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Days Payable Outstanding (DPO) is a financial ratio that compares accounts payable, cost of sales, and the number of days bills remain outstanding to determine the typical number of days an organization needs to pay its bills and invoices to other organizations and vendors. Other names for it include the turnover ratio for payables and the turnover ratio for creditors.
The DPO is computed by dividing the total accounts payable by the daily cost of sales. The obligations that the business owes to its creditors or suppliers for the products or services that were acquired on credit are known as accounts payable. The direct cost of manufacturing or purchasing the goods or services that the company sells is known as the cost of sales, commonly referred to as the cost of goods sold. The cost of sales per day is the cost of sales divided by the number of days in the period, which is often a year or a quarter.
The DPO formula is:
DPO = Accounts Payable / (Cost of Sales / Number of Days)
For example, if a company has accounts payable of $800,000, a cost of sales of $8,500,000, and 365 days in a year, its DPO is:
DPO = $800,000 / ($8,500,000 / 365) = 34.35
This means that the company takes an average of 34.35 days to pay its bills and invoices to its suppliers or creditors.
The DPO demonstrates how well a firm can use its available cash and leverage its trade credit, making it a key indicator of its ability to manage cash flow and maintain liquidity. While a smaller DPO suggests that the company pays its bills and invoices swiftly and has less cash available, a larger DPO suggests that the company can defer payments and use the available cash for short-term investments or other uses.
The quality, makeup, timing, and cost of sales, as well as the credit terms and policies of the suppliers and creditors, are not taken into account by the DPO, making it not a conclusive indicator of liquidity. For instance, some costs of sales might not be clearly tied to the accounts payable or might change dramatically over time, while other expenses of sales might not be immediately due or might be subject to discounts or penalties.
To provide a more complete and accurate picture of the company's liquidity condition, the DPO should be used in conjunction with other liquidity ratios, such as the current ratio, quick ratio, cash ratio, and cash conversion cycle. In order to evaluate the company's relative and absolute performance, the DPO should also be compared to the industry average, the historical trend, and the target or optimal level.
