What is Days Payable Outstanding - DPO
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 include suppliers, vendors or other companies. The ratio is calculated on a quarterly or on an annual basis, and it indicates how well the company’s cash outflows are being managed. A company having a higher value of DPO takes longer to pay its bills, which means that it retains the available funds for a longer duration. It may allow the company an opportunity to utilize the available cash in a better way for maximizing the benefits.
Days Payable Outstanding
BREAKING DOWN Days Payable Outstanding - DPO
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 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.
To manufacture a saleable 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 a purchase which it made on credit. Additionally, there is a cost associated with manufacturing the saleable product, and it includes payment for utilities like electricity and for 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 these figures represent cash outflows, and are used in calculating DPO over a period of time. Mathematically,
DPO = [Accounts Payable / (Cost of Sales / Number of Days)]
The number of days in the corresponding period is taken as 365 for a year and 90 for a quarter.
The denominator (Cost of Sales / Number of Days) represents the average per day cost being borne by the company for manufacturing a saleable 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 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 DPO value “as of” the mentioned date. In another version, average value of Beginning AP and Ending AP is taken, and the resulting figure represents DPO value “during” that particular period. COGS remains the same in both the versions.
The leading retail corporation Walmart Inc. (WMT) had accounts payable worth $46.09 billion and cost of goods sold worth 373.4 billion for the fiscal year 2018. These figures are available in the annual financial statement and balance sheet of the company. Taking the number of days as 365 for annual calculation, the DPO for Walmart comes to [ 46.09 / (373.4/365) ] = 45.05 days.
Similar calculations for technology leader Microsoft Corp. (MSFT) which had $8.62 billion as AP and $38.97 billion as COGS leads to DPO value of 80.73 days.
It indicates that during the fiscal year ending 2018, Walmart paid its invoices in around 45 days after receiving the bills, while Microsoft took around 80 days, on an average, to pay its bills.
A look at similar figures for the online retail giant Amazon.com Inc. (AMZN), which had AP of $34.62 billion and COGS of $111.93 billion for the fiscal year 2017, reveals a very high value of 112.90 days. Such high value of DPO is attributed to the working model of Amazon, which roughly has 50 percent of its sales being supplied by third-party sellers. Amazon instantly receives funds in its account for sale of goods which are actually supplied by third-party sellers using Amazon’s online platform. However, it doesn’t don’t pay the sellers immediately after the sale, but may send accumulated payments based on a weekly/monthly or threshold-based payment cycle. This working mechanism allows Amazon to hold onto the cash for a longer period of time, and the leading online retailer ends up with a significantly high DPO.
Interpreting DPO Values
Companies having high DPO can use the available cash for short-term investments and to increase their working capital and free cash flow. However, higher values of DPO, though desirable, 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. Company may also be losing out on any discounts on timely payments, if available, and it may be paying more than it needs to. A high value of DPO is beneficial if the company is running short of cash, and if the company is better off in delaying the payments than making them in time and then loaning the money by paying interest to continue its business operations. Companies must strike a delicate balance with DPO.
Additionally, a company may need to balance its outflow tenure with that of the inflow. Imagine if a company allows 90-day period to its customers to pay for the goods they purchase, but has only 30-day window to pay its suppliers and vendors. This mismatch will result in the company being prone to cash crunch frequently.
DPO value varies widely across the different industry sectors, and it is not worth comparing the value for different sector companies. A company’s management can compare its DPO to the industry average 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 economy, region and sector and 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.