Days Payable Outstanding

Days payable outstanding help measures the average time in days that a business takes to pay off its creditors and is usually compared with the average payment cycle of the industry to gauge whether the payment policy of the company is aggressive or conservative.

Let us have a look at the graph above. First, we note that Colgate's DPO has been stable over the years and 67.24 days. However, when we compare this with Procter and Gamble, we note that P&G's DPO has been increasing continuously since 2009 and is currently very high at 106.64 days.

The days payable outstanding is a very important metric that identifies the time taken by businesses to make payments to vendors and suppliers for goods and services purchased from them. A high days payable indicates that either the business is getting a credit period form its vendors for a longer timeframe or they are not able to pay the bills on time.

However, both the situations elated to days payable outstanding ratio suggest that the business will have free cash flows left for usage for other operational purposes. But in the process, it is necessary to maintain a balance between making payments and maintaining good relationship with suppliers and vendors. This is important for creating high customer base and retaining them so as to ensure continuity of the business.

Understanding the whole process of Days Payable Outstanding will help understanding it in detail. A company needs to purchase raw materials (inventory) from the vendors or the suppliers. These raw materials can be sourced in two ways. First, the company can buy raw materials in cash. And another way to purchase the raw materials is on credit.

If a company is purchasing the raw materials in bulk, then the supplier/vendor allows the company to buy on credit and pay off the money at a later date. The difference between the time they purchase from the supplier and the day they make the payment to the supplier is called DPO.

Now, whatever we explained above is a simplification of days payable outstanding ratio. However, things are much more complex in a real scenario, and the company needs to deal with multiple vendors/suppliers. Depending on how much time the company takes to pay off the due, the supplier offers many benefits for early payment like the discount on bulk orders or reducing the amount of pay, etc.

Here's the formula –

Days Payable Outstanding Formula = Accounts Payable / (Cost of Sales / Number of Days)

Days payable outstanding is a great measure of how much time a company takes to pay off its vendors and suppliers.

The formula shows that days payable outstanding analysis is calculated by dividing the total (ending or average) accounts payable by the money paid per day (or per quarter or month).

For example, if a company has a DPO of 40 days, that means the company takes around 40 days to pay off its suppliers or vendors on average.

Also, you can have a look at this detailed guide to Accounts Payable.

To understand the perspective of DPO, it's also important to understand how the cash conversion cycle is calculated.

First of all, for getting the average days payable outstanding, the company needs to calculate three things.

The company first needs to calculate DIO by following the formula below –

DIO = Inventory / Cost of Sales * 365

Then, the company calculates the DSO (Days Sales Outstanding) by using the formula –

DSO = Accounts Receivable / Total Credit Sales * 365

Finally, the company computes DPO by the formula we mentioned above –

DPO = Accounts Payable / (Cost of Sales / 365)

Finally, the DIO and DSO need to be added, and then the DPO needs to be deducted from the sum.

This is how the cash conversion cycle is calculated.

The DIO tells a company how much time it takes to transfer the inventory into sales. DSO tells about how much time the company takes to collect the money from the debtors. And DPO tells about how much time the company takes to pay off the money to its creditors.

If we look at all three, the whole cycle of a business is complete – from inventory to cash collection.

We will now look at a practical example to illustrate this.

For a company to succeed, it should look holistically.

By calculating the average days payable outstanding, a company may get how much time it takes to pay off its suppliers and vendors.

But that alone won't do any good until the company does few things.

• Firstly, the company should look at the industry and the average DPO.
• Secondly, if the company's DPO is less than the average DPO of the industry, then the company may consider increasing its days payable outstanding. But the organization should remember that doing this doesn't cost them the vendor or any favorable benefits from the suppliers. Keeping these two things in mind, if a company can match up its DPO with the average DPO of the industry, the company would be able to use the cash flow for better use for a long period.
• Thirdly, if the company's DPO is more than the average DPO of the industry, then the company may consider decreasing its DPO. Doing this will allow them to satisfy the vendors, and the vendors would also be able to provide the company with favorable terms and conditions.
• Fourthly, the company should also look at similar companies and how they're approaching the Days Payable Outstanding. If the company notices closely, they will be able to see the consequences of their approach. And then, the company can get a better idea about whether to increase or decrease the DPO.
• Finally, along with DPO, the company also should look at the other two factors of the cash conversion cycle. There are days of inventory outstanding (DIO) and DSO. Since all three are required to form the cash conversion cycle, it's important that the company pays heed to all three. It will give them a holistic view, and they would be able to improve their efficiency in the long run.

Let us understand the concept of days payable outstanding analysis with the help of some suitable examples.

Example #1

Company Comic has a reputation for paying its vendors quickly. It has an ending account payable of $30,000. Its cost of sales is $365,000. Find out the days payable outstanding for Company Comic.

This is a simple example. All we need to do is to feed the data into the formula.

Here's the formula –

DPO = Ending Accounts Payable / (Cost of Sales / Number of Days)

Or, DPO = $30,000 / ($365,000 / 365) = $30,000 / $1000 = 30 days.

Only calculating the DPO of the company isn't enough; we need to look at it holistically as well.

Example #2

Let us take the example of a company whose accounts payable for the quarter are $100,000. The value of inventories at the beginning of the quarter is $250,000, total purchases made during the quarter $1,000,000, out of which cash purchases are $700,000, and inventories of $100,000 remain unsold at the end of the quarter. Then for the calculation of Days payable outstanding for the quarter, the following steps are to be taken.

Solution:

Use the given data for the calculation of DPO.

Now, First, we have to start with the calculation of the cost of goods sold (COGS) by using the following formula:

COGS = 250,000 + 1,000,000 – 100,000

COGS = $ 1,150,000

Now, DPO for the quarter can be calculated by using the above formula as,

DPO = $100,000 * 90 days / $1,150,000

DPO will be -

DPO = 8 days (Approximately)

Note:

It must be noted that while calculating COGS in this example, a cash purchase is not considered as to whether the purchase is made in cash or on credit; it must be included while calculating COGS.

Example #3

Let us take another example where the company whose accounts payable for the quarter April to June are $100,000, and for the quarter July to September are $500,000 and the cost of goods sold for the quarter April to June is $450,000, and for the quarter July to September is $500,000. Then, the following steps are to be taken to calculate days payable outstanding.

Solution:

Given Data for Quarter April to June:

Now, DPO for the quarter can be calculated by using the above formula as,

DPO = $100000 * 90 days / $450000

DPO will be -

DPO = 20 days.

Similarly,

Given Data for Quarter July to September:

Now, DPO for the quarter can be calculated by using the above formula as,

DPO = $500000 * 90 days / $500000

DPO will be -

DPO = 90 days

Therefore, from the above-given example, it is amply clear that in the period April to June, the company is paying its creditors in 20 days but in the period July to September, the company has increased its days payable outstanding to 90 days.

We will look at the holistic interpretation in the next section.

Example #4

•  Airline companies have varied payment terms that are reflected in their payment outstanding days.
• China Southern Airlines has the lowest payment outstanding days of 13.30, whereas that of LATAM Airlines has the highest amount in this group at 60.48 days.

Example #5

• We observe varied payment terms and payable days outstanding ranging from 0.00 days to 134.66 days
• Ford Payable days Outstanding is at 0 days, and that of Tata Motors is at 134.66 days.

Example #6

• Wal-Mart Stores has Payable days outstanding of 40.53 days, whereas that of Burlington Stores is highest in this group at 70.29 days.

Example #7

• Overall, the payment days are higher than in other sectors ranging from two months to nineteen months.
• Continental Resources has a payable outstanding day of nineteen months, whereas that of Canadian Natural is of one month.

Since this days payable outstanding benchmark is essential for every company in the market, no matter from which sector it belongs to, it is important to keep the outstanding payable days to such a level so that there is no pressure on the management to pay the bills within a very limited time period but at the same time, there is no unnecessary delay leading to loss of reputation in the market. So let us try to understand how to keep the payable time period suitable for the business.

• Payment terms – The payment terms may be extended in such a way so that a good relation is maintained but the business gets some extra time to make payment.
• Availing discounts – it is a good practice to take the advantage of discounts and incentives offered by vendors for early payment. This is because it gives the opportunity to retain some extra cash in the business due to reduction in payment amount and also be in the good books of clients.
• Inventory management – This is an area of the business which needs continuous monitoring. If a lot of inventory is maintained without much usage, it lead to cash being tied up which could have been used for paying off suppliers’ bills.
• Cash planning – The company should be able to plan and forecast its cash inflow effectively so that the outflow can be made on time. An efficient cash management process ensures that the operations carry on without any interruption.
• Invoice processing – Efficient processing of invoices ensure that payments are made on time. If invoices remain to be processed, them deadlines are missed and it leads to high days payable. An automated system helps in such cases.
• Continuous monitoring – The management should maintain a thorough monitoring process so that they are able to identify pending payments using the days payable outstanding benchmark and probe further to find the reason behind it. It will also help in understanding the payment trends and implements strategies to improve the same further.
• Third party financing – Financing arrangement through third party is a good option, where the suppliers receive payments on time and the business can get an extended credit period.

Thus, it should be noted that even though improving the DPO  can be done in the above ways, business relationships or the quality of products and services should not be compromised in any way. This will lead to continuity of the business.   

This article was the guide to what is Days Payable Outstanding. We explain its formula, how to calculate, interpretation, examples & how to improve. You may also have a look at the below articles learn further –

• Compare - Issued vs. Outstanding Shares
• Days Sales Outstanding Formula
• Salary Payable
• Days Sales Uncollected