Days payable outstanding definition
/What is Days Payable Outstanding?
Days payable outstanding (DPO) states the average number of days that it takes for a business to pay its accounts payable. 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. Also, delaying payments too long can damage relations with suppliers.
How to Calculate Days Payable Outstanding
To calculate day payable outstanding, divide the cost of sales by the number of days in the measurement period. The number of days used in the formula is usually either 365 days or 90 days. Then divide the result into the ending accounts payable balance. The formula is noted below:
Ending accounts payable / (Cost of sales / Number of days)
= Days payable outstanding
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Understanding Days Payable Outstanding
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.
Example of Days Payable Outstanding
A business has ending accounts payable of $70,000, an annual cost of sales 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
Advantages of Days Payable Outstanding
There are several advantages to using the days payable outstanding metric. One is that it provides an indicator of any financial difficulty in paying suppliers on time. Conversely, an excessively low DPO metric indicates that the accounting department is having trouble managing when it pays suppliers. In either case, this represents a starting point for a more detailed investigation into the exact reasons for paying suppliers either too late or too early. In short, DPO is useful for overseeing the timeliness of payments to suppliers. This can have a significant impact on supplier relations, since they will be more likely to work with customers who are paying them in a timely manner.