying what it owes, or simply lacks the cash flow necessary to honor its debts, it may be a good idea for companies to look at alternate trading partners in order to reduce the potential financial risk of not being paid.
How can you determine whether a business is able to pay what it owes and if it has done so in the past? While there are several ways to assess this information, one of the most valuable is by considering a particular enterprise’s creditors turnover ratio.
What is a creditors turnover ratio
A creditors turnover ratio can be referred to by a variety of different names. The creditors turnover ratio, also known as the payables turnover ratio, trade payables ratio, and accounts payable turnover ratio, all refer to the same concept. In essence, a creditors turnover ratio is a measure of how often a particular company pays off its debts to suppliers within a given accounting period.
This relates back to the more general term ‘credit turnover’ which simply means the number of total transactions made during a particular time frame. The word ‘creditor’ narrows things down to payments made to anyone whom a business owes money to.
So far so simple, but how is a creditors turnover ratio calculated?
The basic formula is calculated by dividing the cost of goods sold (COGS) by the average accounts payable. COGS refers to the basic costs associated with a company producing its product, while average accounts payable is the average amount owed to creditors. A higher creditors turnover ratio/payables turnover ratio/trade payables ratio/accounts payable turnover ratio is a good sign, as it means a business is paying off its debts more quickly.
Why creditors turnover ratios matter
A creditors turnover ratio is a great place to start when considering a new trading partner. For businesses considering whether to trade with a particular partner, looking at the creditors turnover ratio is an important step. A low ratio may indicate some form of financial distress, while a higher one may indicate a higher likelihood that you will be paid what you are owed within a shorter period. This information is particularly vital to SMEs exporting overseas, where any delayed payments can result in restricted cash flow.
However, it is important to keep in mind that a low accounts payable turnover ratio is not always a warning sign. In some cases, it may simply mean that a particular business has negotiated favorable payment terms that allow for debts to be paid less frequently. This explains why larger companies with a lot of bargaining power often a lower creditors turnover ratio have then you’d expect, as their size allows them to dictate very favorable payment terms.
For exporters, the bottom line is that a creditors turnover ratio is a great place to start when considering a new trading partner, but it is not the only piece of information that should be considered. It is just as vital to look at elements such as inventory turnover ratios and current liabilities to get a full picture.
Unsure where to start analyzing your trade partner’s payment abilities? That’s where Coface can help. We provide our clients with comprehensive assessments of any potential trading partners in Urba360, our holistic risk management dashboard, so you can have a complete picture before entering into any financial agreements. This is in addition to offering trade credit insurance (TCI), which acts as a safety net in the event of non-payment.
To find out more about what we do and how we can help your business trade safely, get in touch today.