Why days payable outstanding is a crucial metric for your cash flow management
The days payable outstanding (DPO) value indicates how long it takes on average for a company to pay its invoices. We show you how to calculate this value, what it says and how it can be improved.
Days payable outstanding: Formula
To calculate days payable outstanding, one compares the costs of goods sold (COGS) within a certain period with the average accounts payable in the same period. Expressed in a formula, it looks like this:
DPO = Average accounts payable / COGS x 365
This formula refers to a period of one year (365 days). This means that one compares the accounts payable within one year with COGS in the same year. However, you can also choose a different period to calculate the DPO, e.g. 90 days. The important thing is that both accounts payable and COGS always refer to the same period.
COGS includes all costs that are directly related to the production and distribution of products or the provision of services. These include, for example:
- Costs for raw materials and materials
- Goods for resale
- Transport costs
- Production costs (energy, personnel)
- Storage costs
Other relevant values: DSO & DIO
Besides DPO, there is also DSO (days sales outstanding) and DIO (days inventory outstanding). DSO indicates how long it takes on average for a company's customers to pay their invoices:
DSO = Average accounts receivable / Total sales x 365
DIO gives the average value of how long it takes for a company to sell and replace its inventory:
DIO = Average inventory / COGS x 365
How to calculate DPO, DSO & DIO: Example
Let us now take a look at the above formulas using an example. A company has determined the following values as part of its annual financial statements:
Total sales: £800,000 COGS: £400,000 Accounts payable at start of year: £200,000 Accounts payable at end of year: £150,000 Accounts receivable at start of year: £280,000 Accounts receivable at end of year: £230,000 Inventory at start of year: £160,000 Inventory at end of year: £100,000
Now we can determine all sizes:
DPO = Average accounts payable / COGS x 365 = (£200,000 - £150,000) / £400,000 x 365 = 45.6
DSO = Average accounts receivable / Total sales x 365 = (£280,000 - £230,000) / £800,000 x 365 = 22.8
DIO = Average inventory / COGS x 365 = (£160,000 - £100,000) / £400,000 x 365 = 54.8
On average, it takes 45.6 days for the company to pay its bills. The company's customers, on the other hand, pay their bills after an average of 22.8 days. It also takes an average of 54.8 days for the company to sell off its stocks and replace them with new ones.
What is a good days payable outstanding?
After looking at the example above, we still need to interpret these values and ask ourselves what are good values for DPO, DSO and DIO. For DPO as well as DSO, it is intuitively clear that a large value for DPO and a small value for DSO are advantageous.
A high DPO means that the company can push its liabilities far into the future. This means it has more cash available for longer to use elsewhere. In contrast, a low DSO value means that the company receives payment from its customers very quickly, which increases cash.
A small value for DIO is preferred by many companies because it means that goods do not remain in the warehouse for long. This indicates good warehouse management because capital is not tied up in inventory for very long, but can be converted into cash promptly. If the DIO value is very high, less cash is available.
Days payable outstanding: High or low is dependent on industry
What is a good value for days payable outstanding cannot be said in general terms, because it depends on the industry in which the company operates. So if you want to evaluate your DSO, DPO and DIO values, just compare them to the common values in your industry and see how you compare to the competition.
Days payable outstanding: Industry average
On average, the value for days payable outstanding is between 30 and 40 days. However, a company that has negotiated good conditions with its suppliers can be far above this average value.
As long as a high value for DPO does not result from a company being in default due to cash shortages, a very high value for DPO is always acceptable.
How to improve days payable outstanding
Days payable outstanding too high
The value for days payable outstanding is too high if a company cannot pay its invoices on time due to cash shortages. In this case, the cause of the cash shortages must be investigated and remedied.
A look at the value for days sales outstanding may help. DSO should always be lower than DPO, as revenue flows into the company faster than expenses flow out. If you shorten the payment terms for customers or encourage them to pay in advance, the DPO value can be reduced.
Days payable outstanding too low
If the DPO is very low, it means that a company pays its invoices on time and has no payment difficulties, but may not make full use of the payment terms.
If, for example, it receives a supplier invoice that is payable within 30 days, but pays it after 7 days, it only benefits if the supplier offers a discount for the early payment. If the company does not receive a discount, cash flows out of the company before it is actually necessary.
To increase the value for days payable outstanding, it is therefore good to make full use of the payment terms on the invoices and pay as late as possible (without getting into arrears!). If a company is in a good negotiating position with its supplier, it may also be able to negotiate longer payment terms with them, which also increases the DPO.
