Understanding Days Payable Outstanding (DPO): A Key Metric

Days Payable Outstanding (DPO) refers to the average number of days it takes a company to pay back its accounts payableAccounts PayableAccounts payable is a liability incurred when an organization receives goods or services from its suppliers on credit. Accounts payables are. 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 Formula

The formula for DPO is as follows:

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

Or

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

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 a company takes longer to pay its creditors, the excess cash on handCash SweepA cash sweep is any deliberately chosen and automated transfer of a portion of a company's or an individual's cash flow to be used for a specific purpose. could be used for short-term investing activities. However, taking too long to pay creditors may result in unhappy creditors and their refusal to extend further credit or offer favorable credit terms. Also, if the DPO is too high, it may indicate that the company is struggling to find the cash to pay its 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 low DPO may indicate that the company is not fully utilizing its credit period offered by creditors. Alternatively, it is possible that the company only has short-term credit arrangements with its creditors.

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

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

• Average accounts payable: $800,000
• Cost of goods soldCost of Goods Sold (COGS)Cost of Goods Sold (COGS) measures the “direct cost” incurred in the production of any goods or services. It includes material cost, direct: $8,500,000
• Number of days: 365

DPO: ($800,000 / $8,500,000) x 365 = 34.35. Therefore, this company takes 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. This metric is used in cash cycle analysis. A high or 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 inefficiently operating company.

There is no clear-cut number on what constitutes a healthy days payable outstanding, as the DPO varies significantly by industry, competitive positioning of the company, and its bargaining power. For example, Walmart is a huge company in the retail industry. With such a significant market share, the retailer can 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 are important concepts in financial modelingWhat is Financial ModelingFinancial modeling is performed in Excel to forecast a company's financial performance. Overview of what is financial modeling, how & why to build a model.. When calculating a company’s free cash flow to the firmValuationFree valuation guides to learn the most important concepts at your own pace. These articles will teach you business valuation best practices and how to value a company using comparable company analysis, discounted cash flow (DCF) modeling, and precedent transactions, as used in investment banking, equity research, (FCFF), changes in net working capitalNet Working CapitalNet Working Capital (NWC) is the difference between a company's current assets (net of cash) and current liabilities (net of debt) on its balance sheet. impact cash flow, and, thus, the average number of days they take to pay bills can have an impact on valuation (especially in the short run).

Below is a screenshot of a DCF model in CFI’s Financial Analyst Training ProgramBecome a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today!.

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Other Resources

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