5.4.4 Payables payment period
The payables payment period determines the average number of days a business takes to pay its trade payables. This ratio investigates the relationship between average trade payables and credit purchases. However, since the average trade payables figure is difficult to obtain, most financial analysts use the average of opening and closing trade payables. Alternatively, the value of trade payables reported at the end of the reporting period can be used. Similarly, since the value of net credit purchases is often difficult to find, cost of sales is used from the published financial statements. For this course, this ratio will be calculated as follows:
Below is the calculation of the payables payment period for Remote Sensors Plc.
| 2025 | 2024 | 2023 | |
|---|---|---|---|
| Trade payables | 3,200 | 2,166 | 1,610 |
| Cost of sales | 10,590 | 10,660 | 9,876 |
| Payables payment period | 110 | 74 | 60 |
You can see that the payables payment period for Remote Sensors Plc increased considerably from 2023 to 2025. A higher payables payment period is considered good as it means that the business is conserving cash by not paying its trade payables as quickly and making use of the money elsewhere in the business. However, it may also mean that the business is not making effective use of any purchase discounts that it may receive if payments are made in a shorter window. It may also result in damaging its relationship with its suppliers if the terms of payment haven’t been agreed with the suppliers. It may also signal that the company is facing cash flow problems and is unable to finance its obligations efficiently. The companies having liquidity problems often have longer payables payment periods. However, in order to gain the full picture, it is important to take all other measures into consideration. For example, what does inventory turnover look like, and how long does the company take to recover cash from its receivables?
The purpose of Activity 17 is to develop your numeracy and financial analysis skills through the calculation and interpretation of efficiency ratios for a real company.
Activity 17 Practising efficiency ratios
Look at Next Plc accounts [Tip: hold Ctrl and click a link to open it in a new tab. (Hide tip)] for the years ending 2022 and 2021 answer the following questions:
- a.Calculate the following ratios:
- Inventory days
- Receivables collection period
- Payables payment period
- Asset utilisation ratio.
Use the notes to the financial statements to retrieve more accurate or additional figures.
Use the following spreadsheet to carry out your analysis.
| Workings | 2022 | 2021 | |
|---|---|---|---|
| £m | £m | ||
| Total revenue | |||
| Cost of sales | |||
| Inventory | |||
| Trade payables | |||
| Trade receivables | |||
| Capital employed | |||
Inventory days = (Inventory/ Cost of sales) × 365 |
|||
Receivables collection period = (Accounts receivable/Total revenue) × 365 |
|||
Payables payment period = (Trade payables/Cost of sales) × 365 |
|||
Asset utilisation ratio = Sales revenue/Capital employed |
Comment
| 2022 | 2021 | |
|---|---|---|
| £m | £m | |
| Total revenue | 4,625.9 | 3,534.4 |
| Cost of sales | 2,625.3 | 2,231.7 |
| Inventory | 633.0 | 536.9 |
| Trade payables (Note 17) | 275.4 | 172.6 |
| Trade receivables (Note 13) | 1,187.1 | 1,041.5 |
Capital employed = (Equity + Non-current debt + Current debt) |
2,058.8 | 1,917.3 |
Inventory days = (Inventory/ Cost of sales) × 365 |
88 | 88 |
Receivables collection period = (Trade receivables/Total revenue) × 365 |
94 | 108 |
Payables payment period = (Trade payables/Cost of sales) × 365 |
38 | 28 |
Asset utilisation ratio = Total revenue/Capital employed |
2.25 | 1.84 |
Workings
Inventory days = (Inventory/Cost of sales) × 365
2022 = (633.0/2,625.3) × 365 = 88 days
2021 = (536.9/2,231.7) × 365 = 88 days
Receivables collection period = (Trade receivables/Total revenue) × 365
2022 = (1,187.1/4,625.9) × 365 = 94 days
2021 = (1,041.5/3,534.4) × 365 = 108 days
Payables payment period = (Trade payables/Cost of sales) × 365
2022 = (275.4/2,625.3) × 365 = 38 days
2021 = (172.6/2,231.7) × 365 = 28 days
Asset utilisation ratio = Total revenue/Capital employed
2022 = (4,625.9/2,058.8) = 2.25 times
2021 = (3,534.4/1,917.3) = 1.84 times
- b.How would you interpret the changes in these ratios? Share your thoughts in the box below.
Feedback
There was no change in inventory days despite an increase in the levels of inventory, because cost of sales also increased. The receivables collection period ratio has reduced from 108 days to 94 days, which is a positive sign and indicates an improved and more efficient collection mechanism within the company. An increase in the payables payment period from 28 days to 38 days is also a positive sign as the company is now retaining cash for a longer time in the business. However, the company’s receivables collection period is quite high in comparison to the payables payment period. An increase in the payables payment period also raises important questions of how this may be affecting the company’s relationship with its suppliers, or whether the company is missing out on any early payment rebates. The asset utilisation ratio also shows an improvement and therefore indicates a more effective use of company assets in generating revenues.