What is days payable outstanding? And how to calculate DPO?

6 min readSep 23, 2023

What is days payable outstanding (DPO)?

Days Payable Outstanding (DPO) also referred as Accounts Payable Days (AP days) is an important metric in accounts payable management, that offers valuable insights into a company’s efficiency in paying its suppliers.

This metric is useful in understanding the financial health and liquidity of a business. The DPO metric frequently serves as a representation of the buyer’s bargaining power. It indicates the company’s ability to influence negotiations with suppliers and vendors, allowing them to secure favorable terms such as price reductions and extensions on payment deadlines.

In this article, we will look at the intricacies of DPO, exploring its definition, calculation, interpretation, and significance in AP processes.

How to calculate DPO?

The Days Payable Outstanding formula is a financial ratio that indicates the average number of days a company takes to pay its suppliers after the purchase of goods or services. It reflects the efficiency of a company’s accounts payable process.

DPO is typically calculated using the following formula:

DPO = (Average Accounts Payable ÷ Cost of Goods Sold) × number of day

DPO is one of the three metrics used in determining the cash conversion cycle (CCC), a measure gauging the time a company requires to transform its inventory into cash.

The other two metrics are DSO, representing the average number of days taken to collect payments from customers, and days inventory outstanding (DIO), signifying the average duration the company holds inventory before its sale.

The formula to calculate CCC, expressed in days, is:

CCC = DSO + DIO — DPO

Interpreting days payable outstanding

Days Payable Outstanding (DPO) offers a nuanced perspective on a company’s financial health and cash flow management. By understanding the dynamics of outward payments, businesses gain crucial insights into their operational efficiency and supplier relationships.

High DPO

A high DPO signifies that a company takes its time to pay suppliers, enabling it to invest in short-term opportunities and bolster working capital. However, an excessively high DPO can strain supplier relations, risking future credit terms and discounts. It might also mean missed opportunities for early payment discounts, potentially leading to higher overall costs.

Advantages of High DPO: Improved cash flow, potential discounts from suppliers, and better working capital management.
Disadvantages of High DPO: Strained supplier relationships, potential loss of early payment discounts.

Low DPO

Conversely, a low DPO showcases efficient cash flow management and timely bill payments. While this strengthens supplier relationships, it might indicate a missed chance to capitalize on early payment incentives. Companies need to strike a balance to avoid unnecessary costs while maintaining positive supplier interactions.

Advantages of Low DPO: Strong supplier relationships, potential discounts for early payments.
Disadvantages of Low DPO: Strained cash flow, increased financing costs.

Balancing outflow and inflow

DPO is not just about the amount a company owes; it’s about when those payments are made. Companies must align the timeframes for paying suppliers with those of receiving payments from customers. A mismatch here can lead to frequent cash shortages, emphasizing the delicate balance necessary in managing DPO effectively.

Industry context and cash conversion cycle (CCC)

Comparing DPO across sectors isn’t advisable due to industry-specific norms. Companies often evaluate their DPO concerning sector averages, ensuring they neither lag behind nor pay excessively early. Moreover, DPO is integral to calculating the Cash Conversion Cycle (CCC), a comprehensive metric tracking the entire cash lifecycle. CCC illuminates how efficiently a company converts resources into cash flows, underlining the intricate relationship between DPO, inventory management, sales, and accounts receivable.

Advantages and disadvantages of DPO

Advantages of DPO

Serves as a gauge of financial health, reflecting creditworthiness and liquidity.

A high DPO indicates effective credit use, revealing insights into operational efficiency.

Facilitates strategic decision-making, enabling balancing of early payments for vendor favor and maintaining purchasing power.

Disadvantages of DPO

Determining a universally healthy figure is challenging due to industry variances and bargaining power.

High DPO doesn’t guarantee efficient capital use; it might indicate delayed payments and potential late fees.

Understanding the underlying drivers behind DPO is crucial, emphasizing the need for comprehensive analysis beyond the metric itself.

How to optimize or improve DPO?

Effectively managing DPO helps in balancing financial flexibility, supplier relationships, and operational efficiency. Companies can optimize DPO through strategic approaches that ensure timely payments while maximizing cash flow.

Here are a few approaches:

Negotiating Payment Terms: Negotiating extended payment terms with suppliers is a common strategy to increase DPO. By communicating and aligning payment schedules, businesses can enhance cash flow without straining relationships. This approach allows companies to use their funds for strategic investments or emergencies.
Leveraging Electronic Payment Systems: Implementing electronic payment systems accelerates payment processes. By shifting from traditional, time-consuming methods like checks to instant electronic transfers, companies enhance efficiency. Real-time payments ensure suppliers receive funds promptly, reducing the DPO period without compromising accuracy or reliability.
Regular Monitoring and Efficient Record-Keeping: Monitoring accounts payable meticulously helps identify and resolve issues promptly. Accurate and up-to-date records facilitate swift resolution of payment-related problems. Proactive management ensures that suppliers are paid on time, fostering positive relationships while maintaining an optimal DPO.
Comparative Analysis Over Time: DPO’s value becomes apparent when analyzed over periods. By tracking DPO trends, companies can assess their financial health and supplier management practices. Comparative analysis over time offers insights into the effectiveness of implemented strategies, enabling businesses to adjust their approaches as needed.

While improving DPO is essential, it’s important to not compromise on business relationships or the quality of products and services. Striking the right balance between delayed payments for financial flexibility and timely payments for positive relationships is key to leveraging DPO effectively in modern business strategies.

Real world example: Calculating DPO

Let’s calculate Apple’s days payable outstanding metric for the six month period ended at March 27, 2021.

The snippets below are taken from the consolidated financial statements of Apple Inc.

Here are the numbers we need to calculate days payable outstanding:

Cost of goods sold (referred above as Total cost of sales): $118,616 million
Average accounts payable: $40,127 million
Number of days (27 September 2020–27 March 2021): 181 days

So Apple’s DPO metric for this period (27 September 2020–27 March 2021) is:

In this period (27 September 2020–27 March 2021), Apple apparently took an average of 61 days to clear its supplier payments.

Conclusion

Days Payable Outstanding offers insights into a company’s financial health, supplier relationships, and cash flow management. Maintaining a higher DPO can lead to increased cash availability and potential vendor incentives. However, it is important to strike a balance, as a high DPO may strain vendor relationships and result in missed supplier discounts. Conversely, a low DPO may indicate operational inefficiencies or worse credit terms compared to competitors.

By understanding DPO and optimizing it effectively, businesses can strike a balance between maintaining healthy supplier relationships and managing their finances efficiently.

It is worth noting that DPO can vary across industries and depends on a company’s bargaining power. Understanding industry benchmarks and leveraging technology for efficient accounts payable management can further enhance DPO and overall financial performance.

Effective cash flow management, working capital efficiency, and optimizing payables are key to sustainable business growth. By closely monitoring and strategically managing DPO, businesses can achieve better financial stability, improve liquidity, and enhance their overall performance in the competitive marketplace.

Originally published at https://nanonets.com on September 23, 2023.