Days Payable Outstanding - Formula, examples, and more

• What is Days Payable Outstanding (DPO)?
• Days Payable Outstanding formula
• How to calculate DPO
• Example of calculating DPO
• Should DPO be high or low? ‘Good’ and ‘bad’ figures
• DIO and DSO vs DPO
• Different benchmarks in different industries
• The pros and cons of using DPO
• How technology can help to improve your DPO
• Streamlining with Financials
• FAQs

What is Days Payable Outstanding (DPO)?

Days Payable Outstanding (DPO) is a financial metric that indicates the average number of days a company takes to settle its accounts payable (AP) and pay its suppliers, vendors, and other trade creditors after receiving an invoice.

DPO is like a company's 'payment speedometer’, telling you how quickly or slowly they clear their bills. Company's often run on a credit system, wherein they purchase goods and services from suppliers and vendors on credit. This money owed by the company is recorded as accounts payable (AP). The average time in days the company takes to settle their accounts payable is referred to as DPO.

A DPO value of 30 would imply that, on average, 30 days are required by the company to pay back its creditors.

• DPO is a measure of time taken by the company to pay off its creditors.
• DPO has impact on company's ability to negotiate favourable credit terms with suppliers. A company with a strong DPO may have better negotiating power, leading to extended payment periods or discounts.
• Companies can strategically adjust DPO to optimise working capital.
• DPO can affect financial ratios such as the current ratio and quick ratio. A higher DPO may lead to a higher current ratio, reflecting a potentially healthier liquidity position.

Days Payable Outstanding formula

Formula 1

DPO = (Average AP / COGS) x Number of Days in Accounting Period

In this formula, DPO is determined by finding the ratio of average accounts payable to cost of goods sold (COGS) and multiplying it by the number of days in the period.

Formula 2

DPO = Average AP / (Cost of Sales / Number of Days in Accounting Period)

This formula calculates DPO by dividing the average accounts payable by the daily cost of sales. The numerator represents outstanding payments, and this formula considers the average daily cost incurred by the company in manufacturing products.

How to calculate DPO

The following steps outline the process for calculating DPO.

Step 1: Determine the average accounts payable

The average accounts payable represents the standard amount owed by the company to its suppliers during the accounting period. It is calculated by averaging the amount owed at the beginning and the amount owed at the end of the period.

Formula to calculate average accounts payable is:

Average AP = Beginning Accounts Payable + Ending Accounts Payable / 2

Instead of using the Average AP, as mentioned in the formulas above, the exact accounts payable amount reported at the end of the accounting period can be used. For instance, if you calculate DPO on December 31, you’d use the total amount owed to suppliers on that exact day. This method of calculation provides a current value of DPO rather than an average during a certain period. The choice of calculation method depends on the accounting practices of your company.

Step 2: Find the cost of goods sold

Accounts payable do not fully represent the money involved in the manufacturing of goods and services. There are additional costs, such as payments for utilities like electricity and employee wages. These costs are included in the COGS, which represents the direct costs of acquiring or producing the goods sold by a company during a specific period. Both accounts payable and cost of goods sold are cash outflows, crucial in the calculation of DPO.

Cost of sales and COGS are often used interchangeably and can be calculated as follows:

COGS = (Beginning Inventory + Purchases) – Ending Inventory

Step 3: Define the accounting period

Determine the number of days in the period for which you want to calculate the DPO. Ensure that the average AP and COGS values are also from this specific time frame. Days Payable Outstanding is typically calculated annually or quarterly. In case of annual calculation, the number of days in the Accounting Period is usually taken as 365. Similarly, 90 is considered for quarterly calculations.

Step 4: Apply the formula and calculate

Now, substitute the values for each component of the DPO formula that you determined in the previous steps.

The formula to find DPO is:

DPO = (Average AP / COGS) × Number of Days in Accounting Period

First, find the ratio of Average AP to cost of goods sold by dividing the Average AP value by the COGS value. Next, multiply this ratio by the number of days in the accounting period.

This will give you the DPO, which represents the average number of days the company takes to pay its suppliers.

Example of calculating DPO

Consider a mid-sized retail company with steady growth. The following tables showcase their financial statements. The figures on the consolidated statement of operations represent the amount of expenses related to the cost of sales. And you can see the accounts payable on the balance sheet.

This information is enough to calculate DPO. We can consider the starting balance of a period as the concluding balance of the preceding period for accounts payable.

Accounts Payable as of December 31, 2022 = £58.3 million

Accounts Payable as of December 31, 2023 = £65.2 million

Hence,

Average Accounts Payable = (£58.3 + £65.2) / 2

Average Accounts Payable = £61.75

The average balance of accounts payable for 2023 is £61.75 (in millions).

The COGS value for 2023 is reported as £419.3 million. We can take 365 as the accounting period, therefore, the DPO can be calculated as:

DPO = (Average Accounts Payable / COGS) × Number of Days

DPO = (£61.75 / £419.3) × 365 days

DPO = 53.70 days

Thus, the Days Payable Outstanding is roughly 53.7 days, indicating that, on average, the company required 53.7 days to settle its accounts payable in the year 2023.

In the second example, let’s calculate the current DPO at the end of the second quarter (June 30th), using the ending Accounts Payable (AP) value rather than the average for the duration.

Consider the following values:

• Ending Accounts Payable on June 30th: £80,000
• COGS for the second quarter: £1,200,000
• Number of days in the second quarter: 91 (April 1 to June 30)

We will use the formula:

DPO = Ending AP / (COGS / Number of Days in Accounting Period)

So, let’s first determine daily COGS:

Daily COGS = COGS / Number of Days in Accounting Period

Daily COGS = 1,200,000 / 91

Daily COGS = 13,186.04

Substituting values into the DPO formula, we get:

DPO = Ending AP / Daily COGS

DPO = 80,000 / 13,186.04

DPO = 6.07

So, the current DPO at the end of the second quarter is approximately 6.07 days. This is not an average value but a snapshot of DPO specifically as of June 30th. This value can be useful for reporting real-time insights into the company's financial management.

It's important to acknowledge that this is a simplified calculation, and a comprehensive financial analysis may require more detailed considerations.

Should DPO be high or low? ‘Good’ and ‘bad’ figures

The timeframe within which accounts payable are settled is arguably as important as the repayment itself, making DPO a crucial metric for giving businesses insights. It reveals nuggets of information about a company’s relationship with suppliers, as well as their efficiency with tracking cash flows and spend management. However, there's no one-size-fits-all answer to the question 'Should DPO be high or low?'. The evaluation should be nuanced, considering the specific context.

For instance, a company might allow a 60-day period for customers to settle invoices but only have a 15-day window to pay suppliers and vendors. This disparity in inflow and outflow duration poses a risk of frequent cash crunches. Hence, DPO is all about finding the right balance according to the needs and best interests of your company.

Reasons for a high DPO

A high DPO is generally regarded as favourable, providing the business with an extended timeframe to settle its dues, and leaving it with ample cash on hand. This surplus cash contributes to the company’s working capital and can be channelled into short-term investments for potential financial gains. Moreover, it allows the company additional time to convert inventory into sales revenue before addressing its payables.

Having a DPO higher than the industry average implies more favourable credit terms compared to competitors. This suggests strong relationships with creditors and suppliers, providing the company with a competitive edge in the market.

Reasons for low DPO

Equally, a high DPO may signal that a company takes too long to settle its debts, indicating potential financial struggles. This approach also carries the risk of straining relationships with suppliers and creditors who might prefer prompt payments. Such strained relationships could jeopardise future credit opportunities, negotiation advantages, and even the chance to avail discounts for timely payments.

Conversely, a low DPO indicates the company is in sound financial health, efficiently managing cash flow and promptly settling bills with suppliers. This fosters more positive relationships.

However, there's a downside to a low DPO too, as it may suggest the organisation is not utilising its capital resourcefully. For instance, if a company typically pays invoices after 10 days, but suppliers allow a 30-day window, they could potentially be earning interest on funds for an additional 20 days before payment.

Also, a lower DPO may imply a lack of trust from creditors for long-term credits and a weaker relationship with them. Thus, a DPO lower than the industry average could indicate less favourable credit terms compared to competitors.

DIO and DSO vs DPO

It is rare for a business to sell its goods instantly; hence, these goods are often stored as inventory. The time this inventory sits with the company before being sold is called Days Inventory Outstanding (DIO). When this inventory is sold, the business often won’t receive payments immediately; instead, it is given on credit to customers. The days taken in receiving these payments after goods are sold are referred to as Days Sales Outstanding (DSO). Similarly, as we’ve discussed, the time taken by the organisation to deal with its own payables is called Days Payable Outstanding (DPO).

DIO, DSO, and DPO indicate how well they are managing inventory, receivables, and payables, respectively. These metrics are necessary to determine the Cash Conversion Cycle (CCC). Achieving a lower CCC, facilitated by low DIO and DSO and a higher DPO, is generally preferred as it signifies an efficient cash conversion process and effective management of working capital.

Different benchmarks in different industries

A Days Payable Outstanding benchmark is an ideal value or standard set as a reference point to compare and evaluate a company’s DPO, essentially to assess the company’s ability to manage its payables. A DPO benchmark can be established for the industry, for competitors, or based on the company's own historical performance. A company can use this benchmark to compare its current DPO and determine its position relative to industry competitors or its own past performance, whether it is performing better or worse and thus identifying areas needing improvement.

The ideal value for Days Payable Outstanding varies widely across sectors, with each region, industry, and niche having its own specific averages. Additionally, these averages change with time, the size of the company, and prevailing market conditions. For instance, manufacturing industries with longer production cycles tend to have higher DPO values.

Similarly, established corporations can leverage their market dominance to secure favourable payment terms and higher DPO compared to startups. It's crucial to note that there is no universal benchmark for Days Payable Outstanding; what is considered healthy in one industry or region might be deemed unfavourable in another.

A DPO benchmark for your industry or competitors can be established by gathering the DPO values of peer companies within the same industry. These values can then be analysed to determine an average or a range of values to set as the benchmark.

The pros and cons of using DPO

With insights around your creditworthiness, liquidity, and overall financial health, an understanding of Days Payable Outstanding certainly comes with its benefits. However, there are also some potential drawbacks, so let’s take a look at some of the main pros and cons:

How technology can help to improve your DPO

Striking the right balance in Days Payable Outstanding (DPO) is paramount for optimal financial management. Leveraging technology can simplify this process. Implementing budgeting and forecasting tools allows for accurate projections, facilitating effective cash flow management. With insights into future expenses, you can optimise payment schedules and enhance your DPO.

Advancements in technology have made financial processes more efficient. Now you can track your cash flow in real time. This enables you to monitor and strategise payments to suppliers, improving DPO without compromising operational efficiency.

Positive supplier relationships are vital for expediting goods receipt. Automation tools for accounts payable and e-payments contribute to this goal by streamlining the invoice processing workflow. Improvements like digitising invoices, automating approvals, reducing manual data entry, and utilising electronic payments significantly reduce processing time and shorten DPO.

Streamlining with Financials

Financials is a financial management software designed to streamline processes and enhance your control over financial decisions. With automated reporting, it minimises manual work and provides key insights effortlessly, driving strategic initiatives across the organisation. Being cloud-based, it facilitates seamless communication of real-time data across departments, aiding in informed decision-making regarding payments and supplier relationships for DPO optimisation.

The software supports finance teams in managing various accounting elements, including general ledger, accounts payable, credit management and invoice management.

Additionally, Financials offers a self-service portal for suppliers. Here, registered suppliers can address queries, review contracts, catalogues, purchase orders, and invoices directly through the portal. This interactive platform strengthens supplier relationships, contributing to favourable DPO terms and ensuring optimal deals.

Explore more about Financials and take the next step towards optimising your financial management today.

FAQs

What does DPO ratio mean?

DPO is a financial ratio that measures the average number of days a company takes to pay its suppliers after receiving an invoice. It compares accounts payable to the daily cost of goods sold or purchases, providing insight into how efficiently a company manages its payables relative to its expenses for goods or services over a specific period.

What is the average value of days payable outstanding?

A DPO of 30 to 45 days is generally considered a standard across many businesses and industries. However, it is important to note that there is no single figure that defines the average value of DPO, as it varies widely based on industry, company size, and other factors.

Industries with longer production cycles and large companies with greater negotiating power tend to have a DPO of 45 to 60 days or even more. Industries with faster inventory turnover and shorter supplier payment terms, such as retail, often have a low DPO.

However, these numbers are generalised, and the actual average can vary significantly. For instance, in the tech sector, DPO is based on business models and can range broadly, from as low as 30 days to as high as 90 days.