Title: Days Payable Outstanding (DPO) — What It Is, How to Calculate It, and Practical Steps to Manage It
Introduction
Days payable outstanding (DPO) is a liquidity and working-capital metric that measures the average number of days a company takes to pay its suppliers for purchases made on credit. It’s used by management, creditors and analysts to evaluate how effectively a firm is managing cash outflows and supplier relationships. A longer DPO means the company is retaining cash longer; a shorter DPO means it pays suppliers quickly.
Key takeaways
– DPO = average time (in days) to pay trade creditors.
– Typical calculation uses accounts payable, cost of goods sold (COGS) and the number of days in the period.
– A higher DPO can free cash for operations or investing, but if too high it risks supplier relations or signals liquidity stress.
– Compare DPO only among peers in the same industry and consider seasonal/structural differences.
(Source: Investopedia)
Formula for Days Payable Outstanding (DPO)
Basic formula:
DPO = (Accounts Payable × Number of Days in Period) / COGS
Notes:
– Number of days is usually 365 for a year or ~90 for a quarter.
– Some analysts use average Accounts Payable: ((Beginning AP + Ending AP) / 2) to better reflect the period rather than end-of-period AP.
– COGS should match the same period as the AP figures.
How to calculate DPO — step-by-step
1. Select the period to analyze (annual, quarterly). Use 365 for a year, 90 for a quarter as the number of days.
2. Obtain Accounts Payable (AP) for the period. Prefer using the average of beginning and ending AP for the period for a period-average measure.
3. Obtain Cost of Goods Sold (COGS) for the same period. If COGS isn’t applicable (service firms), use purchases or operating costs consistent with the business model — be explicit about what you use.
4. Plug into the formula: DPO = (AP × Days) / COGS.
5. Interpret and compare with industry peers and prior periods.
Worked numeric example
Assume:
– Beginning AP = $40,000
– Ending AP = $60,000 → Average AP = ($40,000 + $60,000) / 2 = $50,000
– COGS (annual) = $500,000
– Days in period = 365
DPO = (Average AP × 365) / COGS = (50,000 × 365) / 500,000 = 36.5 days
Interpretation: On average the company takes about 37 days to pay suppliers.
What DPO tells you
– High DPO (longer payment period): The company keeps cash longer which can improve free cash flow and allow short-term investments. But if DPO is too high, it may signal strained supplier relations, lost early-pay discounts, or financial stress.
– Low DPO (shorter payment period): Shows the company pays suppliers quickly — good for supplier relationships and possibly qualifying for discounts — but might indicate inefficient use of available cash if payment is earlier than terms allow.
Special considerations and caveats
– Industry differences: Typical DPOs differ greatly by sector (retail, manufacturing, tech, services). Only compare within the same industry.
– Seasonality: Retailers and manufacturers may show wide swings due to inventory build-up or seasonal sales. Use trailing twelve months (TTM) or seasonal adjustments where relevant.
– COGS vs Purchases: Some firms prefer using Purchases (if available) rather than COGS; make sure the numerator and denominator are consistent for the period.
– Accounting policies: Use of factoring, extended supplier financing, or off-balance-sheet arrangements can distort DPO.
– End-of-period bias: Using ending AP gives a snapshot at a date; using average AP gives a period-average metric — choose based on analysis needs.
– Non-operational payables: Capital expenditures and long-term payables should generally be excluded since DPO focuses on trade payables.
DPO vs DSO (Days Sales Outstanding)
– DPO measures how long the firm takes to pay suppliers.
– DSO measures how long the firm takes to collect receivables from customers.
Difference matters because mismatches can create cash pressure: if DSO >> DPO (customers pay much slower than suppliers require payment), the firm may experience working-capital strain.
Role in the Cash Conversion Cycle (CCC)
CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) − DPO
Higher DPO reduces CCC (improves working-capital position) because it delays cash outflows.
Practical steps to improve (or manage) DPO
1. Negotiate extended payment terms with suppliers: Seek 30→45 or 60-day terms where reasonable. Maintain dialogue to preserve relationships.
2. Centralize accounts payable: Consolidate AP processing to standardize terms and ensure optimal payment timing.
3. Implement invoice automation: Electronic invoicing and AP automation reduce processing time, give better visibility and allow optimized payment timing.
4. Use vendor financing / supply-chain finance: Third-party finance providers can pay suppliers early while the company pays later, preserving supplier relations.
5. Take selective early payment discounts when they exceed the company’s cost of capital: Evaluate discount vs. return (e.g., a 2% discount for payment in 10 days might be attractive compared to short-term borrowing rate).
6. Consolidate and rationalize suppliers: Fewer suppliers can simplify negotiations and improve terms.
7. Forecast and manage cash: Improve short-term forecasting to pay on the last allowable day without risking penalties.
8. Implement KPIs and benchmarking: Track DPO monthly and compare to industry peers to detect trends or warning signs.
9. Avoid supplier concentration risks: Don’t push all suppliers too far on extended terms — critical suppliers may react negatively.
10. Communicate: Keep strategic suppliers informed of policy changes and provide transparency to avoid surprises.
Tips and best practices
– Always benchmark against peers and industry medians.
– Reconcile DPO with supplier agreements (payment terms) — DPO significantly longer than contractual terms can be a red flag.
– When improving DPO, weigh cash benefits against the potential cost of damaged relationships or lost discounts.
– Use average AP for period analysis to reduce end-period distortions.
– Combine DPO analysis with cash flow forecasting and liquidity ratios.
Advantages and disadvantages of focusing on DPO
Advantages
– Preserves cash and improves short-term liquidity and free cash flow.
– Can reduce need for external short-term borrowing.
– When used appropriately, strengthens working-capital management and lowers CCC.
Disadvantages
– Excessively long DPO can harm supplier relationships and lead to supply disruptions.
– Potentially forgo early-payment discounts that provide higher returns than holding cash.
– A rising DPO could mask liquidity problems — a company forced to delay payments due to cash shortages rather than strategic policy.
Real-world / hypothetical example
RetailCo sells consumer goods. Last fiscal year:
– Average AP = $120 million
– COGS = $1,200 million
– Days = 365
DPO = (120,000,000 × 365) / 1,200,000,000 = 36.5 days
RetailCo’s supplier contracts typically allow 45 days. RetailCo’s DPO of 36.5 days suggests it pays well within terms. Management can consider pushing to 40–45 days to free incremental cash, but should negotiate carefully so that suppliers remain cooperative.
When to worry
– DPO increasing quickly while cash balances and current ratio worsen — could signal liquidity stress.
– DPO longer than contractual payment terms — indicates late payments.
– DPO diverging widely from industry norms without operational justification.
Conclusion (Bottom Line)
DPO is a useful measure of how long a company takes to pay suppliers and is an important component of working-capital and liquidity analysis. Used correctly — with industry benchmarks, attention to seasonality and supplier contracts, and in combination with other metrics like DSO, DIO and CCC — DPO helps management optimize cash usage without damaging supplier relationships. Changes in DPO should be interpreted in context: they can reflect strategic policy, negotiation success, or financial stress.
Source
Investopedia — Days Payable Outstanding (DPO): https://www.investopedia.com/terms/d/dpo.asp
If you’d like, I can:
– Calculate DPO for a specific company if you provide AP and COGS (or show how to pull them from a financial statement).
– Benchmark DPO for an industry and show what a “healthy” range looks like.