The most effective accounts payable teams are those that have a firm grip on the key metrics, KPIs, and measurements that dictate success in AP.
To be able to measure and track these metrics accurately and to analyze changes in the context of your company’s financial health, you’ll need to understand the formulas that go into creating them.
In this article, we’ll guide you through the process of calculating accounts payable.
You’ll learn the AP formula, and we’ll also dive into three additional critical accounts payable formulas for optimizing the financial health of your business.
How to calculate accounts payable
The formula for accounts payable is simple:
A few definitions are in order:
- Beginning AP: The opening balance of accounts payable at the start of the financial period in question.
- Purchases on Credit: The total value of goods and/or services that your company has purchased on credit during the same period and for which you’ve incurred new debt obligations.
- Payments to Suppliers: The total amount of all payments made toward settling accounts payable in order to reduce your outstanding debt liability.
Pretty straightforward, right?
You take your previous period’s AP, add any new purchases on credit, subtract any payments made, and you’ve got your ending AP.
Let’s illustrate with an example.
Your ending AP for the last month (now your beginning AP for this month) was $18,000.
During the month, your company purchased $5,000 worth of goods and services on credit, and made $7,500 in payments to suppliers.
Gathering our figures:
- Beginning AP = $18,000
- Purchases on Credit = $5,000
- Payments to Suppliers = $7,500
Then, we apply the accounts payable formula:
Interpreting the accounts payable formula
So, what should you do with this information once you have it?
The best practice here is to track total accounts payable over time, comparing changes month on month.
Ideally, your outstanding AP will be decreasing over time, which is a good sign that your business is successfully paying down debts and meeting repayment obligations.
However, an increasing accounts payable amount isn’t necessarily a bad sign as long as it's aligned with business growth.
If your company is expanding and consistently growing the top line, then it's natural that its expenses will grow alongside revenue. As such, your total AP owing is likely to grow, too, even if you’re meeting your debt obligations without issue.
For that reason, it's important to apply this formula alongside other metrics like the accounts payable turnover ratio, which we’ll cover shortly.
3 more important accounts payable formulas
The basic accounts payable formula discussed above isn’t the only one you should have under your belt.
Let’s look at three more critical metrics for measuring AP success.
Accounts payable turnover ratio
Accounts payable turnover ratio is an AP metric that informs you about how quickly your organization makes payments to creditors and suppliers.
It's a key measure of back office efficiency and financial health.
To calculate your AP turnover ratio, you’ll need to:
- Determine what time period you want to look at
- Calculate the total payments made to AP during that time
- Calculate your average AP balance over that period (we share this formula below)
Then, you apply the accounts payable turnover ratio formula:
Let’s say you want to calculate your AP turnover ratio for the last 30 days.
You’ve made $30,000 in total payments during that period and have an average AP balance of $15,000.
Your AP turnover ratio calculation looks like this:
So, is 2 good?
Well, that depends on your time period and industry. A monthly turnover of 2 would be a quarterly turnover of 6, so you need to compare apples with apples.
Rather than being concerned with benchmarking against other companies, focus on improving your own AP turnover ratio (higher is better) by implementing automated approval workflows or paying certain vendors via credit card to defer payment.
Here’s a helpful guide to speed up your approval process and improve your AP turnover ratio: How to Simplify Your AP Approval Workflows.
Days payable outstanding (DPO)
Days payable outstanding (DPO) shows you how many days your company typically takes to pay supplier invoices.
It's used to track the efficiency of cash flow across a particular period of time.
Here’s what the DPO formula looks like:
You’ll need your ending accounts payable, the number of days in your account period (365, for example), and the cost of goods sold from your most recent income statement.
Let’s look at an example:
Say our ending accounts payable is $8,000, our accounting period is 365 days, and our current COGS is $95,000.
This means that it takes our organization an average of 31 days to pay an outstanding bill.
Days payable outstanding is helpful for understanding how quickly you pay invoices, but it's not a cut-and-dry “faster is better.”
Higher DPOs can mean a business is struggling to pay its bills on time, but it can also mean that an organization is successfully taking advantage of vendor credit terms and keeping cash on hand for other short-term investments.
On the other hand, a lower DPO can mean that a company isn’t fully using its available credit terms, but it could also mean that it is wisely taking advantage of early payment discounts.
Best practice here is to track DPO alongside your own business goals. For example, if you have a need to improve the turnover of AP, then you’ll want to push DPO upward.
Average accounts payable
Average accounts payable is a nice, simple one.
It tells you, on average, what your outstanding AP is. This is particularly helpful for calculating other important metrics like the AP turnover ratio.
To calculate your average accounts payable, you just need your AP amounts for the start and end of the period, then apply the formula:
For example, if our outstanding AP at the beginning of the quarter was $85,000, and at the end, it was $76,000, our calculation would look like this:
The easiest way to track accounts payable formulas
Calculating key metrics like total accounts payable and your AP turnover ratio is crucial for understanding the efficacy of your AP team.
But going through the motions of running those formulas manually is time-consuming and distracts you from more important tasks like optimizing processes to create efficiencies.
That's why the most effective accounts payable teams use an accounts payable automation solution like BILL to:
- Capture and import invoices
- Route payment approvals to relevant stakeholders
- Pay via ACH, credit card, and international wire transfer
- Maintain an AP reporting dashboard
