Creditor Turnover Ratio

A business organisation has to pay creditors if it buys goods on credit. Any new creditor will give us the goods on credit if he knows that we pay our creditors' bill within short period of time. So, for knowing this time period, both parties calculate creditor turnover ratio. We will calculate this because if our time period is more than normally standard period, we will try to decrease it. On the other side, new creditor will take the decision on this ratio whether goods on credit will be given to us or not.

We calculate creditor turnover ratio just like calculating of debtor turnover ratio but we show net credit annual purchase and average trade creditors instead of net credit annual sales and average trade debtors. If we have not the information of net credit purchase, we can take total purchase as numerator. Like this, if we have no information of opening balance of creditors, we can take closing balance of creditors. We can calculate average trade creditors by taking the average of opening balance and closing balance of creditors. Following is the formula

Creditor or Payable Turnover Ratio

= Net Credit Annual Purchase / Average Trade Creditors

This ratio can be used for calculating Average Payment period.

Example

Total purchases =  Rs. 400,000

Cash purchases =  Rs. 50000

purchase return =  Rs. 20000

Creditors at end =  Rs. 60000

Bills payable at end =  Rs. 20000

Reserve for discount on creditors =  Rs. 5000


Creditor Turnover Ratio = Annual Net Credit Purchase / Average Trade Creditors

= 400000 - 50000 - 20000 / 60000+20000 = 330000 / 80000 = 4.13 times

Interpretation of Creditor Turnover Ratio

Higher creditor turnover ratio is good because it will decrease the average payment period.

In the question, if we have given the information of creditor turnover ratio and other information, we can calculate one missing information. For example, in following video, we can find opening balance of creditors, if all other information is given.