The average payable period gauges the relationship between your use of trade credit and your cash flow. The following example looks at how the average payable period is calculated.
Scott Widget, the owner and president of Widget Manufacturing, just received the quarterly financial statements from his accountant. The balance sheet shows that the ending balance in accounts payable was $9,424 for the quarter. The income statement listed $14,108 in manufacturing costs, and $8,212 in other operating expenses. Scott has decided to compute Widget's average payable period for the quarter.
Average daily purchases on account. The average daily purchases on account is computed as Widget's total purchases on account divided by 90 — the number of days in a quarter. For all practical purposes, Widget seldom pays cash for any manufacturing supplies or operating expenses. Widget has established credit with all of its suppliers and receives a bill for any purchases made over a certain period of time. Therefore, Scott has determined that it is safe to assume that all of the manufacturing and operating expenses paid during the quarter were purchases on account. The total purchases on account is $22,320, which is the sum of the manufacturing costs ($14,108) and operating expenses ($8,212). Widget's average daily purchases on account is $248:
The average payable period. The average payable period for Widget Manufacturing is 38 days:
During Widget's previous quarter, it used each dollar of its trade credit 38
days on the average. Each day that Widget Manufacturing can extend its average
payable period delays $248 of cash outflow. You could also say that each day in
the average payable period provides Widget Manufacturing with free financing!