The following term may seem like a simple line item on a balance sheet, but it actually reveals more about a business and how they pay their creditors than practically any other accounting information. Let’s take a look at how Days Payable Outstanding (DPO) can be an excellent indicator of how a company does business and whether or not they are worth your investment capital.
Days Payable Outstanding (n.)
- The average payable period for accounts payable.
- The typical time period that elapses before a company pays its invoices from trade creditors such as suppliers.
DPO is usually analyzed either once a year or every quarter. It can be calculated by dividing the ending accounts payable by a number of days before it is paid. An interested party can usually find these numbers on both the balance sheet and income statement for any company.
Why DPO Matters
Finding just the right balance with DPO is essential to good business practice and financial management. On the one hand, the longer a business takes to pay invoices from creditors, the more cash they have on hand at any given time. This money improves the working capital and free cash flow statements from month to month. On the other hand though, if a business takes too long to pay its creditor invoices, the creditor may be unhappy. Unhappy creditors are far less likely to extend credit going forward, or if they do it will be on less favorable financial terms (higher interest/fees/, etc.). Another problem with paying later is that many creditors extend discounts to clients for paying on time, thus increasing the cost of supplies if the invoice is paid late. When a business is hard up for cash though, increasing DPO may cost less in the long run than paying early or on time and end up borrowing money to cover shortfalls for operational expenses.
The average DPO for most business is approximately 30 days so that vendors can expect payment of invoices typically within a month. However, different industries have different average DPOs, so doing one’s homework about a particular business sector or industry’s average DPO is crucial for both owners and investors. After all, you don’t want to pay too early and short your business on cash on hand, but you also don’t want to let the invoice go so long that it negatively impacts your relationships with creditors, suppliers, and vendors. DPO is a key indicator of overall company financial performance, though it does tend to vary from year to year based on overall economic prosperity or difficulty. If you are considering investing in a company, a close examination of their DPO and how well they manage that number is always an excellent place to start.
