Days Payable Outstanding (DPO) calculator is a tool that enables you to estimate the time needed to pay the company’s bills. It is used when analyzing how efficient the company is. This metric can be very helpful for enterprises and businesses looking to improve their efficiency. That’s what every company strives for, so calculating DPO is useful for every type of business.
What can you learn today? We will explain what DPO stands for in this article. In addition to finding out more about days payable outstanding, you will also learn how it’s calculated. Furthermore, you will see how DPO can be applied in company analysis and why it’s important for just about every business. Let’s get started, shall we?
What Is Days Payable Outstanding?
Days payables outstanding (DPO) is a metric that can let us know how quickly a company can pay its bills. It indicates the average period of time required to settle funds owed to lenders or suppliers. In other words, DPO is the number of days a company’s creditors have to wait before they are paid. It includes how many days the company has been in business and how many days it takes for the company to pay its bills. The term can also refer to how much of a bill is left unpaid by a business or individual.
The higher the number, the more likely it is that the company is having financial difficulties. This activity ratio is meant to help estimate business efficiency. In addition to telling how effective a business is being operated, DPO also helps reveal how well working capital is utilized. That’s why every company should take into account this measure.
As a matter of fact, a company’s days payable outstanding (DPO) is the length of time between when it receives an invoice and when it pays the invoice. It is calculated by dividing the Average Accounts Payable by Cost of Goods Sold and multiplying this result by 365 – the number of days in a typical payment cycle, which is usually the number of days in a year.
The result is then expressed as a decimal. For example, if a company has $100,000 in accounts receivable and $200,000 in current assets, its days payable outstanding would be 0.5 or 50%. We will explain this calculation in detail later on.
There are many reasons why a company’s DPO might be higher than usual, but one common reason is that they are having trouble paying their bills on time. Keep in mind that the DPO value does not include any items which are still in progress, but only those which have already been invoiced and are waiting to be paid.
Why Is It Important for Companies to Calculate DPO?
As we have said earlier, DPO is used when analyzing the operation and effectiveness of a company. It allows you to quickly find out how effective a business is. It’s not all about managing payable expenses, though. That’s it is important to take into consideration other metrics like DSO (days sales outstanding) and days inventory outstanding (DIO). This will provide you with a complete picture of the operational effectiveness of the company.
There are a lot of good reasons to calculate Days Payable Outstanding. In particular, there are three benefits of calculating DPO. Let’s check them out!
1. DPO is a crucial factor in determining CCC (cash conversion cycle)
The cash conversion cycle is the process of converting raw materials into cash. Actually, it represents the process of converting raw materials into cash. It is also known as the “cash cycle,” “cash conversion period,” or “conversion period.” It includes the time it takes to collect money from customers, place an order for inventory, and then receive that inventory.
The length of this time depends on what type of business you are in and how much inventory you have on hand. For example, if you are selling a product that has a long shelf life and doesn’t need to be ordered often (e.g., food), your CCC will be shorter than someone who sells products with a short shelf life (e.g., electronics).
2. It lets suppliers know when they can expect their return on the money invested
Based on DPO, suppliers can evaluate the quality of their customers. Low DPO indicates that the payments will probably be received in a short period of time. This metric affects the company’s operating cash flow.
3. DPO can help determine how effective working capital is being managed by a company
A low DPO tells that the obligations and bills are paid quickly to the supplier. On the other hand, a high DPO leads to retaining cash, so it can be used for other purposes. This can eventually boost the working capital position of the company.
DPO Formula: How to Calculate Days Payable Outstanding?
If you want to calculate DPO, then you should use the formula below:
DPO = Average Accounts Payable / Cost of Goods Sold * 365
Example:
- Average Accounts Payable: $200,000
- Cost of Goods Sold: $200,000
DPO = 200,000 / 200,000 * 365
DPO = 365
We will take another example and see how DPO can be calculated in 4 steps.
Step 1
First, you need to calculate the average accounts payable. You will actually have to determine the average inventory using the following formula:
For instance, let’s say you want to compute the average accounts payable for a business in 2021 ($100,000) and 2022 ($150,000). Hence, it will be ($100,000 + $150,000) / 2 = $125,000 in our example.
Step 2
At this stage, you need to determine the purchases of a company. This value can be derived from the equation below:
Purchases = cost of goods sold + (ending inventory – beginning inventory)
In our example, the purchases will be 150,000 + ($350,000 – $250,000) = $250,000.
Step 3
Now you should determine days in the accounting period of the company. It is usually identical to the fiscal year. Considering that the fiscal year has 365 days, you will probably use this number when calculating DPO.
Step 4
Now you can finally calculate DPO. This is the last step to take. Use this simple formula:
DPO = days in accounting period * (average accounts payable / purchases)
In our example, DPO = 365 * ($125,000 / $250,000) = 182.50 days. We recommend using the DPO calculator to determine days inventory outstanding correctly and quickly.