What does days payable outstanding mean? DPO definition, formula, and calculation

Perhaps you’ve heard of days payable outstanding—also known as DPO or accounts payable days outstanding—but do you know how this essential business metric works?

Keep reading for an outline of the DPO formula, how to calculate days payable outstanding, and why it’s significant to your business’s financial health.

Here’s what we’ll cover

What is days payable outstanding and what does it tell you?

Days payable outstanding, often abbreviated as DPO, is a financial metric that shows how long, on average, it takes your company to pay its invoices from trade creditors, such as suppliers.

In other words, it measures the average number of days your company takes to pay its bills.

This indicator gives us insights into how well (or not) your company manages payables and cash flow.

The DPO formula and calculation

Calculating DPO might seem like a complex task, but once you understand the DPO formula and its components, you’ll find it surprisingly straightforward.

The formula involves 3 essential components:

• Accounts payable,
• Cost of Goods Sold (COGS),
• and the number of days in the period you’re analyzing.

Accounts payable (AP)

Accounts payable (AP) represents the money your company owes to its suppliers or vendors for goods or services received. You can typically find this information on your balance sheet.

Cost of Goods Sold (COGS)

Cost of Goods Sold (COGS) is the total cost of all the goods sold by your company during a particular period.

It includes direct costs associated with producing the goods your company sells, such as raw material costs and direct labor costs.

This information is typically found in your income statement.

Number of days

Number of days represents the period you’re analyzing.

This could be a year (365 days), a quarter (90 days), a month (30 days), or any other period you choose, depending on the specificity you want in your analysis.

How to calculate days payable outstanding

You can use a days payable outstanding calculator, but it’s reasonably straightforward to do your DPO calculation manually.

You simply divide the accounts payable by the cost of goods sold, then multiply the result by the number of days in the period:

DPO = (AP / COGS) x Number of days

The formula for days outstanding essentially translates your accounts payable amount into a timeframe.

It shows how long it typically takes you to settle your bills. The calculation is most commonly done on an annual basis using 365 days.

However, it can be adjusted for any period.

For instance, if you want a quarterly analysis, you can adjust the number of days to 90.

This flexibility allows you to adjust the calculation to suit your specific analytical needs.

Using the DPO formula correctly will provide you with insights that are relevant to your company’s operations and financial planning.

An example of the DPO formula in action

To put the days payable outstanding calculation into context, let’s consider an example.

Suppose a company, Stellar Manufacturing, has an account payable of $150,000 and a COGS of $600,000. We want to calculate the DPO for the year.

Here’s how the calculation would look using the days payable outstanding formula:

DPO = ($150,000 / $600,000) x 365 = 91.25 days

The resulting DPO indicates that Stellar Manufacturing pays its bills, on average, about 91 days after receiving them.

Understanding the significance of DPO

We’ve covered the DPO formula and what this metric measures, but why does it matter?

Let’s take a look at the implications of a high or low DPO, with some illustrative examples.  

What does a high DOP tell you?

If you have a higher DPO, your company takes a longer time to pay its suppliers.

This can be beneficial from a cash flow perspective.

It implies that your company can use the cash it has on hand for a more extended period before settling its payables.

What about a low DPO?

Conversely, a lower DPO suggests that your company pays its bills faster.

This might reflect favorably on your company’s reputation. However, it may also mean that cash is not being used as efficiently as it could be.

What are the implications of both?

To illustrate the implications of a high and low DPO, let’s imagine two hypothetical companies: QuickPay Corp and SlowPay Ltd.  

QuickPay Corp has a DPO of 30 days. Meaning on average, it pays its bills within a month of receiving them.

On the other hand, SlowPay Ltd has a DPO of 90 days, indicating it usually takes about 3 months to pay its bills.

A first glance might lead you to think QuickPay Corp is more efficient because it pays faster.

However, SlowPay Ltd may be in a stronger position from a cash flow perspective.

SlowPay Ltd gets to utilize its cash on hand for a longer period before paying off its debts.

This could potentially allow SlowPay Ltd to invest that money back into the business, fund its operations, or even earn interest.

That said, it’s important to strike a balance.

If SlowPay Ltd takes too long to pay its suppliers, it could potentially harm its supplier relationships or risk missing out on early payment discounts.

Therefore, an optimal DPO isn’t necessarily about paying as soon as possible or delaying as long as possible; it’s about finding a balanced duration that maximizes cash utility without compromising supplier relationships.

DPOs and different industries

Just as the speed of life differs between a bustling city and a tranquil village, DPO varies significantly between industries.

Factors such as payment terms, business models, and industry practices all contribute to this variation.

For instance, industries such as the retail sector might have a shorter DPO due to quick inventory turnover and traditionally shorter payment terms.

In contrast, a manufacturing business, which often deals with large-scale suppliers and has longer production cycles, might have a higher DPO.

For example, let’s say the days payable outstanding industry average for retail is around 30 days, but for manufacturing, it’s 60 days.

If a retail company has a DPO of 45 days, it might seem reasonable when compared with manufacturing.

However, this figure is considerably higher than the retail industry average.

It suggests that this retail company takes a longer time to pay suppliers compared to its industry peers.

Therefore, comparing your company’s DPO with the industry average provides a more accurate picture of your payment practices.

It allows you to benchmark your company against others in the same sector.

By looking at your DPO in the context of your industry’s average, you’ll gain insight into your relative performance and a clearer understanding of your cash management efficiency.

In addition, analyzing the trends in your DPO over time, alongside industry averages, can indicate the effectiveness of changes in your payment policies or cash management strategies.

This makes DPO not just a snapshot of your current situation, but a tool for monitoring progress and driving improvements.

Striking the right balance with DPO

DPO, like many financial metrics, is not just about reaching the highest or lowest number.

Instead, it’s about finding the right balance that works best for your business’s unique circumstances and strategies.

This balancing act is crucial because it directly impacts your relationships with suppliers and your overall cash flow.

On one hand, a higher DPO means that your company is able to hold onto its cash longer.

This can be advantageous, as it allows for greater liquidity and the opportunity to use that cash for other operational needs or investments.

You’re essentially extending an interest-free loan from your suppliers, enabling you to make the most of your available resources.

This could make a significant difference in the company’s financial health and growth trajectory.

On the other hand, excessively stretching the DPO could strain your relationship with suppliers.

They might become reluctant to offer the same generous payment terms in the future or could even decide to stop doing business with you altogether.

Moreover, some suppliers offer discounts for early payments, which you could miss out on if you take too long to pay.

Terms like “2/10, net 30″ mean that the supplier offers a 2% discount if the bill is paid within 10 days instead of the standard 30 days.

If your DPO is significantly above this, your business could be leaving money on the table.

Similarly, a very low DPO might seem ideal since it means your company pays its bills promptly.

While this can foster good relationships with suppliers, it might also indicate that you’re not maximizing your cash efficiency.

Quick payments can tie up cash that could otherwise be used for running daily operations or capitalizing on investment opportunities.

In essence, managing DPO is a delicate act of juggling the benefits of holding onto cash with the need to maintain healthy supplier relationships and optimizing cash management.

It’s about finding that sweet spot—a DPO that reflects strategic payment timing, balanced cash utilization, and sustainable supplier relationships.

How to improve your DRO

You can adopt various different strategies to improve your DPO, whether you’re looking to increase or reduce it.

These tactics can also help you enhance your cash flow and optimize your payment processes.

Extend your payment terms

For a higher DPO, you could try negotiating extended payment terms with your suppliers.

If your company manages to negotiate longer payment terms with suppliers without penalties, you’ll be able to keep cash on hand for longer.

This could be used to fund your operations, invest in growth opportunities, or even earn interest.

As long as you’re prepared to sacrifice any early payment discounts.

Streamline and automate payments

If you want to reduce your DPO,  automating accounts payable, using digital tools to track and approve invoices, can speed up processing times and reducing delays.

By investing in software that provides real-time visibility into payment status, you can ensure invoices are processed efficiently and minimize the risk of late payments.

Closely monitor your accounts payable

Whether you use an automated payment solution or not, keeping a close eye on your accounts payable can help you improve your DPO.

Regularly reviewing your outstanding payments will allow you to identify any issues that might be causing delays, such as discrepancies in invoices or approval bottlenecks.

Proactively resolving these issues can help you ensure that payments are made promptly, keeping your suppliers happy.

Nurture supper relationships

Fostering good relationships with your suppliers can facilitate a better DPO by maintaining flexibility in your payment terms.

A collaborative approach with suppliers can result in mutually beneficial agreements—such as longer payment terms (higher DPO) or early payment discounts (lower DPO)—offering you better payment options without jeopardizing supplier relationships.

Benefits and challenges of DPO

Benefits of DPO

• It can provide insight into your financial flexibility, creditworthiness, and liquidity, helping you balance early payments with preserving cash flow.
• It can facilitate good supplier relationships by helping you assess whether your company is managing its payments well, prompting you to take action if improvements need to be made.

Challenges of DPO

• There’s no universal benchmark for a “healthy” DPO, as it varies by industry and company circumstances, including size and purchasing power.
• DPO alone doesn’t provide a complete picture; you’ll need to do more digging to understand its true impact. For example, a high DPO could indicate efficient use of capital or issues with payment delays and late fees.

Final thoughts on DPO

DPO is more than just a financial metric.

It’s a strategic tool that can offer valuable insights into your company’s cash flow and payables management.

It allows you to:

• benchmark against industry peers,
• evaluate the effectiveness of your payment practices,
• and make informed decisions that can influence your company’s financial health.

However, the power of DPO lies not just in understanding what it is, but in how to use it effectively.

The right DPO for your company strikes a balance between maintaining a healthy cash flow and preserving good relationships with suppliers.

By understanding and managing your DPO wisely, you’re not just crunching numbers, you’re shaping your business’s financial future.

Remember, in the world of business, knowledge is power, and understanding your DPO gives you the power to manage your cash more efficiently, negotiate better terms with suppliers, and ultimately, drive your business success.

So, take a closer look at your DPO and uncover the opportunities it might hold for your business.

Editor’s note: This article was originally published in June 2023 and has been updated for relevance.