Days payable outstanding is accounting speak for "How long does it take the company to pay its bills?" The amount of time to settle a given account may depend on how much cash the company has handy and how important the vendor is. The DPO formula combines total accounts payable and the cost of sales to get a DPO average. There are several different formulas you could use.
TL;DR (Too Long; Didn't Read)
To find your DPO for the fiscal year, divide the cost of sales by 365 days. Divide the total into the accounts payable balance at the year's end. The result is your accounts payable days.
How to Make a DPO Calculation
DPO is one of the simpler calculations in business accounting. Suppose you're looking at the DPO for the previous year. Take your accounts payable balance at the year's end. Then calculate the cost of sales, which is beginning inventory plus purchases less ending inventory. Divide the cost of sales by 365 days. Divide the accounts payable by the result.
Example of a DPO Calculation
For example, suppose your company's ending accounts payable is $100,000 and your cost of sales is $1.46 million. Divide 365 into the cost of sales and you get $4,000. Divide $100,000 by $4,000 and you get 25. Your DPO, the average time it takes to pay a vendor, is 25 days.
There are variations on this DPO formula, for example multiplying the cost of goods sold by 365 and dividing that into accounts payable. What's important is that you use the same formula when comparing your DPO from different periods, to see changes over time.
What DPO Means
In one sense, having a big DPO is a plus for your business. If you have a 30-day DPO and your chief competitor has 20 days, you're hanging on to your money longer than them before paying your bills. That gives you more time to earn interest on the money or use it in quick-turnover investments. The flip side is that suppliers prefer to get their money quickly. When you and your competitor ask for credit terms, the company that pays the fastest is positioned to get the better deal. In the worst case scenario, the DPO is high because your company is having trouble with cash flow.
DPO may also reflect a company's power. A powerhouse corporation may be able to demand great credit terms from its suppliers. It has less pressure to pay than a struggling start-up that has no clout in the industry.
What's a Good DPO?
The average days payable outstanding varies from industry-to-industry. A vendor deciding on credit terms for your business won't look at your DPO in isolation. It'll be more concerned with how your DPO compares with the industry average: is your DPO average, under or way over?
- To avoid issues with vendors, let them know up front what the company's accounts payable policy is. For example, if the company pays bills on a 30-day basis, include this information in all vendor contracts to avoid hassles.
- If a company waits too long to pay its bills, its credit rating may take a plunge and other businesses may not be willing to offer credit because of a larger DPO number.
Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com