Days Payable Outstanding

What Is Days Payable Outstanding (DPO)?

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.

Days Payable Outstanding  Explained

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.

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For eg:
Source: Days Payable Outstanding (wallstreetmojo.com)

Formula

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.

How To Calculate?

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 DIOCalculate DIODays Inventory Outstanding refers to the financial ratio that calculates the average number of days of inventory held by the company before selling it to the customers, providing a clear picture of the cost of holding and potential reasons for the delay in the inventory sale.read more by following the formula below –

DIO = Inventory / Cost of Sales * 365

Then, the company calculates the DSOThe Company Calculates The DSODays sales outstanding portrays the company's efficiency to recover its credit sales bills from the debtors. The number of days debtors took to make the payment is computed by multiplying the fraction of accounts receivables to net credit sales with 365 days.read more (Days Sales Outstanding) by using the formula –

DSO = Accounts ReceivableAccounts ReceivableAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more / Total Credit Sales * 365

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

DPO = Accounts Payable / (Cost of SalesCost Of SalesThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales.read more / 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.

Explanation of Days Payable Outstanding in Video

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

Interpretation

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 DSODSODays sales outstanding portrays the company's efficiency to recover its credit sales bills from the debtors. The number of days debtors took to make the payment is computed by multiplying the fraction of accounts receivables to net credit sales with 365 days.read more. Since all three are required to form the cash conversion cycleCash Conversion CycleThe Cash Conversion Cycle (CCC) is a ratio analysis measure to evaluate the number of days or time a company converts its inventory and other inputs into cash. It considers the days inventory outstanding, days sales outstanding and days payable outstanding for computation.read more, 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.

Example

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 payableAccounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more 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 soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more 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

Name	Market Cap ($ billion)	DPO
American Airlines Group	24,614	35.64
Alaska Air Group	9,006	14.86
Azul	7,283	71.19
China Eastern Airlines	9,528	47.23
Copa Holdings	5,788	30.49
Delta Air Lines	39,748	60.12
Gol Intelligent Airlines	21,975	58.62
JetBlue Airways	6,923	38.72
LATAM Airlines Group	8,459	60.48
Southwest Airlines	39,116	59.36
Ryanair Holdings	25,195	26.79
United Continental Holdings	19,088	57.42
China Southern Airlines	9,882	13.30

•  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

Name	Market Cap ($ billion)	DPO
Ford Motor	50,409	0.00
Fiat Chrysler Automobiles	35,441	86.58
General Motors	60,353	64.15
Honda Motor Co	60,978	37.26
Ferrari	25,887	124.38
Toyota Motor	186,374	52.93
Tesla	55,647	81.85
Tata Motors	22,107	134.66

• 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

Name	Market Cap ($ billion)	DPO
Burlington Stores	8,049	70.29
Costco Wholesale	82,712	27.87
Dollar General	25,011	36.19
Dollar Tree Stores	25,884	30.26
Target	34,821	55.11
Wal-Mart Stores	292,683	40.53

• 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

Name	Market Cap ($ billion)	DPO
ConocoPhillips	62,980	100.03
CNOOC	62,243	104.27
EOG Resources	58,649	320.10
Occidental Petroleum	54,256	251.84
Canadian Natural	41,130	30.08
Pioneer Natural Resources	27,260	120.03
Anadarko Petroleum	27,024	312.87
Continental Resources	18,141	567.83
Apache	15,333	137.22
Hess	13,778	54.73

• 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.

How To Improve?

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.   

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