What is Days Payable Outstanding (DPO)?
Days Payable Outstanding is a metric used to calculate how many days a company takes to settle its bills with suppliers or other creditors. A high DPO indicates that the company takes a relatively long time to pay its suppliers. However, this is not necessarily positive or negative.
Why is Days Payable Outstanding important?
DPO is crucial because it reflects how well a company manages its cash flow. A high DPO means the company has the ability to defer payments, allowing available capital to be used for short-term investments or improving cash flow. A high DPO is also ideal for increasing working capital. However, a high DPO may not always be favorable, as it could indicate a potential shortage of funds to pay supplier invoices.
How do you calculate DPO?
There is a formula available to calculate DPO based on accounts payable, the number of days, and the cost of goods sold. The company’s accounts payable balance can be applied in various ways, such as using the average balance of a specific period or the balance at the end of a specific period for the formula. The number of days refers to the total within a quarter (90 days) or year (365 days) of an accounting period. The most common method is to calculate the number of days per quarter or per year. The cost of goods sold includes production and transportation costs.
DPO Formula: Accounts Payable x Number of Days / Cost of Goods Sold
Example calculation of Days Payable Outstanding
Suppose the average accounts payable balance over a quarter is €50,000, and the cost of goods sold is €100,000. The DPO is calculated as follows: €50,000 x 90 / €100,000 = 45 days.
DPO in relation to the industry
A DPO of 45, as in the example, means the company takes an average of 45 days to pay its creditors. To determine if this is a high DPO, it is essential to look at the industry benchmark. Comparing DPO with companies in completely different sectors is not meaningful. However, it provides a good indication when compared to businesses in the same industry. Additionally, DPO can vary quarterly or yearly due to economic performances, possible seasonal effects, and competition within the sector and region.
Importance of DPO for working capital
A high DPO positively impacts working capital, indicating the company’s liquidity and its ability to pay bills in the short term. If a company takes more time to pay its bills, it retains more working capital, holding onto cash for an extended period. In this case, it is positive if the company consciously chooses to extend payment terms for creditors. However, if the DPO is high because the company is unable to pay earlier, it is less favorable.
Benefits of a low DPO
In certain situations, a low DPO is also considered positive. If a company quickly pays its suppliers’ bills, it can have advantages. It demonstrates the reliability of the company, positively influencing the relationship with suppliers. The company is perceived as creditworthy, which aligns with reliability. If the DPO is low and there is limited working capital available when needed, it may be worth considering delaying payments, for example, until the payment deadline.
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