Days Payable Outstanding (DPO) Defined and How It's Calculated

What Is Days Payable Outstanding (DPO)?

Days payable outstanding (DPO) is a financial ratio that indicates the average time (in days) that a company takes to pay its bills and invoices to its trade creditors, which may include suppliers, vendors, or financiers. The ratio is typically calculated on a quarterly or annual basis, and it indicates how well the company’s cash outflows are being managed.

A company with a higher value of DPO takes longer to pay its bills, which means that it can retain available funds for a longer duration, allowing the company an opportunity to use those funds in a better way to maximize the benefits. A high DPO, however, may also be a red flag indicating an inability to pay its bills on time.

Formula for Days Payable Outstanding (DPO)

 $\begin{aligned} &\text{DPO} = \frac{\text{Accounts Payable}\times\text{Number of Days}}{\text{COGS}}\\ &\textbf{where:}\\ &\text{COGS}=\text{Cost of Goods Sold} \\ &\qquad\ \ \, \,= \text{Beginning Inventory} + \text{P} -\text{Ending Inventory}\\ &\text{P}=\text{Purchases} \end{aligned}$​DPO=COGSAccounts Payable×Number of Days​where:COGS=Cost of Goods Sold  =Beginning Inventory+P−Ending Inventory​

How to Calculate DPO

To manufacture a salable product, a company needs raw material, utilities, and other resources. In terms of accounting practices, the accounts payable represents how much money the company owes to its supplier(s) for purchases made on credit.

Additionally, there is a cost associated with manufacturing the salable product, and it includes payment for utilities like electricity and employee wages. This is represented by cost of goods sold (COGS), which is defined as the cost of acquiring or manufacturing the products that a company sells during a period. Both of these figures represent cash outflows and are used in calculating DPO over a period of time.

The number of days in the corresponding period is usually taken as 365 for a year and 90 for a quarter. The formula takes account of the average per day cost being borne by the company for manufacturing a salable product. The numerator figure represents payments outstanding. The net factor gives the average number of days taken by the company to pay off its obligations after receiving the bills.

Two different versions of the DPO formula are used depending upon the accounting practices. In one of the versions, the accounts payable amount is taken as the figure reported at the end of the accounting period, like “at the end of fiscal year/quarter ending Sept. 30.” This version represents the DPO value as of the mentioned date.

In another version, the average value of beginning AP and ending AP is taken, and the resulting figure represents the DPO value during that particular period. COGS remains the same in both versions.

What Does DPO Tell You?

Generally, a company acquires inventory, utilities, and other necessary services on credit. It results in accounts payable (AP), a key accounting entry that represents a company's obligation to pay off the short-term liabilities to its creditors or suppliers. Beyond the actual dollar amount to be paid, the timing of the payments—from the date of receiving the bill till the cash actually going out of the company’s account—also becomes an important aspect of the business. DPO attempts to measure this average time cycle for outward payments and is calculated by taking the standard accounting figures into consideration over a specified period of time.

Additionally, a company may need to balance its outflow tenure with that of the inflow. Imagine if a company allows a 90-day period for its customers to pay for the goods they purchase but has only a 30-day window to pay its suppliers and vendors. This mismatch will result in the company being prone to cash crunch frequently. Companies must strike a delicate balance with DPO.

High DPO

Companies having high DPO can use the available cash for short-term investments and to increase their working capital and free cash flow (FCF). However, higher values of DPO may not always be a positive for the business. If the company takes too long to pay its creditors, it risks jeopardizing its relations with the suppliers and creditors who may refuse to offer the trade credit in the future or may offer it on terms that may be less favorable to the company. The company may also be losing out on any discounts on timely payments, if available, and it may be paying more than necessary.

Low DPO

On the other hand, a low DPO indicates that a company is paying its bills to suppliers quickly, which may suggest that the company is managing its cash flow effectively. A low DPO is considered to be a positive sign for a company's financial health, as it shows that the company is able to pay its bills in a timely manner. This also helps maintain good relationship with suppliers.

However, a low DPO may also indicate that the company is not taking advantage of discounts offered by suppliers for early payment. For example, a company may be extended a payment period of 30 days; if it usually pays invoices after 10 days, the company could have been earning interest on the funds for an additional 20 days before remitting payment.

Special Considerations

Typical DPO values vary widely across different industry sectors and it is not worthwhile comparing these values across different sector companies. A firm's management will instead compare its DPO to the average within its industry to see if it is paying its vendors too quickly or too slowly. Depending upon the various global and local factors, like the overall performance of the economy, region, and sector, plus any applicable seasonal impacts, the DPO value of a particular company can vary significantly from year to year, company to company, and industry to industry.

DPO value also forms an integral part of the formula used for calculating the cash conversion cycle (CCC), another key metric that expresses the length of time that a company takes to convert the resource inputs into realized cash flows from sales. While DPO focuses on the current outstanding payable by the business, the superset CCC follows the entire cash time-cycle as the cash is first converted into inventory, expenses, and accounts payable, through to sales and accounts receivable, and then back into cash in hand when received.

How to Improve DPO

Most often companies want a high DPO as long as this doesn't indicate it's inability to make payment. A company can negotiate with its suppliers to extend payment terms. If a company really prioritizes maximizing its DPO, it can decline to take advantage of early payment discounts.

By using electronic payment systems, a company can streamline its payment processes and make payments more quickly and efficiently. This means that instead of issuing slower means of payment such as a check that may have to be processed and mailed early in order for it to be received in time. Instead, a company can issue electronic payments the instant something is due.

If a company wants to decrease its DPO, a company can also regularly monitor its accounts payable to identify and resolve any issues that may be delaying payment to suppliers. A company can also more quickly resolve supplier payment problems if it has accurate and up-to-date records.

Advantages and Disadvantages of DPO

Advantages of DPO

A company can use DPO to understand its financial flexibility. By evaluating its DPO, it can project its creditworthiness, liquidity, and financial health. When a company's DPO is high, this may either mean the company is struggling to pay bills on time or is effectively using credit terms. Only by measuring DPO can a company further evaluate.

When a company knows its DPO, it can better assess whether it is paying its bills quickly which helps maintain good relationships with suppliers. A company usually wants to balance the benefit of paying a vendor early against the purchasing power lost by spending capital early. In many cases, a company want want to be on the good graces of a supplier to potentially receive goods earlier.

Disadvantages of DPO

While DPO is useful in comparing relative strength among companies, there is no clear-cut figure for what constitutes a healthy days payable outstanding, as the DPO varies significantly by industry, competitive positioning of the company, and its bargaining power. Large companies with a strong power of negotiation are able to contract for better terms with suppliers and creditors, effectively producing lower DPO figures than they would have otherwise.

In addition, a higher DPO may mean several things and usually must be further investigated as the figure by itself doesn't mean much. For example, a company may be thinking that its DPO means it is efficiently using capital. On the contrary, the company may actually be paying vendors late and racking up late fees. Therefore, DPO by itself doesn't amount to much unless management knows the drivers behind it.

Real-World Example of DPO

The snippet below is taken from Amazon's consolidated statement of operations. The figures represent the amount of expenses related to the cost of sales. Note that in the calculation beloe, other operating expenses such as sales, marketing, technology, general, or administrative costs have been omitted.

In addition, Amazon reports its accounts payable balance on its balance sheet.

Using this information, you can calculate Amazon's DPO. For the accounts payable portion, we can assume that the beginning balance of one period is the ending balance of the prior period. Therefore, using this method, the average balance of accounts payable for 2022 was $79,132 (in millions). Alternatively, Amazon's average daily accounts payable balance was $216.8 million.

For the COGS, the company directly reports that as cost of sales. For 2022, Amazon's cost of goods sold was $288.8 billion.

Therefore, DPO can be calculated as: ($79,132/$288,851) * 365 days. Therefore, Amazon's DPO is approximately 100 days. This DPO calculation demonstrates Amazon's ability to leverage its size to enter into contracts in which it has long, open periods where it is not expected to pay an invoice.