Days Payable Outstanding

The average number of days it takes a company to pay back its accounts payable

What is Days Payable Outstanding?

Days Payable Outstanding (DPO) refers to the average number of days it takes a company to pay back its accounts payable. Therefore, days payable outstanding measures how well a company is managing its accounts payable. A DPO of 20 means that on average, it takes a company 20 days to pay back its suppliers.

 

Days Payable Outstanding

 

Days Payable Outstanding Formula

The formula for DPO is as follows:

 

Days Payable Outstanding = (Average Accounts Payable / Cost of Goods Sold) x Number of Days

 

Or

 

Days Payable Outstanding = Average Accounts Payable / (Cost of Sales / Number of Days)

 

Where:

 

Cost of Sales = Beginning Inventory + Purchases – Ending Inventory

 

Interpreting Days Payable Outstanding

Let us consider the implications of a high and low DPO:

 

High DPO

A high DPO is generally advantageous for a company. If it takes longer for a company to pay their creditors, the cash on hand could potentially be used for short-term investing activities. However, taking too long to pay creditors may result in unhappy creditors and their refusal to extend credit or offer favorable terms. In addition, if the DPO is too high, it may indicate that the company is struggling to find cash to pay creditors.

Therefore, a higher DPO than the industry average would suggest:

  • Better credit terms than competitors; or
  • Inability to pay creditors on time

 

Low DPO

A company with a DPO could indicate that a company is not fully utilizing its credit period offered by creditors. In addition, it is possible that the company possesses a short credit term.

Therefore, a lower DPO than the industry average would suggest:

  • Worse credit terms than competitors; or
  • Not fully utilizing the credit period offered by creditors

 

Example of Days Payable Outstanding

 

Days Payable - Example

 

Calculating the DPO with the beginning and end of year balances provided above:

DPO: ($800,000 / $8,500,000) x 365 = 34.35. Therefore, this company would take an average of 34 days to pay back its accounts payable.

 

The Importance of Days Payable Outstanding

Days payable outstanding is an important efficiency ratio that measures the average number of days it takes a company to pay back suppliers and is used in a cash cycle analysis. A high and low DPO (compared to the industry average) affects a company in different ways. For example, a high DPO may cause suppliers to label the company as a “bad client” and impose credit restrictions. On the other hand, a low DPO may indicate that the company is not fully utilizing its cash position and may indicate an inefficient company.

There is no clear-cut number on a healthy days payable outstanding as the DPO varies by industry, competitive positioning of the company, and its bargaining power. For example, Walmart is a huge company in the retail industry. With such significant market share, the retailer is able to negotiate deals with suppliers that heavily favor them. As of July 2017, the DPO of Walmart stands at around 42.

 

Applications in financial modeling and analysis

DPO and the average number of days it takes a company to pay its bills is an important concept in financial modeling.  When calculating a company’s free cash flow to the firm (FCFF), changes in net working capital will have an impact on cash flow and thus the average number of days they take to pay bills could have an impact on valuation (especially in the short-run).

Below is a screenshot of a DCF model in CFI’s Financial Analyst Training Program.

 

financial modeling impacted by days payable

 

Other Resources

Free Accounting Courses

Learn accounting fundamentals and how to read financial statements with CFI's free online accounting classes. These courses will give the confidence you need to perform world-class financial analyst work. Start now!  

Building confidence in your accounting skills is easy with CFI courses! Enroll now for FREE to start advancing your career!