Days Payable Outstanding
Days Payable Outstanding (DPO) is a financial ratio that measures the average number of days it takes a company to pay its bills and invoices to its trade creditors, which can include suppliers, vendors, or financiers. DPO is an indicator of the company’s payment policy and its management of payables.
The formula to calculate DPO is as follows:
Days Payable Outstanding = (Accounts Payable / Cost of Goods Sold) x 365
- “Accounts Payable” is the money that the company owes to its suppliers or vendors for goods or services received.
- “Cost of Goods Sold” (COGS) refers to the direct costs of producing the goods sold by a company. This includes the cost of the materials and labor directly used to create the good.
The result is the average number of days it takes for a company to pay its bills once they’ve been received.
A higher DPO indicates that a company takes more time to pay its bills, which can be beneficial for its cash flow as it retains cash for longer periods. However, if the DPO is too high compared to industry norms, it could indicate that the company is struggling to pay its bills, which could strain relationships with suppliers and potentially lead to supply disruptions.
On the other hand, a lower DPO indicates that a company pays its bills relatively quickly. While this can be positive for supplier relationships, it could put a strain on the company’s cash flow if it’s paying out faster than cash is coming in.
As with many financial metrics, DPO is most useful when compared to previous periods or to other companies in the same industry. This can help identify trends over time and evaluate the company’s payables management efficiency.
Example of Days Payable Outstanding
Let’s consider a hypothetical example of a company.
Suppose for the current fiscal year, the company reported:
- Accounts Payable: $300,000
- Cost of Goods Sold (COGS): $1,200,000
We can now calculate the Days Payable Outstanding (DPO) as follows:
DPO = (Accounts Payable / COGS) x 365
DPO = ($300,000 / $1,200,000) x 365 = approximately 91.25 days
This means that, on average, it takes the company about 91 days to pay its bills once they’ve been received.
To interpret this DPO, the company would need to compare it with its own DPO from previous years, as well as with the DPOs of other companies in the same industry.
For instance, if the industry average DPO is 80 days, this company is taking longer than its competitors to pay its bills, which could suggest cash flow issues, but also might mean that it is utilizing its cash on hand more effectively. On the other hand, if the company’s DPO was 100 days the previous year, the current DPO of 91 days could indicate an improvement in its ability to manage its payables.