Determining how much money you owe to keep your business running, compared to how much you’ve earned in a certain period of time can help you decide when to most effectively pay your bills. The payables to operating expenses ratio helps you do just that. While you must pay bills to keep the lights on and the doors open, those payments do take money out of your business; money that when appropriately distributed keeps you out of debt and in the black.
The longer you can hang on to your money, the more time you have to use it to promote sales and build profits. You don’t want to incur penalties from paying bills late. At the same time, you don’t want to pay bills too early or in advance, taking critical funds out of your usable cash flow. The smaller the payable to operating expenses ratio you can devise, the better because it means you have more time to convert your assets into business generating income.
In addition to finding ways to hang on to your profits longer, the payables to operating expense ratio can help you determine if your operating costs are too high, or cutting into your profits too drastically. At the same time, you can use this ratio to monitor customer payments to set your own credit time limits accordingly so that you are always being paid before your bills are due. Watch patterns that will emerge over time to make adjustments in the way you pay your bills, the timeliness of your collections as well as to efficiently balance operating costs and profits.
The typical formula used to determine the payable to operating expense ratio relies on a specific time period. Two weeks or a month are common periods that give you accurate ratio numbers. At the end of your time period, divide your accounts payable, or sales totals, by your operating expenses for the same time period. Line items for expenses should not include taxes, depreciation or costs of goods sold at this time. For example, if you have $1,000 owed to you and your operating expenses were $500 for the two-week period, your payables to operating expenses ratios would be two to one, or 50 percent.
Employ strategies wherever you can to reduce your payables to operating expense ratio. Work with vendors to extend the period of time before you must pay off your final tab. Take advantage of grace periods provided by vendors and creditors. Grace periods usually do not cause you to incur penalties. Arrange electronic and mailed payments to hit creditors exactly on the final day they are due. Institute a financial management program that ensures you collect on payables before your primary obligations are due so that you always have more liquidity.