Many businesses acquire inventory and supplies using credit. The supplier provides an invoice, and there's a period between when you receive the invoice and when you pay the invoice. This period is known as the days payable outstanding, or DPO.

Put simply, DPO is a measure of the average time it takes for your company to pay its bills.

In this article, we explain what days payable outstanding means and why it's important for your business.  

Table of Contents

1. What is days payable outstanding (DPO)?

2. How to calculate DPO

3. What does a high DPO mean?

4. What does a low DPO mean?

5. What DPO is right for your company?

6. Pros and cons of DPO

7. Tips to improve DPO

8. Finding the right fit for your small business

9. FAQ

What is days payable outstanding (DPO)?

Days payable outstanding (DPO) is the average number of days it takes for a company to pay its suppliers' bills. If your company has a DPO of 15 days, this means it takes you an average of 15 days to pay your creditors or suppliers.

DPO is important because it can help shine a light on your company's cash flow and accounts payable management.

Having a higher DPO is often preferable because it means your business has liquidity in the short term. Many companies want to increase their DPO to increase their available cash. 

How to calculate DPO

Calculating DPO can help you measure the efficiency of your company.

There are two formulas you can use to calculate DPO:

DPO = Average accounts payable x Number of days / COGS

DPO = Average accounts payable / (COGS / Number of days)

You'll need to know three factors to perform the calculation:

• Average accounts payable. This represents the amount your company owes to your suppliers. Average accounts payable can be found as a line item on your balance sheet.
• Number of days. The number of days in a period is often 365 for a full year, 90 days per quarter, or 30 days for a month.
• Cost of goods sold (COGS). This represents the cost of acquiring or manufacturing the products your company sells over a period of time. Examples of COGS include the materials and labour required to make a product or perform a service, and overhead costs such as electricity.

You can use the following formula to calculate COGS:

Cost of goods sold (COGS) = Beginning inventory + Purchases - Ending inventory

Suppose your company, Amazing Goods, has an average accounts payable of $100,000 and a COGS of $1,000,000. We want to calculate the DPO for a year (365 days):

Average accounts payable x Number of days / COGS = DPO

$100,000 x 365 / $1,000,000 = 36.5 days

The company takes an average of 37 days to pay back its accounts payable. 

What does a high DPO mean?

A higher DPO means your company has more cash on hand and more liquidity. While a higher DPO leaves cash available for things like short-term investments, a high DPO isn't always a good thing.

Taking too long to pay your suppliers has the potential to ruin important business relationships. Your suppliers might decide to impose restrictions or cut ties.

In other cases, your supplier or creditors might charge interest if you take too long to pay. Having a high DPO can also indicate that your company is struggling to pay. 

What does a low DPO mean?

While having a low DPO can demonstrate your company's ability to pay its bills on time, you might miss out on some benefits.

For instance, if your supplier has a payment period of 60 days and you always pay in the first 10 days, you could miss out on other opportunities. You could invest that money for an extra 50 days to earn interest, pay off debt, or fund your daily operations.

If you're going to keep your DPO low, reach out to your suppliers or creditors to see if they'll offer you a discount for early payment. 

What DPO is right for your company? 

When it comes to finding the right DPO for your small business, it's a bit of a balancing act. To get a sense of the DPO you should aim for, compare DPO within your industry. Trying to compare outside your industry won't work because there's too much variation.

For instance, if you're in the retail industry, take a look at the average DPO among other retail companies selling similar products. If you find your DPO is much lower or higher than the industry average, it's worth evaluating.

Paying much slower than others in your industry could damage your relationship with suppliers. Paying a little faster could work to improve industry relationships. It might take some negotiation to find the DPO that works best for your company. 

Pros and cons of DPO

As a business owner, it's smart to monitor your cash flow periodically. Selecting which method works best for you is an individual choice.

Here are a few pros and cons to consider:

Pros

• Increases awareness of how fast you're paying your bills.
• Can help project the financial health of your company.
• Helpful in measuring your relationship with suppliers.

Cons

• There's no right answer for a good DPO — it can vary between industries.
• Finding the right DPO for your company often requires research.
• The wrong DPO can strain relationships with suppliers.

Tips to improve DPO

After assessing DPO across your industry, if you decide you need to make adjustments, consider the following tips:

• Align your DPO with your industry standards and company size.
• Increase payment terms when you need more cash flow.
• Decrease payment terms if your suppliers offer an early payment discount.
• Create strong relationships with creditors and suppliers so they are willing to adjust payment terms.

Finding the right fit for your small business

When it comes to DPO, there is no one-size-fits-all solution. The right DPO for your small business will depend on your industry and unique circumstances. Aim for a DPO that allows you to have the right cash flow for your company while also maintaining good relationships with your suppliers.

For help calculating your company's DPO and other important financial metrics, check out QuickBooks Online solutions.