Days Payable Outstanding – Everything a Procurement Professional Should Know

During a procurement process, it is important to check the days payable outstanding of your current procurement. Every procurement manager should be aware of this variable since this will help determine how much money the company can stretch when it comes to its procurement savings.

For this article, we are going to tackle how to use days payable outstanding to your advantage. We’ll first discuss its definition, analyze what a good days payable outstanding rate is for most procurement processes, and how you can take advantage of this knowledge during your company’s next procurement project.

After reading this article, you should already know how to deal with days payable outstanding.

Days Payable Outstanding – What is It?

Days payable outstanding is the measure of the average time taken for a company to pay its suppliers or creditors. If the days payable outstanding have a greater duration, this means the funds are kept in the company for long, thus giving its creditors the impression that it will repay its liabilities at a slower rate. This may not look good for a company that depends on regular procurement in order to operate on a daily basis.

However, there are also exceptions to the rules. Depending on the industry to which the company belongs, the DPO may sometimes vary. There are times when it will look good for the company and times when it may dive into unfavorable numbers. In cases where a company has greater DPO though, it becomes more flexible to use the funds available for its working capital and investment purposes.

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What is the Ideal Days Payable Outstanding Rate?

The only answer to this question is that it depends on the nature of the company and the industry where it works in. Not to mention the vendor payment terms agreed upon as well.

Unlike other metrics used in the procurement process, DPO is a rather fickle thing. It’s not necessarily a good thing that a company has high or low DPO. Having a higher DPO rate will get your suppliers frustrated while having too low DPO will not be good for your company’s financial records. So the question always here is what is the ideal DPO rate?

Before even contemplating whether your Days Payable Outstanding is strong, you need to know what your on-time payment percentage is. If you are below 90%, there likely needs to be an initial focus on improving that percentage, including confirming how close to the due date on-time payments are made (hint: the closer the better when it comes to improving DPO).

Skipping this step likely means improving the DPO at the expense of supplier relationships. While it may give short-term rewards, it will cause long-term problems when suppliers start tightening charging late fees and reducing payment terms.

How to Calculate for the Right DPO?

The only way to calculate the right DPO is by first confirming whether your vendors are being paid on time and that you have negotiated stronger payment terms with them. Once that’s done, you can start calculating your target Days Payable Outstanding as the average payment term for your spend, subtracting around 2-3 business days. 

This is usually the number of days needed in order to repay via mailing a check. Nowadays, it’s faster to repay thanks to an ACH or vCard.

Here’s are some examples of calculating for the right DPO:

1. Monthly Days Payable Outstanding

A company has an outstanding payment of $2500, and the cost of sales in producing the product is $760.

The entity wants to calculate the days payable outstanding on a monthly basis.

This is a straightforward problem where the total of outstanding payable is given, and the cost of sales is mentioned to compare against. The only thing to consider here is that the calculation has to be made monthly rather than the frequent annual cycle.

So the values are:

• Accounts Payable – $250
• Costs of Goods Sold – $760
• Number of Days – 6

The solution for this is as follows:

DPO (Days Payable Outstanding) = Accounts Payable X Number of Days / Cost of Sales

So based on the values given above, the results would be:

• Days Payable Outstanding ($250X30 / $760)
• Days Payable Outstanding = 9.87

2. Total Accounts Payable

Your company has an account payable at the end of the year. The total is around $1350. 

The direct costs incurred are as follows:

• Accounts Payable – $1350
• Cost of Direct Materials – $5400
• Cost of Direct Labour – $2380
• Cost of Direct Expenses – $1290
• Number of Days – 365

So how do we calculate the DPO on an annual basis?

The accounts payable is mentioned as a single slab here, whereas the cost of sales is divided into various categories. This is because the cost of sales involves the sum of the material, labor, and other direct expenses that went into getting the final product.

So if we are to create a formula, it will go like this:

DPO (Days Payable Outstanding) = Accounts Payable X Number of Days / Cost of Sales

• Days Payable Outstanding = ($1350 X 365) / $9,070
• Days Payable Outstanding = 54.33

What are the Advantages and Disadvantages of DPO?

Advantages

• Days payable outstanding helps a company in ensuring its prompt payments towards its debtors and creditors. Being able to pay on time increases the debtor/creditor’s trust in the company, allowing for more chances for the company to borrow money.
• The entity can compare the terms given by the various debtors/creditors. This will give the company more options on who to choose from when considering borrowing money from various creditors.
• The company can also compare its own DPO with the industry standards. This will give the company enough time to make adjustments.

Disadvantages

• The DPO is not an accurate measurement of how a company should use its funds. As stated, days payable outstanding rates are affected by a number of issues, such as industry, season, or industry-specific issues. These factors may also not help in the duration of the DPO at its optimum level.
• While DPO enables the management to better use company funds, there is also nothing the company can do in terms of checking the DPO since the terms placed by most creditors are already fixed.

FAQs

What is Days Payable Outstanding?

Days Payable Outstanding is the number of days a company is able to pay its creditors.

Why is Days Payable Outstanding important?

DPO allows companies the ability to better budget their finances so they can pay their creditors on time.