Understanding why your business takes a certain amount of time to pay its bills and invoices, whether to vendors, suppliers, or other companies, can tell you a significant amount. That’s why it’s a good idea to have a solid understanding of days payable outstanding ratios. But what is days payable outstanding? Find out more about this handy financial ratio, right here.
What is “days payable outstanding”?
Days payable outstanding refers to the average number of days that it takes a company to repay their accounts payable. Calculated on a quarterly or annual basis, the days payable outstanding ratio can help you understand how well your business is managing accounts payable and whether you need to make any changes to the way your company handles cash outflows. It’s usually compared to the average industry payment cycle, so you can see how aggressive or conservative your business is compared to your competitors.
Understanding days payable outstanding ratios
A high days payable outstanding ratio means that it takes a company more time to pay their bills and creditors. Generally, having a high DPO is advantageous, because it means that the company has extra cash on hand that could be used for short-term investments. However, if your business takes too long to pay its creditors, they may refuse to extend further credit. Overall, a high DPO means one of two things: you have better credit terms than your competitors or you’re unable to pay your bills on time.
On the other hand, a low days payable outstanding ratio indicates that a company pays their bills relatively quickly. This could mean that the business isn’t fully utilizing the credit period that’s offered by creditors. Alternatively, a low DPO may also mean that your business’s credit terms aren’t as good as your competitors, possibly because your credit history isn’t as good or because you haven’t taken advantage of opportunities to renegotiate.
How to calculate days payable outstanding
Here’s how to calculate days payable outstanding with a simple days payable outstanding formula:
Days Payable Outstanding = (Average Accounts Payable / Cost of Goods Sold) x Number of Days in Accounting Period
Let’s look at an example to see how to calculate days payable outstanding in practice. Imagine Company A has an average accounts payable of $100,000, which you can calculate by adding the accounts payable balance at the start of the year to the balance at the end of the year and dividing by two. Company A has a total cost of goods sold (COGS) of $1,500,000 and – if we’re working out annual DPO – the number of days in the accounting period is 365. To find the DPO, you can use the following days payable outstanding formula:
(100,000 / 1,500,000) x 365 = 24.33
So, this means that Company A takes around 24 days to pay back its accounts payable. This is relatively quick, so may indicate that Company A isn’t fully utilizing the credit period.
How to improve days payable outstanding
To improve your days payable outstanding ratio, you’ll need to optimize accounts payable. By taking a strategic approach, you can free up working capital to fuel your business’s growth, strengthen corporate cost management, and reduce the complexity in accounts payable processing. If you want to increase DPO, it can be a good idea to rework your invoicing process. Be sure to set up a centralized office to handle processing so that you can implement a consistent, standardized approach. It’s also a good idea to set up preferred supplier lists, giving you the opportunity to negotiate the best possible payment terms for your business.
We can help
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