What is Days Payable Outstanding? (DPO)
Days payable outstanding (DPO) is a useful working capital ratio used in finance departments that measures how many days, on average, it takes a company to pay its suppliers. As such, DPO is an important consideration when it comes to managing a company’s accounts payable – in other words, the amount owed to creditors and suppliers. The higher a company’s DPO, the longer it takes to pay its bills.
Days payable outstanding formula
Days payable outstanding is calculated using the following formula:
DPO = accounts payable x number of days/cost of goods sold
- Accounts payable is the company’s accounts payable balance. Some companies calculate DPO using the accounts payable balance at the end of the relevant period, while others may use the average account payable balance during the relevant period.
- Number of days is the number of days within the accounting period – i.e. 365 days for one year or 90 days for a quarter.
- Cost of goods sold is the cost the company incurs in producing a product, including raw materials and transportation costs.
Days payable outstanding example
For example, if a company has average accounts payable of $100,000 over a 365-day period, and the cost of sales is $500,000, the DPO will be calculated as follows:
DPO = 100,000 x 365 / 500,000
= 73 days
Days payable outstanding and the cash conversion cycle
The opposite of DPO is days sales outstanding (DSO), which is a ratio calculating the average number of days taken by a company to collect payment from its customers. DPO and DSO are both key components of a company’s cash conversion cycle (CCC), which measures how long it takes to convert cash into inventory and then to cash again through the sales process. The cash conversion cycle also takes into account days inventory outstanding (DIO) and is calculated as follows:
CCC = DIO + DSO – DPO
As such, companies can optimize (reduce) their CCC by addressing any of these three ratios – in other words, by increasing DPO or by reducing DSO or DIO.
High DPO or low DPO?
A high DPO is preferable from a working capital management point of view, as a company that takes a long time to pay its suppliers can continue to make use of its cash for a longer period. However, it may also be an indication that an organization is struggling to meet its obligations on time.
It can be beneficial to compare a company’s DPO to the average DPO within its industry. A higher or lower than average DPO may indicate a few different things.
If a company’s DPO is less than average, this could be an indication that the company is not getting the best credit terms from suppliers or is not taking full advantage of the credit terms available. Consequently, there may be an opportunity to extend DPO in order to improve the company’s cash conversion cycle. However, a low DPO is not necessarily bad news as it may indicate that the company is paying suppliers early in order to take advantage of early payment discounts – thereby securing an attractive return on the company’s excess cash.
Companies may find that their DPO is higher than the average within their industry. While this means that the company is taking a longer time to pay its suppliers – and is therefore able to invest cash for a longer period of time – in some situations it may prudent to consider reducing DPO. For example, a company with a high DPO may be missing out on early payment discounts offered by suppliers.
When comparing DPO between companies, it’s important to remember that practices can vary considerably between different industry sectors and geographical locations. It is therefore only beneficial to compare DPO with other companies in the same sector – there is no concrete number that represents a ‘good’ or ‘bad’ DPO.
Optimizing working capital for both buyers and suppliers
A further consideration is that if a company has a high DPO, this will have a knock-on effect for the company’s suppliers. The longer a company takes to pay its suppliers, the longer its suppliers’ DSO will be – meaning that they have to wait longer before receiving payment. This can have a detrimental effect on supplier relationships. It can also give rise to the risk of supply chain disruption if cash-strapped suppliers struggle to fulfil orders.
For companies looking to optimize their own working capital while also offering their suppliers access to early payments, solutions such as supply chain finance can be used effectively to support the whole supply chain.