Days Payable Outstanding (DPO) is a metric used to calculate how many days your company needs to pay the bills of suppliers or other creditors. A high DPO means that the company takes relatively more time to pay suppliers. This is not necessarily always positive or negative.
Why is Days Payable Outstanding important?
DPO is important because it indicates the extent to which there is good management of the company’s cash flow. A high DPO means that the company has the ability to defer payments. The available money can then be used for short-term investments or to improve cash flow. Thus, a high DPO is also ideal for increasing working capital. However, a high DPO is not necessarily beneficial for the company. It can also mean that there may be a shortage to pay suppliers’ bills.
How to calculate DPO?
There is a formula available to calculate DPO based on creditors, number of days, and cost of goods sold. The company’s creditor balance can be applied in various ways. For example, by taking the average balance of a specific period as a starting point. Another way is to use the balance at the end of a specific period for the formula. The number of days relates to the total within a quarter (90 days) or year (365 days) of an accounting period. The most commonly used method is to calculate the number of days per quarter or per year. The cost of goods sold relates to production costs and transportation costs.
Formula to calculate DPO: creditors x number of days / cost of goods sold
Example calculation of Days Payable Outstanding
The creditor balance over a period of a quarter averages €50,000, and the cost of goods sold amounts to €100,000. DPO is then as follows: 50,000 x 90 / 100,000 = 45 days.
DPO in relation to own industry
A DPO of 45, as in the example mentioned, means that the company takes an average of 45 days to pay the creditors’ bill. To determine whether there is a high DPO, it is important to look at your own industry. For example, it makes no sense to compare with a DPO of companies in completely different sectors. The outcome does provide a good picture if there is a comparison with companies in the same industry. Moreover, DPO is a metric that can vary quarterly or annually. There are various factors that influence this. For instance, general economic performance plays a role, as do possible seasonal effects and competition in the own sector and region.
Importance of DPO for working capital
With a high DPO, there is a favorable influence on working capital. This concerns the liquidity of the company and indicates the extent to which the company is able to pay bills in the short term. If a company takes more time to pay its bills, it has more working capital available, as you keep cash on hand for a longer period. In this case, it is positive if the company consciously chooses to maintain a longer payment term for creditors. If the DPO is high without this being a conscious choice, but because the company simply cannot pay earlier, that is obviously less favorable.
Advantages of low DPO
A low DPO can also be positive in certain situations. If a company quickly pays suppliers’ bills, it can offer advantages. It shows, among other things, the reliability of your company, which has a positive influence on the relationship with suppliers. The company is then considered creditworthy, and this goes hand in hand with reliability. If the DPO is low and there is little working capital available that is needed, it is worth considering deferring payments. For example, until the last date of the payment term.
