What is Days Payable Outstanding?
Days Payable Outstanding (DPO) measures the number of days a company takes on average before paying outstanding supplier/vendor invoices for purchases made on credit.
The DPO metric is oftentimes a proxy for the bargaining power of the buyer – which is the extent to how much a company can exert pressure in negotiating favorable terms with suppliers/vendors (e.g., price reductions, payment date extensions).
How to Calculate Days Payable Outstanding (Step-by-Step)
Days payable outstanding, or “DPO”, counts the number of days a company takes on before fulfilling its outstanding invoices owed to suppliers or vendors for purchases made using credit, rather than cash.
On the balance sheet, the accounts payable (AP) line item represents the accumulated balance of unmet payments for past purchases made by the company. The good or service has been delivered to the company as part of the transaction agreement, but the company has yet to pay.
During that stretch of time when the supplier awaits the payment, the cash remains in the hands of the buyer with no restrictions on how it can be spent.
The longer a payment is delayed, the longer the company holds onto that cash, which tends to benefit the company’s profit margins, as well as increase free cash flows (FCFs).
Therefore, a higher days payable outstanding results in more near-term liquidity, i.e. increased amount of cash on hand.
Since an increase in an operating current liability such as accounts payable represents an inflow of cash, companies strive to increase their DPO. While bills must eventually be paid, for now, the company is free to use that cash for other needs.
Calculating a company’s days payable outstanding (DPO) is a two-step process:
- Step 1: Start by taking the company’s average (or ending) accounts payable balance and divide it by its cost of goods sold (COGS).
- Step 2: From there, the next step is to then multiply that figure by 365 days.
Days Payable Outstanding Formula (DPO)
The formula for calculating the days payable outstanding (DPO) metric is as follows.
One distinction between the DPO calculation and days sales outstanding (DSO) calculation is that COGS is used instead of revenue since to calculate DPO, COGS tends to be a better proxy for a company’s spending related to supplies/vendors.
But note that the COGS is directly related to revenue, thereby revenue indirectly drives the A/P forecast. For this reason, while A/P is typically projected using DPO, it is also perfectly acceptable to project A/P as a simple percentage of revenue.
What is a Good Days Payable Outstanding? (High or Low)
If all companies could “push out” their payables, any rational company would opt for delayed payment to increase their free cash flows (FCFs).
But the reason some companies can extend their payables whereas others cannot is tied to the concept of buyer power, as referenced earlier.
In general, buyer power and negotiating leverage usually stems from:
- Large Order Volume on a Dollar-Basis
- High Frequency of Orders
- Long-Term Relationship with Customer
- Low Number of Potential Customers
The more a supplier/vendor relies on a customer, the more negotiating leverage that buyer holds.
For a company that constitutes low revenue concentration (i.e., minuscule percentage of total revenue) and low order volume, the inconvenience to the seller and disruption to operations from going out of their way to receive the cash payment could outweigh the benefit of serving that particular customer.
In this type of scenario, the seller could either cut off the customer or place restrictions on the customer (e.g., require upfront payment).
However, if the customer comprised a significant percentage of the seller’s total revenue, the seller can be forced to accept a request for delayed payment as the seller cannot afford to end its relationship with this customer and must comply with their requests.
- Low DPO ➝ Low Bargaining Leverage (Less Free Cash Flow)
- High DPO ➝ High Bargaining Leverage (More Free Cash Flow)