Days payable outstanding (DPO) states the average number of days that it takes for a business to pay its accounts payable. It is calculated as follows:
Ending accounts payable / (Cost of sales / Number of days)
= Days payable outstanding
For example, a business has ending accounts payable of $70,000, an annual cost of goods sold of $820,000, and is measuring over a period of 365 days. This results in the following calculation:
$70,000 Ending payables / ($820,000 Cost of sales / 365 Days)
= 31.2 Days payable outstanding
A high result is generally considered to represent good cash management, since a business is holding onto its cash for as long as possible, thereby decreasing its investment in working capital. However, an extremely long DPO figure can be a sign of trouble, where a business is unable to meet its obligations within a reasonable period of time.
A low DPO figure generally implies that a business is paying its obligations too soon, since it is increasing its working capital investment. However, it may also mean that a firm is taking advantage of early payment discounts being offered by its suppliers. The savings implicit in most early payment terms can make early payment an extremely attractive option, justifying a low DPO figure.
Given these disparate interpretations of DPO, a good way to evaluate the payables performance of a business is to compare its DPO to that of other companies in the same industry. They are likely all using similar suppliers, and so are being offered the same early payment discounts.
The DPO measurement can be useful as part of a larger examination of the liquidity of a business by a lender or creditor, or by an investor who wants to understand the cash position of a potential investee.