Days Payable Outstanding (DPO)

Days payable outstanding (DPO) is a ratio measuring the average time a company takes to pay its invoices & bills to suppliers and vendors. To make a product, companies need capital—either raw materials, workers, and/or any other expenses. Not all of these resources are paid in advance.

In normal practice, some of them are purchased in credit and become liabilities. DPO estimates the proportion of these liabilities among the total cost to create sellable goods then determine the average time—in days—taken by a company to paid them off.

DPO is calculated regularly, whether on a quarterly basis (once every 3 months) or a yearly basis. By looking at the DPO of the company, we can see how the internal management handles the cash outflows. Higher DPO equals a longer period to pay the liabilities, meaning the company retains the cash for a greater length of time.

Paying in advance is often against businesses’ interests. If they can afford to purchase goods or services on credit, they will most likely do it, reasonably. Why? Because the money that otherwise used to pay these services or goods can be used for something else, like increasing their capital. By doing this, they increase the value of accounts payable—the variable representing companies’ short-term liabilities to suppliers.

Days Payable Outstanding Formula

$$DPO = \dfrac{Accounts\: Payable \times Number\: of\: Days}{Cost\: of\: Goods\: Sold}$$

Accounts payable is the first variable we need. Accounts payable (AP) refers to the account representing a business’ obligations to pay off liabilities towards suppliers or vendors. The value of AP is the price of goods or services that haven’t been paid by the company. It’s practically the same as the situation when someone buys electricity in credit. He or she gets the service first, but eventually, need to pay for it in the future.

Now, imagine that it’s not a person that purchases the electricity in a loan, but a company. Additionally, on the balance sheet, accounts payable falls under the current liabilities section. Keep in mind the word ‘current’ so any long-term liabilities (due in more than one year) are not included.

The version of accounts payable used for this calculation may vary. You can either take the value reported at the end of the period (a year or quarter) or you can take the average value of accounts payable. The average value of AP can be obtained by adding the figure of APs of the beginning period and the ending period, then divide the result by 2.

Cost of goods sold (COGS) is the direct cost related to producing goods sold by a business. Not just material costs, COGS includes labor costs and factory overhead. As a side note, factory overhead is also a direct expense that includes electricity, oiling, repairs, etc. Since the metric only takes into account direct expenses, indirect expenses such as distribution costs and office supplies are not calculated. To determine the COGS, use this formula:

$$COGS = Beginning\: Inventory + Purchases - Ending \: Inventory$$

Remember that inventory is the assets or goods intended for sales. This includes raw materials. In other words, the beginning inventory is the value of inventory owned by a company in the beginning period—whether at the start of the year or quarter. To put it simply, beginning inventory is the leftover inventory from the previous term.

This means we can intuitively say that the ending inventory is the remaining inventory at the end, i.e. the products that haven’t been sold. Lastly, purchases mean the additional purchase or production made during that period. You can think of it as the inventory plus the production expenses added during that time.

Finally, the number of days refers to the duration of the period. It is often determined as 365 for yearly calculation or 90 for quarterly calculation. By multiplying the result of the calculation with the number of days, we can determine the average days needed for companies to pay off their payable outstanding to its vendors (accounts payable).

Days Payable Outstanding Example

A retail company releases its financial statement every year. By looking at the balance sheets of the previous year and the present, we can calculate the average value of accounts payable (AP) to be $40 billion. The cost of goods sold (COGS) is also determined to amount to $300 billion. What is the days payable outstanding of the company?

Let’s break it down to identify the meaning and value of the different variables in this problem.

  • Accounts Payable (in billion) = 40
  • Cost of Goods Sold (in billion) = 300
  • Number of Days = 365

Now let’s use our formula and apply the values to our variables to calculate the days payable outstanding:

$$DPO = \dfrac{40 \times 365}{300} = 48.67\: days$$

In this case, the days payable outstanding would be 48.67 days.

From this result, we can estimate that, on average, it takes 48.67 days for the company to pay off each of its accounts payable to its vendors and/or suppliers. Keep in mind that this number does not tell us the bigger picture since there’s no ideal number of DPO. To get a better outlook, you can compare the result to other companies within the same industry and the same period. More on this later.

Days Payable Outstanding Analysis

By using the days payable outstanding, we can evaluate how long it takes for a company to pay off these liabilities.

To put it simply, companies need to strike the balance in DPO. Again, a big value of DPO may help companies but it also risking their credibility. Supplies and vendors may no longer wish to lend their service or goods for them due to late payments. Otherwise, the term of the loan may not be as favorable as it used to, not to mention the companies can pay less if they pay off its debts earlier.

DPO value can be useful for companies when they compare their result against the DPO’s of other corporations in the same industry since the way businesses manage their cash flows can vary. By doing this, they can see if they are paying their debts too slow or too fast. It’s generally ideal to make the number as close to the average industry value as possible. The period used for the comparison should also be the same.

Things like global economic performance and seasonal impacts are factors that are closely knitted with time. That’s why comparing DPO value with companies in different sectors and/or time is rather fruitless.

One potential weakness that DPO has is it may not give us an accurate result when we compare the value of a big company against the smaller one, even if they are the same type. Big corporations are most likely to have connections and negotiation power with vendors so that they can have a better contract term. This can reduce the DPO figure to increase company evaluation.

As a side note, we can use DPO as a part of the Cash Conversion Cycle (CCC) calculation that gauges the entire cash flow of a company, not only the cash outflows, to get a better view.

Days Payable Outstanding Conclusion

  • The days payable outstanding is an indicator showing the average days it takes for a company to pay its payable outstanding to its suppliers.
  • This formula requires three variables: accounts payable, COGS, and number of days.
  • Accounts payable refer to the short-term liabilities a company has to its vendors or suppliers, while the cost of goods sold is the direct total cost of creating a product.
  • DPO is calculated yearly or quarterly. The number of days can be 365 or 90 depending on the period.
  • Comparing the DPO value of business against another is a good idea as long as they are of the same type and the variables used are from the same time frame.

Days Payable Outstanding Calculator

You can use the days payable outstanding calculator below to quickly evaluate the average days it takes for a company to pay its payable outstanding to its suppliers by entering the required numbers.

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