In business, cash flow is king when it comes to a company being able to pay its invoices from suppliers and other bills on time. When analyzing a company’s cash position, one commonly used financial metric is the Days Payable Outstanding (DPO), which is part of the Days Working Capital calculation.
Days Payable Outstanding helps measure a company’s ability to pay its short-term liabilities to its creditors or suppliers. This financial ratio represents the average time cycle for outgoing payments by calculating standard balance sheet figures applied to a specified period of time.
Corporate finance leaders use DPO to determine whether their company is meeting its strategic cash flow requirements. Depending on the DPO value and the company’s goals, they may recommend strategies to the finance team for adjusting the DPO to improve the company’s cash and competitive positioning.
Investors, lenders, and creditors also use this key metric as part of an extensive examination to measure a company’s liquidity and efficiency in managing its cash.
In this article, we’ll look at how to calculate your DPO, what your DPO means for your business, and how you can use automation to improve it.
What is Days Payable Outstanding (DPO)?
Days Payable Outstanding (DPO) represents the average number of days between when a company receives an invoice and when it is paid. In general, a high DPO can indicate that a company has good cash management because it can hold onto cash for as long as possible to invest in other aspects of its business. However, if a DPO is unusually high, it could suggest cash flow problems and an inability to pay its bills.
Low DPO can suggest favourable cash flow as well. Companies in this category often have the cash flow to pay bills quickly and maintain good supplier relationships.
Determining your company’s DPO is relatively easy, requiring a simple formula you can regularly use to help track your company’s financial health.
The Days Payable Outstanding Formula
To calculate your DPO, you need to determine these three values:
The number of days in your accounting period
Most companies either use 365 days or 90 days as an accounting period in DPO calculations
Cost of goods sold (COGS)
You can calculate your COGS by adding the costs of materials, labour, and other expenses that are directly attributable to the creation of your products and services
Ending accounts payable
This sum is determined by adding up all of the amounts owed to creditors, either at the end of the accounting period or an average balance during the accounting period
You then apply these values to the below DPO formula:
Days Payable Outstanding = Ending accounts payable / (Cost of sales / Number of days in accounting period)
Let’s look at an example by applying sample numbers to the DPO formula.
How To Calculate Days Payable Outstanding
Company A wants to measure its DPO over a fiscal year (365 days). It has calculated its ending accounts payable to be $70,000 and its annual cost of goods to be $800,000.
By applying these numbers to the DPO formula, we get the below result:
$70,000 Ending payables / ($800,000 Cost of goods / 365 Days)
= 31.9 Days Payable Outstanding
In this scenario, Company A takes an average of 31.9 days to pay its bills after receiving an invoice.
Some companies use an alternate formula that takes the average value of the beginning and ending accounts payable. The result is the DPO for that particular period.
Now that you have your DPO ratio, let’s see what it can mean for your company’s financial health.
How Does DPO Inform You?
A high DPO often indicates that a company is cash-flow positive and able to hang onto cash for short-term investments or to preserve working capital. It may also use available excess cash to pay other business expenses instead of borrowing money, thus avoiding interest costs.
Many lenders, creditors, and investors look favourably at companies with high days payable outstanding. A high DPO figure suggests that a company has a healthy cash flow, better positioning it to invest in growth opportunities or weather any temporary downturn in business.
A low days payable outstanding value indicates that a company pays its accounts payable balance relatively quickly. It can also mean that the firm isn’t fully utilizing the credit period offered by its suppliers. Low DPO ratios could also suggest that your company’s credit terms with suppliers aren’t as good as your competitors’. This could be due to poor credit history or not taking advantage of opportunities to negotiate extended payment terms.
However, a company with a low DPO can also suggest that its accounts department is taking advantage of early payment discounts offered by its suppliers. Many companies consider early payments desirable as they help keep as much cash as possible within the organization. However, the finance team must determine whether the early cash payment discounts outweigh the benefits of holding onto cash for other purposes and paying the invoices later.
Since DPO can be interpreted in many different ways, it’s a good idea to compare a company’s DPO with that of other companies in the same industry to get a more accurate picture of its payables performance. They all likely use the same or similar suppliers and may be offered the same credit terms and early payment discounts.
A Note on Having a High DPO
While a high DPO ratio can indicate that a company is managing its cash outflows well, it’s not always a positive sign for the business. High DPO ratios can also be a sign of trouble to potential investors that the company is struggling to pay its outstanding invoices.
In addition, taking too long to pay your creditors may cause them to deny you further credit. You may also be losing out on the early-payment discounts that many suppliers offer, as well as late payment penalties if you pay your bills past their payment due date.
Over time, late payments can also have a negative impact on vendor relationships. Many small suppliers rely on timely invoice remittances to keep their business afloat. If you’re delaying payment, you could hamper their business growth and cause them to offer their products elsewhere.
It’s best to manage your DPO to strike a delicate balance between paying your creditors promptly and ensuring you always have enough working capital. For example, suppose your company allows 90 days for your customers to pay for goods but your suppliers have a payment policy of within 30 days. In this case, your business could suffer from frequent cash crunches. Companies can solve this by negotiating better credit terms with their suppliers, leading to a more favourable DPO.
How to Improve Accounts Payable Days
Optimizing your accounts payable processes is the best way to improve your days payable outstanding ratio. Taking a proactive strategic approach to attaining a more favourable DPO will help you free up more working capital to help fuel business growth, bolster corporate cost management, make short-term investments, and streamline your accounts payable processing to ensure a more efficient flow of outgoing funds.
Much of improving DPO has to do with reworking your invoice processing system. Adopting a solution that centralizes invoice processing can help you implement a consistent, standardized approach to paying your suppliers. You can accomplish this through a comprehensive automated solution that streamlines your accounts payables into a cost-effective cloud-based system.
Making significant changes to your accounts payable may sound daunting, but partnering with the right business solutions provider will make the transition much easier for your accounting team.
Use ACI’s AP Automation to Improve Your DPO
For over 40 years, Ash Conversions International has been the go-to supplier of tech-based, cost-effective solutions that transform how companies run their business processes. ACI offers customized AP automation solutions that increase efficiency, streamline operations, and save money so you can optimize and improve your days payable outstanding.
Our AP Automation solution efficiency makes invoice processing easier and more cost-effective for your accounts payable department by streamlining the lifecycle of the entire payment process:
- All hard copy and digital invoices are captured into the AP Automation system
- Optical character recognition (OCR) accurately scans and captures relevant data from the invoices
- Information such as vendor name, invoice amount, product and service details, and more are stored as data points
- Invoice information can be retrieved, reviewed, and approved for payment online by authorized end-users, both in-office and while working remotely
Invoice images and data files are captured and stored in FileManager™, our cloud-based document management platform that provides real-time visibility into your AP system through a secure login from anywhere in the world.
Our AP Assistant™ tool also offers the power of machine learning that adds an extra layer of artificial intelligence with every scanned and processed invoice. This advanced technology helps provide better invoice classification and more accurate data validation, leading to fewer exceptions and more touchless invoice approvals in the future.
With ACI’s automated AP solution, you will have the information at your fingertips to make decisions that will allow you to control when cash is remitted to suppliers, achieving better cash flow and optimizing days payable outstanding that fuels business growth.
Click the button below to contact us today and learn more about how ACI’s invoice imaging and AP Automation solutions and services can help improve your DPO ratio and make your business more profitable.
