Days payable outstanding is one of several key points Accounts Payable KPI to track and acts as a surrogate for overall operational efficiency. Basically, the DPO helps business owners and analysts determine how effectively and efficiently a company balances cash flow and relationships with suppliers while also acting as a proxy to determine how creditworthy outsiders judge you. Understanding how the days outstanding ratio is calculated is an important step to obtain a strategic and panoramic view of your business and, at the same time, open opportunities for improvement.
What is the outstanding days payable ratio?
Days payable outstanding, generally reduced to DPO, measures how quickly (or slowly) your company pays its vendors and suppliers on average. Although accounts payable automation tools do allows you to calculate how long it takes for each AP entry to close; Finding the days payable outstanding ratio using a general average is a more useful tool for making strategic decisions without getting lost in the weeds.
The DPO Formula
His AP or accounting platform likely automates calculation of days payable, but understanding the mechanics of the relationship is useful for generating information, knowing what feed DPO calculation, you can understand what operational adjustments or modifications you can make in improve the DPO calculation.
But first we need to look at the DPO formula:
DPO = (Average Accounts Payable ÷ Cost of Goods Sold) × number of days
Where:
Average accounts payable: Your average accounts payable The balance is found by adding the initial AP balance to the ending and dividing it by two. For example, if you are looking at your annual DPO for fiscal year 2023, you would add the Q4 2022 AP balance (since that's how 2023 started) to the Q4 2023 balance and then divide it by two.
CoGS: Cost of goods sold, a direct figure that reflects manufacturing, distribution, delivery, and similar costs associated with your product. CoGS is found on your income statement but alternatively you can use The cost of sales. If you go this route, you calculate your cost of sales by adding the balance of your beginning inventory to your purchases during the period and then subtracting your ending inventory.
Days in period: This is the total number of days elapsed during the measured period, i.e. 90 days for a quarterly DPO calculation or 365 for an annual assessment.
A DPO calculation
Let's see how this plays out in real life. We'll use Ford's year-end report for 2022 to find the company's annual DPO estimate. Remember that we will need to find the CoGS on our income statement along with the beginning and ending AP totals from the balance sheet.
Fountain: Ford
Ford uses cost of sales as a metric, so in this case its annual total is $134.394 billion, a hefty price tag, but remember that automobile manufacturing It is an expensive task.
Fountain: Ford
Next, we'll average Ford's payable balance by adding the 2021 ending balance to the 2022 ending balance and dividing by two: we get $23.977 billion as our average accounts payable balance.
Finally, we'll put it all together:
This means that, on average, it takes Ford 65 days to pay your AP balance. But what does the DPO formula tell us from a strategic and operational perspective?
How are outstanding days payable interpreted?
Remember that your company's operations live and die by your overall cash flow, and a major cash gap is your accounts payable balance. While it is necessary to keep sellers and suppliers happy, it is also generally wise to postpone sending money. outside of your business for as long as possible (except in specific circumstances, such as early payment discounts). In these cases, a higher DPO indicates that you will keep cash in your business longer. It can also mean:
- You have greater flexibility in finding investment or business growth opportunities because you have more cash on hand.
- Your suppliers rate your creditworthiness and reliability highly and trust you to pay your debt.
a bass days to pay pending This is generally not preferable as it may indicate that you are missing out on an opportunity to invest or grow by sending cash earlier than necessary. Alternatively, a low DPO could indicate poor lending conditions from providers, which, in turn, may be a criticism of your overall credit worthiness.
On the other hand, judging the outcome of a high/low paydays formula is not a binary evaluation; It is not just “good” if it is high and “bad” if it is low. Rather, it is contextual. If your business is struggling, a high DPO does not indicate good credit or prudent cash management; It means you may not have the money to pay debts on time. Likewise, a low days outstanding is not bad. You may operate in a niche industry where quick payback is expected, so your DPO should be judged on a relative, rather than absolute, basis. Or your suppliers offer early payment discounts, in which case a low DPO means you're proactively saving money in the long run.
Conclusion
Cash management is key to business longevity, but keeping suppliers happy is too. In both cases, days outstanding acts as a metric to balance your cash and capital allocations with maintaining positive supplier relationships through on-time payment. The DPO also acts as a substitute for your general operation and accounts payable efficiency also; Since the DPO formula tells us how effectively resources and relationships can be planned and managed, it is often reliable to draw broader conclusions from that data point.
From a strategic perspective, the DPO also helps project future cash flow when running financial modeling programs. Net working capital (NWC) includes your accounts payable balance and NWC informs your free cash flow (FCF) projections. FCF is one of the main valuation variables, so balancing your DPO with the FCF forecast in mind is also useful if you are considering an acquisition, purchase or otherwise planning the future of your company and need a business valuation. updated.
