In order for businesses to succeed when trading goods and services internationally, it’s critical to have as much information as possible about their trading partners. Of particular importance is whether or not 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 honour its debts, it may be a good idea for companies to look at alternate trading partners in order to reduce the potential risk of not being paid.
The tricky part of this is establishing whether or not a business is in a position to pay what it owes and if it has done so in the past. While there are several ways to look at this information, one of the most valuable is by considering a particular enterprise’s creditors turnover ratio.
A creditors turnover ratio can be referred to by a variety of different names.
What is a creditors turnover ratio
A creditors turnover ratio can be referred to by a variety of different names, including a payables turnover ratio, trade payables ratio and accounts payable turnover ratio. These different terms can be slightly confusing, but all mean the same thing. 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 an accounts payable turnover ratio calculated? Without going too deep into the maths behind these ratios, 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.
This calculation provides a business with its accounts payable turnover ratio. A higher ratio is a good sign, as it means a business is paying off its debts more quickly.
Why creditors turnover ratios matter
For businesses considering whether or not to trade with a particular partner, taking a look at the creditors turnover ratio is an important step. A low ratio may indicate some form of financial distress, while a higher one is a good sign that you’ll be paid what you’re owed within a shorter period of time. This information is particularly vital to SMEs exporting overseas, where any delayed payments can result in restricted cash flow.
However, it’s important to keep in mind that a low accounts payable turnover ratio isn’t always a warning sign. In some cases, it may simply mean that a particular business has negotiated favourable payment terms that allow for debts to be paid less frequently. This explains why larger companies with a lot of bargaining power often have a lower creditors turnover ratio then you’d expect, as their size allows them to dictate very favourable payment terms.
A creditors turnover ratio is a great place to start when considering a new trading partner.
For exporters, the bottom line here is that a creditors turnover ratio is a great place to start when considering a new trading partner, but it’s not the only piece of information that should be considered. It’s just as vital to look at elements such as inventory turnover ratios and current liabilities in order to get a full picture.
That’s where Coface can help. We provide our clients with comprehensive assessments of any potential trading partners, in order to provide a complete picture before entering 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.