Days payable outstanding (DPO) is a financial ratio often used to determine how well a company is managing its cash flow. This ratio shows the average time in days that it takes for a company to pay its bills and invoices for purchases made on credit. A company’s DPO is typically calculated on a quarterly or annual basis.
As the age-old saying goes, in order to make money, you need to spend money. How a company spends its money can determine whether it will meet its full potential. Good cash flow management keeps a company in business and helps it grow, but when its days payable outstanding (DPO) ratio increases, that could be a sign of poor cash management or a decline in cash income. On the other hand, days payable outstanding increasing can also represent a company’s bargaining power.
So what does days payable outstanding mean? Let’s explore how DPO is calculated and how it can reflect a company’s financial health.
What is days payable outstanding in accounting?
Days payable outstanding, or DPO, refers to the average number of days it takes for a company to pay back its accounts payable. This ratio is generally calculated on an annual or quarterly basis. For example, a DPO of 30 means that the company takes 30 days on average to pay invoices on purchases made on credit terms.
As a financial ratio, days payable outstanding can indicate multiple factors of a company: it can reveal how a company is managing its cash, or it can gauge a company’s capacity to utilize cash toward short-term investments that may boost its cash flow.
How to calculate days payable outstanding
The days payable outstanding formula calculates the number of days it takes a company to fulfill its outstanding invoices for purchases made using credit. The calculation of a company’s annual DPO can be simplified using the following steps:
- Divide the company’s average (or ending) accounts payable balance by its cost of goods sold (COGS).
- Multiply that figure by 365 days (or 90 to 92 days, if calculating by quarter).
Days payable outstanding (DPO) formula
To calculate a company’s days payable outstanding, you would use the following formula:
Days payable outstanding formula variables explained
The variables used to calculate a company’s DPO can all be found on its balance sheet and income statement. To better understand what DPO truly represents, let’s take a look at each of these variables and what they represent.
Accounts payable (AP)
Accounts payable represents the money the company owes to creditors and is listed under current liabilities on its balance sheet. This number only refers to a company’s short-term obligations to pay creditors, such as debts that must be paid off within a given period to avoid default. On a corporate level, accounts payable usually refers to short-term payments not yet made to suppliers — simply put, it’s essentially an IOU from one business to another.
Number of days
Days payable outstanding is typically calculated annually, but it can also be calculated on a quarterly basis. If the figures taken from the company’s balance sheet and financial statement are year-end totals, then the number of days would be 365. On the other hand, if the figures are taken from a quarterly report, then you would use the number of days in that quarter in the formula.
Cost of goods sold (COGS)
Cost of goods sold refers to the direct costs related to producing goods. This amount includes material and labor costs required to make the goods but excludes indirect expenses, such as distribution costs and sales force costs. On a company’s income statement, cost of goods sold appears as the first line item under revenue and is calculated by adding purchases in the current period to the beginning inventory, then subtracting the ending inventory.
Factoring in accounting practices when calculating DPO
Depending on a company’s accounting practices, there are two ways to calculate days payable outstanding: one is the DPO of a given date, and the other is the DPO average of a given accounting period. Regardless of which DPO you calculate, the cost of goods sold will be the same; the difference will be in how you factor in accounts payable.
When calculating the DPO of a given date, the accounts payable amount will be the figure reported at the end of the accounting period. This could be the end of the fiscal year or the end of a given quarter.
When calculating the DPO average of an accounting period, you would add up the beginning and ending accounts payable amounts, then halve that number to obtain the average accounts payable value for that period.
What does days payable outstanding represent?
Many companies use credit to purchase inventory, materials, and other necessary business expenses. Days payable outstanding is the average number of days it takes a company to pay back its creditors, and it can reflect the company’s timeliness in paying back its debts or its buying power and ability to use free cash on hand.
DPO and cash flow
Buying on credit is generally more advantageous than using solely cash payment. When a company doesn’t need to pay its suppliers right away, it can use available cash for short-term investments instead. If the company is resourceful with its available cash, it can increase working capital and free cash flows (FCFs). Granted, just because a company has the capacity to use free cash doesn’t automatically mean that cash will be managed proficiently. There is also the possibility that the company does not have the capital to pay off its debts in a timely manner.
Imagine a company has the ability to make early payments on short-term debts to suppliers, but it waits to pay those debts off. If the company takes too long to pay back a debt, its relations with the supplier may suffer, which could make it harder for the company to receive future credit. Creditors could eventually decide to offer less favorable payment terms or even refuse to offer credit altogether. The company could also lose out on any potential discounts offered for timely payments.
On the other hand, a company’s cash outflows also need to be balanced with its cash inflows. Imagine a company offers its customers a 90-day window to pay for any goods purchased. If the company only has only a 30-day period to pay off its suppliers and vendors, it may end up in a cash crunch, which can impact business operations and hinder company growth. These examples demonstrate how a company must strike a balance between paying its creditors too soon (low DPO) and paying them too late (higher DPO).
High DPO vs. low DPO in terms of buying power
Payment delays to creditors can offer benefits to the borrowing company, such as increasing working capital and free cash flows. However, a company’s ability to extend the time it needs to pay off debts can also indicate its buying power and negotiating leverage.
The following are some signs that a company’s high DPO reflects its buyer power and ability to negotiate extended payment terms:
- The company frequently places large orders with its suppliers.
- The company has a long history of good supplier relationships.
- The supplier has a low number of potential customers.
When a company has a high DPO, it could mean its suppliers or vendors rely on that company to stay in business. In this scenario, the supplier may be forced to accept a request for delayed payment because it cannot afford the risk of ending its relationship with the company.
On the other hand, a low days payable outstanding could be due to a low order volume or a low revenue concentration — that is, a smaller percentage of total revenue to suppliers. In this scenario, the supplier may be required to go out of its way to sell to the company. This inconvenience to the supplier could outweigh the benefit of serving that particular company and reduce any favorable terms offered, which means the company will eventually be required to pay its suppliers sooner rather than later, resulting in a lower DPO.
Average DPO values can fluctuate greatly from one industry to another, so it’s generally not worthwhile to compare average DPO values between companies from different industries. Instead, DPO is best utilized as a tool to compare companies within the same industry.
By comparing a company’s DPO to the industry average, you can determine if that company pays its vendors too quickly or too slowly in relation to similar businesses. This result can indicate how well a firm is managing its cash flows and how much buying power it may possess over its suppliers.
It’s worth noting that DPO can also vary greatly from company to company and from year to year based on global and local factors — such as the economy, seasonal impacts, or natural disasters — so make sure to consider these factors whenever you conduct an industry-wide comparison.
DPO and financial stability
While DPO can be useful for comparing one company to other businesses in the same industry, there is no exact number that constitutes a healthy days payable outstanding. Because DPO varies significantly depending on a given business’s industry and bargaining power, the days payable outstanding formula is most useful as a complex tool to determine a company’s working capital management, competitive positioning, negotiating power, and capacity to pay back creditors.
What is the difference between DPO and DSO?
DPO stands for “days payable outstanding” and refers to the average number of days it takes for a company to pay its creditors. By contrast, DSO means “days sales outstanding” and represents the average number of days it takes for sales to be paid back to the company. A company with a high DSO is likely waiting extended periods of time to collect money for products that it sold on credit.
Do you calculate DSO the same way you calculate DPO?
No, the formulas for DPO and DSO are different. To calculate DPO, you multiply accounts payable by the number of days, then divide that value by the cost of goods sold. To calculate DSO, you divide accounts receivable by total credit sales (TCS), then multiply that figure by the number of days in that period.
What causes days payable outstanding to increase?
The result of the days payable outstanding formula tells you the average number of days that it takes for a company to pay back its creditors. Therefore, the DPO will increase the longer it takes on average for the company to pay back its suppliers and short-term debts.
How does days payable outstanding relate to the cash conversion cycle?
Days payable outstanding is an integral part of the formula used to calculate a company’s cash conversion cycle (CCC), which is the length of time that it takes a company to convert its resources into cash from sales. To calculate CCC, you add the days of inventory outstanding (DIO) to days of sales outstanding (DSO), then subtract days payable outstanding (DPO). The simplified formula is as follows:
CCC = DIO + DSO – DPO
- Days payable outstanding (DPO) refers to how many days it takes for a company to pay back its debts to creditors.
- Extending its days payable outstanding can allow a company to utilize free cash for short-term investments over a longer period of time. The more time a company has to use its available cash, the more potential the company has to increase its capital.
- A high DPO may not always reflect well on a business, as it could signal a cash shortfall or the company’s inability to pay its creditors. If a company takes too long to pay back its suppliers, creditors may be incentivized to offer less favorable terms.
- Conversely, a low DPO may reflect a company’s low buying power or negotiating leverage.
- There is no single number that indicates a healthy days payable outstanding, as DPO varies widely across industries. Instead, every business must strike a careful balance between paying its creditors too soon and paying them too late compared to other businesses within the industry.
View Article Sources
- Days Payable Outstanding – Know The Impact of High or Low DPO – Corporate Finance Institute
- Days Payable Outstanding – Business Literacy Institute
- How to Calculate Marginal Cost: Formula and Examples – SuperMoney
- What is Negative Working Capital? – SuperMoney
- Net Operating Assets: Formula & Examples – SuperMoney
- What is a Vendor? – SuperMoney