Ratios: Days Payable Outstanding (DPO) - Online Tutor, Practice Problems & Exam Prep

Days Payable Outstanding (DPO) measures how long a dollar remains in accounts payable before payment. Calculated as 365AP, where AP turnover is derived from Cost of Goods Sold (COGS) divided by average accounts payable. A lower DPO indicates strong liquidity, while a higher DPO may suggest leverage with suppliers. Understanding DPO is crucial for financial analysis, as it reflects a company's payment efficiency and can impact creditworthiness.

Ratios: Days Payable Outstanding (DPO)

Alright, this ratio is related to our AP turnover, it’s our days payable outstanding. So the days payable outstanding, it helps us analyze how long a dollar sits in AP. How long we're able to owe this dollar before we have to pay it back, before being paid back, right? So you can imagine we might want to hold on to be able to maintain that dollar in AP as long as possible, right? Because that's almost interest-free loans, right? They don't charge us interest on our AP. They give us 30 days to pay, 60 days to pay. It's not like they say, okay, after 60 days, you also have to pay interest. No. With these accounts payable, they're just saying pay us in 60 days, right? No interest involved, so you can imagine. It might be nice to be able to hold on to these a little longer. So the days payable outstanding, it's a common efficiency ratio. And like I said, it's related to the AP turnover, so let's go over that real quick and then calculate days payable outstanding. First, we’ve got AP turnover and remember that in the numerator you’ve got purchases or COGS, and generally we’re going to deal with COGS in the numerator, divided by our average AP. Every time we deal with an average, that's going to be the beginning balance plus the ending balance divided by 2. Regardless of what account it is, right? That’s how we calculate our average balance. So once we’ve calculated our AP turnover, we can use that number to calculate our DPO, our days payable outstanding. So in the numerator, we’re going to have 365 for 365 days, and we’re gonna divide that by the AP turnover that we had just calculated. Cool? So what does this tell us? Well, it's going to give us a number of days. This is going to tell us a number of days and that's how long that that dollar that we owe is sitting in accounts payable on average before we pay it back. So it's a number of days. And, in different industries, well, there's going to be different credit terms depending on the industry. Maybe you have some leverage with your suppliers and you're able to owe them the money longer. Whatever it is, you're going to use benchmarking and you're going to check against your competitors, you’re going to check against the industry average for what your DPO is, right? So when you’ve got a lower DPO, it implies strong liquidity, right? Because you’re able to pay off your suppliers quickly. If your DPO is 10 days, well that means you buy something and you’re able to pay it off in 10 days. Compared to, you know, a 50 day, 60 day DPO, well that means it takes you a lot longer to pay. That might imply worse liquidity. And a creditor is gonna pay attention to that when they loan you money. Compare that to a higher DPO. When you got a higher DPO, well, it implies that it’s taking you longer to pay, right? It’s taking you 50 days, 60 days rather than 10. That’s a higher DPO. But like I said, it could mean you have leverage with your suppliers, right? Maybe you’re some giant like Amazon or Walmart and you have leverage because you own so much of the market that you can modify the credit terms based on what you want. Because you have that kind of power in the market. Okay? So DPO, it could be good or bad, right? Low or high, it could mean different things. So this could be nice information when you’re doing an analysis project. Alright. Let’s go ahead and we'll do an example together and then you guys can practice one. Alright? Let’s do that now.

Days Payable Outstanding (DPO)

Alright. Let's try this one together. XYZ Company had net sales of 500,000 and COGS of 320,000. The beginning balance of AP was 60,000, and the ending balance of AP was 100,000. What is the DPO? Days payable outstanding. Alright. So remember, the first thing we want to do is calculate our AP turnover, and then we can calculate our DPO. Alright? So the first thing we want to do is find AP turnover, which is our COGS divided by our average AP. Right? The first thing I like to do is solve for that average AP balance, which is going to be our denominator in our AP turnover. So we've got 60,000 plus 100,000. Right? The beginning balance plus the ending balance divided by 2, that comes out to 80,000. That's going to be our denominator in our AP turnover. Right? That's not going to get us to our answer yet. So, let's first calculate our AP turnover and then we can get to our answer through the DPO. So, what's our numerator? Well, net sales, we don't use at all in this question. Right? That's extraneous. Our numerator is going to be COGS. Right? It's either purchases or COGS. Well, if they only give us COGS, that's going to be what we use here. If they give you both, purchases are probably the better thing to use in the numerator, but COGS is all we've got here. So 320,000 divided by 80,000, which we just calculated as our average AP, is going to give us 4 as our AP turnover. Right? So that's our AP turnover. We're not done yet. Now we've got to calculate our DPO. So DPO, remember, all we've got to do is put 365 in the numerator and divide by our AP turnover of 4, and that's going to come out to approximately 91 days. Right? So that means that every time we have accounts payable that we're allowed to pay someone later, it takes us 91 days to pay them back. Alright? So that could be a good thing or a bad thing, right? It could be a bad thing for a creditor. They're like, "Hey, 91 days, that's quite a long time." But maybe you have leverage in the market, and you're able to say, "Hey, I'm not going to pay you for 90 days, and there's nothing you can do about it because you have so much market power." Either way, that's the answer here, 91 days. Let's go ahead and move on to the next one.

ABC Company had $200,000 in Net Sales and Gross Profit of $80,000. If AP had a balance of $60,000, what is the DPO ratio?

• A. 274 days
• B. 182 days
• C. 110 days
• D. Not enough information

Here’s what students ask on this topic:

What is Days Payable Outstanding (DPO) and how is it calculated?

Days Payable Outstanding (DPO) measures the average number of days a company takes to pay its suppliers. It is calculated using the formula:

$\frac{365}{\mathrm{AP} \mathrm{turnover}}$

where AP turnover is derived from the Cost of Goods Sold (COGS) divided by the average accounts payable. The formula for AP turnover is:

$\frac{\mathrm{COGS}}{\mathrm{Average AP}}$

This ratio helps in understanding how long a dollar remains in accounts payable before being paid.

Why is Days Payable Outstanding (DPO) important for financial analysis?

DPO is crucial for financial analysis because it reflects a company's payment efficiency and liquidity. A lower DPO indicates strong liquidity, meaning the company can pay off its suppliers quickly. Conversely, a higher DPO may suggest that the company has leverage with its suppliers, allowing it to hold onto cash longer. This can be beneficial for cash flow management but may also indicate potential liquidity issues. Understanding DPO helps analysts assess a company's operational efficiency and creditworthiness.

How does Days Payable Outstanding (DPO) impact a company's creditworthiness?

DPO impacts a company's creditworthiness by indicating its ability to manage and pay off its short-term liabilities. A lower DPO suggests that the company pays its suppliers quickly, which can be a sign of strong liquidity and financial health. This can positively influence creditors' perception, making it easier for the company to obtain loans. On the other hand, a higher DPO might raise concerns about the company's liquidity, potentially making creditors wary. However, if the high DPO is due to favorable credit terms with suppliers, it might not negatively impact creditworthiness.

What are the implications of having a high Days Payable Outstanding (DPO)?

A high DPO implies that a company takes longer to pay its suppliers. This can have both positive and negative implications. On the positive side, it allows the company to hold onto its cash longer, which can be beneficial for cash flow management. This might indicate that the company has strong negotiating power with its suppliers. On the negative side, a high DPO might suggest potential liquidity issues, as the company may be delaying payments due to cash constraints. It is essential to compare DPO with industry benchmarks to understand its implications fully.

How does Days Payable Outstanding (DPO) vary across different industries?

DPO can vary significantly across different industries due to varying credit terms and business practices. For example, industries with longer production cycles, like manufacturing, might have higher DPOs because they negotiate longer payment terms with suppliers. In contrast, industries with shorter cycles, like retail, might have lower DPOs. It is essential to benchmark a company's DPO against industry averages to gain meaningful insights. A DPO that is high or low compared to industry norms can indicate different operational efficiencies and financial strategies.