Days Payable Outstanding (DPO) is a financial metric used to calculate, on average, how many days a company is taking to pay its suppliers. DPO is a useful indicator of a company’s health. Accounts payable refers to the amount of money that a company owes to its creditors and suppliers. Days Payable Outstanding is an important metric that often informs decisions regarding accounts payable.
How is Days Payable Outstanding Calculated?
The formula for calculating days payable outstanding is:
DPO = accounts payable x number of days / cost of goods sold
(/ = divided by)
Where accounts payable = the money that is owed to suppliers at the end of a specified period (normally a year or a quarter). Alternatively, it can be the average money owed over that period.
Where number of days = the period of time used in the accounts payable calculation.
Where cost of goods sold = the cost for producing inventory, which includes raw materials and shipping costs.
As an example, a company has an accounts payable valued at £150,000. This is the average over a year period. The cost of goods sold came to £450,000 over that same period of time. Thus:
DPO = 150,000 x 365 / 450,000 = 121.6 Days
How to Interpret DPO
As with Days Inventory Outstanding (DIO) and Days Sales Outstanding (DSO), it is important to consider the DPO in the context of the sector that a company works in. This will give a good indicator to the financial health of a company.
High DPO
A high DPO means that a company is delaying payments successfully allowing more money in working capital. If a company can make inventory and sell it before paying for the materials and shipping it is in a dream situation. That is, as long as the high DPO is not the result of liquidity issues. If a company is delaying payments because it hasn’t got the money to pay its creditors then that is a nightmare scenario.
Low DPO
A low DPO may indicate a number of things. Firstly, it might be that a company is not taking full advantage of its terms of payment agreements with its suppliers. Better terms might be available. It might be that the suppliers are charging extra and are happy to accept slow payment because they are factoring their invoices. And it might be that the company in question is being smart and securing early payment discounts.
From the outside, a company that is quick to pay its suppliers creates good will. A low DPO might indicate a close and mutually beneficial relationship between supplier and customer.
The Sweet Spot
DPO should not be taken in isolation. Supply chains have become long and complex in the global age. Thus, if a company takes a long time to pay its suppliers it will cause the suppliers to have a high Days Sales Outstanding (DSO). A high DSO means a company has money tied up in unpaid bills for too long. This affects working capital in a detrimental way. A winner who takes ages to pay must also create a loser who has to wait ages for payment. Communication between company and supplier is key to finding a good balance.
Cash Conversion Cycle
Another facet of Days Payable Outstanding is that it is used in the calculation for the cash conversion cycle. This metric measures how long it takes for money spent on raw materials to be converted into inventory, and then to be converted back to cash via sales. For more read our post What is the Cash Conversion Cycle?
In Summary
The Days Payable Outstanding is a number indicative of how long a company is taking to pay its suppliers. While a high number is usually preferable, it is not always the case. DPO is also used to calculate a number for the cash conversion cycle.
