Days Payable Outstanding

What Is Days Payable Outstanding (DPO)?

Days Payable Outstanding (DPO) is the average number of days it takes to pay back suppliers, vendors, or creditors. It is a useful measure for determining how well the firm is managing its accounts payables and their cash out-flows.

A company with a high DPO takes longer to pay back its suppliers, and as a result, retains that cash for longer periods of time to maximize its benefits. 

For example, firm’s will typically invest cash into money-market securities and earn interest, rather than paying down debts immediately. A high DPO can also be a red-flag for analysts as it may indicate low levels of liquidity as the company fails to pay its bills on time.

A low DPO value may indicate that the company is paying its bills too soon and not taking advantage of possible interest bearing short-term securities.

However, this may also indicate that the firm is taking advantage of discounts for early repayment, which may justify a lower value. 

Interpretation of the DPO figure can be difficult when looking at just one company, looking at comparable companies in the industry can provide insight into what is considered “normal”.

These companies are likely also using similar suppliers who are offering similar early payment discounts. 

How To Calculate Days Payable Outstanding (DPO)?

Days Payable Outstanding (DPO) can be calculated as:

DPO = (Average Accounts Payable / Cost of Goods Sold) X 365 Days

or

DPO = 365 Days / Payables Turnover

where

Payables Turnover = Purchases / Average Accounts Payable

and

Cost of Goods Sold = Beginning Inventory + Purchases - Ending Inventory

All firms incur costs when manufacturing goods for sale, and when buying the resources required to make these products, companies will often purchase them on credit and pay at a later date. This creates a liability known as “Accounts Payable” and indicates the payments to be made to suppliers. 

The costs associated with the actual manufacturing of products (raw materials, wages, and utilities) are grouped together and represented by Cost of Goods Sold (COGS)

What is Accounts Payable Turnover Ratio?

Accounts payable turnover ratio is a short-term liquidity ratio used to show how many times a company pays its suppliers in a year. For example, a payables turnover ratio of 10 means that a company pays suppliers 10-times a year, and the DPO would be 36.5 (365/10). 

As mentioned above, the optimal ratio is entirely dependent on the industry, to better understand how a company stacks up against its competitors, you should compare it against the industry as a whole.

Interpreting Days Payable Outstanding (DPO)

Looking at the DPO at one point in time can only tell you so much about the firm’s cash flow management. Looking at trends in the DPO over quarters and years can provide a better picture on the future of a company.

Increasing DPO may indicate that a firm is having difficulty paying its suppliers and may be cause for concern, especially if the cash isn’t being put to good use.

Another reason could be that the firm has negotiated alternative payment terms with suppliers or is such a large buyer that it brings a lot of bargaining power to the table.

Decreasing DPO means that a company is paying off its suppliers faster than it did in the previous period. It is indicative of a company that is flush with cash to pay off short-term obligations in a timely manner.

Consistently decreasing DPO over many periods could also indicate that the company isn’t investing back into the business and may result in a lower growth rate, and lower earnings in the long-run.

High DPO

High DPO is generally a good thing for a company to have. It takes longer to pay back suppliers and as a result keep more cash on their accounts to invest in the business or to purchase short-term money market securities and earn interest.

That being said, taking too long to pay back suppliers could lead to poor future relations with suppliers, especially if competitors are paying back suppliers faster.

If the DPO is too high, it could be a sign that the company is in financial distress and does not have the cash to pay its obligations on time.

In general, a high DPO suggests:

• Better terms with suppliers
• Potential inability to pay back suppliers on time

Low DPO

A company with a low DPO could indicate that it has poor credit terms with suppliers and is unable to attain more attractive terms. It could also indicate improper cash management by the firm as they are not taking advantage of the credit being offered.

Not all is bad with a low days payable, it could also indicate that the company has struck favorable short-term payment terms with a supplier in exchange for attractive discounts that are in line with their business model.

In general, a low DPO suggests:

• Poor terms with suppliers
• Improper utilization of credit offered by suppliers
• Short-term payment terms with discounts

Days Payable Outstanding (DPO) Examples

Now let’s look at an example on how to calculate the DPO. Below is some hypothetical information about WSO Corporation:

• Beginning Inventory = 12,000
• Purchases = 4,000
• Ending Inventory = 8,000
• Beginning Accounts Payable = 4,000
• Ending Accounts Payable = 2,000

First, let's calculate the average accounts payable and COGS:

Average Accounts Payable = (4,000 + 2,000) / 2 = 3,000

COGS = 12,000 + 5,000 - 8,000 = 9,000

After calculating these two figures, all that's left to do is put them together into the formula.

Days Payable Outstanding (DPO) = (Average Accounts Payable / Cost of Goods Sold) * 365 Days

3,000 / 9,000) x 365 days = 121.67 Days

This means that WSO Corporation takes 121.67 days, on average, to pay back its suppliers.

Real World DPO Example

Let’s look at a real world example and calculate the DPO for Costco Wholesale (COST).

By looking at the balance sheet Costco had accounts payable of $16.27 billion and the income statement shows Cost of Goods Sold (COGS) of $170.68 billion for the year ending Aug 31, 2021. Using a 365 day calendar year, the DPO for Costco is ( 16.27 / 170.68 ) x 365 = 34.8 days.

This tells us that during Costco’s 2021 fiscal year, they paid their suppliers 34.8 days after receiving the invoice. 

Now let’s take a look at one of its peers, Walmart, who has a DPO of 42.7, and the overall industry average of ~54 days. Costco in relation has a DPO much lower than industry average.

This could indicate that the company has negotiated good terms with suppliers for early payment and is able to get a good discount for early payment. It could also indicate that the company isn’t investing back into itself to fund future growth.

However this ratio should not be used in isolation and further investigation into the company’s operations is required to gain a better understanding of its cash flow management.

Days Payable Outstanding Advantages

It is a crucial metric that, when harnessed effectively, can provide businesses with a variety of strategic advantages and financial benefits.

The following are the advantages of days payable outstanding:

• DPO helps companies manage their cash flow effectively by indicating how long they can retain funds before paying their suppliers.
• It provides insights into a company's liquidity position. A high DPO can suggest strong cash management and financial stability.
• DPO optimization can lead to better working capital management, allowing companies to use available cash for growth or investment opportunities.
• Companies with high DPO can use the retained cash to invest in interest-bearing securities, potentially generating additional income.
• A high DPO may give a company more leverage in negotiating favorable payment terms with suppliers, such as extended credit periods or discounts.
• Maintaining a high DPO compared to competitors can be a competitive advantage, as it allows for strategic financial planning.
• While high DPO can strain supplier relations, it can also encourage suppliers to offer better terms and discounts to maintain the business relationship.
• High DPO can indicate financial stability, reassuring investors and creditors about a company's ability to meet its obligations.

Days Payable Outstanding Disadvantages

Despite its advantages, Days Payable Outstanding also comes with its share of disadvantages  that companies need to consider in their financial management strategies.

Below we enlist the disadvantages of days payable outstanding:

• Maintaining an excessively high DPO may strain relationships with suppliers, as they may feel burdened by extended payment terms, potentially affecting the quality and timeliness of future supplies.
• A high DPO might cause a company to miss out on early payment discounts and favorable terms offered by suppliers, leading to increased costs over time.
• An excessively high DPO could indicate that the company is not effectively utilizing available cash for investments, business growth, or debt reduction, potentially hindering future prospects.
• If competitors in the same industry pay their suppliers more promptly, the company may lose out on supplier preference and potentially better terms, affecting competitiveness.
• Maintaining a high DPO may encourage suppliers to tighten credit terms, making it more difficult for the company to secure necessary supplies or negotiate future contracts.
• Prolonged DPO may lead to contractual breaches if a company consistently fails to meet its payment obligations, resulting in legal disputes and potential damage to its reputation.
• In some cases, an extremely high DPO could be an indicator of financial distress, suggesting the company lacks the necessary funds to meet its payment obligations on time.
• An extraordinarily high DPO may lead to concerns among investors about the company's ability to invest in its own growth and innovation, potentially impacting stock performance.

Days Payable Outstanding Vs Days Sales Outstanding

Days Payable Outstanding (DPO) is a measure of how long it usually takes a business to pay its suppliers. For cash inflows, Days Sales Outstanding (DSO) is the analogous statistic.

DSO is the average number of days it takes for a business to get paid for unpaid bills it has sent to clients. A healthy business may strive for a very low DSO, which shows that money is collected rapidly, along with a high DPO, which shows that bills are paid more slowly.

Both are crucial indicators for evaluating a company's cash flow management, and they both make up the Cash Conversion Cycle (CCC).

High DSO is a sign of loose credit policies and a corporation that takes longer to get payment from clients. As a result of spending extra time waiting for payments, a lax credit policy may prohibit the corporation from reinvesting in the business.

On the flip side, too strict a credit policy, customers may choose to switch to competitors who offer more flexibility on payment. Again, the focus when analyzing DPO or DSO is to look at industry averages.

Here's a table comparing Days Payable Outstanding (DPO) to Days Sales Outstanding(DSO) :

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Accounts Payable
• Accounts Payable Turnover Ratio
• Deferred Tax Liabilities
• IFRS vs. US GAAP
• Non-Controlling Interest (NCI)