What is dpo in business?

Days payable outstanding (DPO) is a useful working capital ratio used in finance departments that measures how many days, on average, it takes a company to pay its suppliers.

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.

 DPO = Accounts Payable × Number of Days COGS where: COGS = Cost of Goods Sold     = Beginning Inventory + P − Ending Inventory \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​

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.

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.

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.

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.

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.

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.

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.

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.

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.

Days Payable Outstanding or DPO is the average number of days between the time the company receives an invoice and when the invoice is paid. DPO is typically calculated on a quarterly or annual basis. If a company has a DPO of 23 for its most recent quarter, that means it took 23 days on average to pay its suppliers during that time.

DPO is a key cash-flow metric that indicates how well a company manages its cash outflows. A high DPO is often desirable because if a company takes longer to pay creditors, it has more cash available in the short term to use for other purposes.

While DPO is an important measure of cash outflows, days sales outstanding (DSO) is the corresponding metric for cash inflows. DSO is the average number of days it takes a company to receive payment for the outstanding invoices it has issued to customers. A healthy company may aim for a very low DSO, which indicates that it collects revenue quickly, together with a high DPO, which indicates it pays its bills more slowly. The combination of low DSO and high DPO increases the amount of cash available at any time.

Companies generally obtain goods and services on credit, paying for them only after they receive invoices from suppliers. A high DPO means that the company waits longer to pay those bills. Because the company holds on to its money for a longer period, a high DPO generally helps to improve the company’s cash position — more cash is available to fund everyday operations and make short-term investments. But it’s important to balance the advantages of better cash availability against the potential impact on vendor relationships. Vendors prefer customers that pay their bills faster. Those that do may qualify for discounts and enjoy a better overall relationship with their vendors.

Companies generally aim to optimize cash flow and manage cash efficiently. Increasing DPO contributes to these goals.

DPO is one of three metrics used to calculate the cash conversion cycle (CCC), which measures how long it takes a company to convert its investments in inventory into cash. The other two metrics are DSO, which is the average number of days it takes to collect payment from customers, and days inventory outstanding (DIO), which is the average number of days the company holds inventory before it is sold. The formula for calculating CCC, in days, is CCC = DSO + DIO - DPO.

A low CCC is generally advantageous because it indicates that the company can rapidly turn its resources into cash. One way to reduce CCC is to pay vendors more slowly (increasing DPO). Companies can also reduce CCC by collecting money from customers faster (reducing DSO) and by selling inventory more quickly (reducing DIO).

In most situations, a high DPO is considered to be beneficial. It implies that the company is getting better credit terms from its suppliers and that it’s taking full advantage of those terms. As a result, the company is able to free up more cash that it can use to pay operating expenses. A low DPO means the company pays its bills faster, which can be an indication that it’s not able to negotiate extended payment terms from its vendors. However, a low DPO isn’t always a bad sign. A company may choose to pay quickly in order to improve vendor relationships and qualify for early-payment incentives.

The formula for calculating DPO takes into account three factors: the accounts payable (AP) balance, the number of days in the relevant accounting period, and the costs incurred to produce the company’s products and services, known as the cost of goods sold (COGS) or cost of sales.

There are two ways to calculate DPO:

DPO = AP x days in accounting period / COGS or DPO = AP / (COGS / days in accounting period)

Calculating DPO involves three steps:

Let’s say a company wants to determine its DPO for the most recent fiscal year. Its AP at the end of the year is $30,000, and it has calculated COGS at $500,000.

DPO = 30,000 x 365 days / 500,000 = 21.9 days

We can see that on average in the past year the company took 21-22 days to complete payment on invoices received.

Actively managing DPO as part of a broader cash-flow management strategy can provide several benefits:

Although maintaining a high DPO can improve cash flow, it also has potential drawbacks:

The average DPO among the largest U.S. companies rose 7.6% in 2020 to more than 62 days; however, DPO varies widely by industry and by company. It’s sometimes possible to calculate DPO for public companies from data included in their financial statements. Take Walmart, as an example. The retail giant reported accounts payable of approximately $55.3 billion and COGS of $429 billion for the fiscal year ending Jan. 31, 2022. Using the DPO formula (AP x days in accounting period / COGS), Walmart’s DPO for the fiscal year was approximately 47 days ($55.3 billion x 365 days / $429 billion).

Here’s another example: Aerospace company Boeing reported accounts payable of approximately $9.3 billion for the year ending Dec. 31, 2021. The combined cost of goods and services sold was approximately $59.2 billion. Based on the formula above, its DPO was approximately 57 days (9.3 billion x 365 / 59.2 billion).

A high DPO is a key element in an effective cash-flow management strategy. It indicates that the company is maximizing the amount of free cash available. That’s particularly the case if the company has a high DPO combined with a low DSO because that means the company collects cash from its customers faster than it pays its suppliers.

Generally speaking, a company with a high DPO is also viewed as having more leverage in the marketplace. It’s an indication that the company is important enough to its suppliers that they are willing to accept longer payment terms in return for doing business. A low DPO, in contrast, could indicate that a company is not able to get the best terms from its suppliers or is not fully exploiting the extended payment terms that are available. But it could also indicate that the company is paying early and getting discounts for quick payment from suppliers.

DPO is used primarily as an internal financial metric. Finance leaders view the metric as a bellwether of their success at meeting the company’s strategic cash-flow requirements. If the company is tight on cash, it will look to the finance team to extend DPO as long as possible. DPO is a key factor in the company’s cash conversion cycle, which measures its ability to quickly convert resources into cash.

DPO also has applicability in the investment community. Investors scrutinize DPO as a measure of the company’s liquidity and efficiency in managing cash.

Companies can take a variety of steps to improve DPO, depending on factors such as their goals and the industry in which they operate. Those steps include analyzing invoice processing methods, negotiating terms and automating accounts payable processes.

NetSuite Cloud Accounting Software enables companies to centralize, automate and track financial information for improved cash-flow management. It helps businesses automate the capture of vendor invoices, approvals, payments, reconciliations and more. Find all your business bills, receipts and contracts in a single place and eliminate manual data entry errors. Real-time insights into financial metrics such as days payable outstanding (DPO) help companies track business performance and respond quickly to trends.

Conclusion

Focusing on tracking and optimizing DPO helps a company better manage all-important cash flow. Increasing the number of days taken to pay vendor invoices helps the finance team ensure more cash is available to fund operations. On the other hand, reducing DPO can be advantageous if it means the company wins greater supplier discounts.

Days payable outstanding (DPO) shows the average number of days your company takes to pay its vendors. The value of a high DPO is improved cash flow — the company has more cash available for other uses. However, it’s important to strike the right balance between efficient cash management and vendor relations. Rapid payments can earn supplier discounts, while companies that pay too slowly may incur late-payment penalties or even be unable to work with some suppliers.

Days payable outstanding (DPO) is calculated by multiplying the average accounts payable balance by the number of days in an accounting period and then dividing the result by the costs of goods sold (COGS). The formula is:

DPO = AP balance x days in accounting period / COGS

A high days payable outstanding (DPO) is often desirable because a company that takes longer to pay its bills has more cash available for other purposes. On the other hand, a company that pays its bills quickly (low DPO) may improve its relationships with its vendors.