Days Payable Outstanding
It is important to regularly assess the performance of the company in order to enhance it. One of the most important measures to track the total efficiency and productivity in accounts payable (AP) is Days Payable Outstanding (DPO).
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What is Days Payable Outstanding?
Days payable outstanding is a type of financial ratio that helps in calculating the average number of days taken by a company to pay off its bills to creditors, suppliers, etc. It helps in identifying the payment cycle of a particular company. Thus, it helps in understanding how well the company is managing its cash flows. This ratio is calculated typically on a Quarterly or Annual basis.
High & Low DPO:
The main reason for calculating this ratio is to know the creditability of the company and how effectively they are using their cash flow and time period for payment allotted to them. Basically, this ratio is calculated to analyze the variables i.e. high DPO or low DPO
- High DPO:
This means that the company takes more time to pays off its debts and as a result of this investors can assume that company is using its cash flow in an effective manner by investing in short-term investment. But if a company takes more than require in paying off its bills then it creates a negative impression of the company in the market.
- Low DPO:
This means that the company is paying off its bills quickly. This also means that the company is not utilizing the total time given by the suppliers and other parties to pay off its bills. Instead of investing the cash in some very short term security company is paying their expenses. This also results that the company is not appropriate in maintaining its cash flow.
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Formula:
Days Payable Outstanding = Average Accounts Payable / Cost of Goods Sold *Number of Days in Accounting Period
Here,
Average Account Payable is the total amount of bills or payments that the company has to pay to outsiders.
Cost of goods sold = Beginning inventory + purchases – Ending inventory.
The number of days in the accounting period will be 365 and some time number of days depends on the investor and company for what specific activity they are calculating.
Examples:
- Let say a company is having 1, 00,000 of account payable and 15,00,000 of COGS (Cost Of Goods Sold) for 365 days.
Days Payable Outstanding = Average Accounts Payable / Cost of Goods Sold *Number of Days in Accounting Period
Days Payable Outstanding = (1, 00,000/15, 00,000) * 365
Days Payable Outstanding = 24.33
Thus, we can say that company is having a low DOP ratio which means the company is quick for paying its bills and not using its cash flow inappropriate.
- Let say another company is having 100,000 of account payable and 10, 00,000 of COGS for 365 days.
Days Payable Outstanding = Average Accounts Payable / Cost of Goods Sold *Number of Days in Accounting Period
Days Payable Outstanding = (1, 00,000/10, 00,000) * 365
Days Payable Outstanding = 36.5
Thus, we can say that company is having a high DPO ratio this means company that the company is not quick for paying their bills and uses their cash flow inappropriate from.
Limitation:
The main limitation of this ratio is that if companies DPO is high then this means that the company is using its cash flow for short-term investment. However, if the company is continuously maintaining the same DPO ratio, then the suppliers may stop giving a discount to the company and the creditors may reduce their credit period, which may result in weakening the company’s image in the market. Further, it may lose its suppliers and the need arises to find new suppliers, which may increase the cost for the company.
Final Thoughts:
Days Payable Outstanding is just a small part of financial accounting and overall financial planning, however knowing how it works will make organizations expand, with sound financial statements, and compete successfully in today’s environment.
Author: Charmi Mehta
About the Author: Charmi Mehta is currently pursuing MBA with a specialization in Finance from the Department of Business Administration, Bhavnagar. Charmi is very much interested to work with data and its analysis and she is also fascinated by the financial market.
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