How to calculate the average payment period is included in the calculator.
A solvency ratio is the average number of days it takes a business to pay its vendors for purchases made on credit.
The average payment period is how long it takes a company to pay off credit accounts.Credit arrangements are used when a business makes a wholesale or basic materials purchase.Simple payment arrangements give the buyer a certain number of days to pay for the purchase.
In a shorter period of time, discounts are given.A 10 / 30 credit term gives a 10% discount if the balance is paid within 30 days, whereas the standard creditterm is 0 / 90, offering no discount but allowing payment in 90 days.
A company's cash flow and creditworthiness can be revealed by the average payment period calculation.Is the company meeting current obligations?Is the company using its cash flows effectively?The business management team should find this information useful.
To calculate, locate the accounts payable information on the balance sheet.The average payment period is usually calculated using a year's worth of information, but it may be useful evaluating on a quarterly basis or over another period of time.The desired period of time may affect which financial statements are needed.
The average payment period formula is calculated by dividing the average accounts payable by the days in the period.
To calculate, first determine the average accounts payable by dividing the sum of beginning and ending accounts by two, as in the equation:
clothing, Inc. purchases materials on credit from wholesale textile makersThe management team is trying to formulate a lean plan to retain the most profit from sales, because the company has great sales forecasts.They need to decide if it is better for the company to extend purchases over the longest available credit terms or to pay as soon as possible at a lower rate.The management team can see how efficient the company has been over the past year by looking at the average payment period.
The team needs to calculate the average accounts payable.The beginning accounts payable balance was $200,000 last year.Over the course of the year, $875,000 was spent on credit purchases.The average accounts payable is $202,500.
The average payment period equation is 84.48.
This information will be used by the management team to determine if paying off credit balances faster and getting discounts will result in better results.
The above scenario shows an average payment period.The company may be giving up savings by taking so long to pay.You can get a 10% discount for paying within 60 days from one of its main suppliers.If there is adequate cash flow to cover the purchase in 60 days, the company management team would need to evaluate this.If it can, that could make for a nice increase to the bottom line, as 10% is a huge difference in the clothing industry.
It would be better for Clothing, Inc. to keep its money for the entire payment period and not use the early pay discount.It would make more money if it reinvested in new inventory sooner.
It is apparent that the average payment period is a key measurement in evaluating the company's cash flow management.It should always be other companies metrics.
The current average payment period may show that the current credit terms are appropriate if the company doesn't have adequate cash flows to cover payments at a faster rate.It makes sense to stick with this plan if the industry has an average payment period of 90 days.
Making timely payments is important to analysts and investors, but not always at the fastest rate.If a company's average period is less than competitors, that could mean opportunities for reinvestment of capital are being lost.It may be possible to generate higher cash flows if the company extended payments for a longer period of time.