# Days Payable Outstanding - Explained

What is Days Payable Outstanding?

# What is Days Payable Outstanding?

Days Payable Outstanding is an efficiency ratio indicating the average number of days a company takes to pay its bills and invoices. A company needs to make payments to suppliers, vendors, and other companies on a regular basis for the services and materials they provide to the company. The Days Payable Outstanding measures the efficiency of a company's cash outflow management. It also indicates the company's dependency on trade credit for short-term financing.

## How does Days Payable Outstanding Work?

A high DPO indicates the company takes a longer period of time for making payments to its trade creditors. The DPO is calculated on a quarterly or on an annual basis. A company acquires raw materials and services from its suppliers and vendors on a credit basis. The suppliers issue a bill after supplying the materials to the company. Similarly, the vendors raise the invoices after rendering a service. These are the account payables which the company is obligated to pay to its trade creditors. The time between the date of receiving bills and invoices and the date of payment is an important aspect for a business. The longer the period is, the more chances of utilizing that fund for maximizing the benefit. The DPO measures the average time taken for making these payments.

## Computing the Days Payable Outstanding

The formula for calculating the DPO is, DPO= account payable/ (cost of goods sold/ number of days). As it is calculated on a quarterly or on an annual basis, depending on that the number of days is either 90 or 365. The costs of goods sold include the cost of the raw materials and other resources which forms the inventory and labor and other utility costs. It is the total cost of manufacturing the products. Here, the denominator indicates the average per day cost of producing the goods and the numerator represents the outstanding payments the company owes to its trade creditors. The result indicates the average number of days a company takes to pay its dues to its trade creditors after receiving the bills and invoices. A higher value of DPO indicates a company is getting better terms of trade credit from its career while a lower number indicates there is a scope of improving the terms of credits by negotiation. Comparison of this value of different competing companies reveals which one is getting better credit terms from the trade creditors. In general, the DPO value should not exceed the 40 to 50 days limit in order to maintain a healthy cash flow management. 40 to 50 days limit is considered to be the optimized number for DPO by most of the companies. However, the value largely depends on the industry the company belongs to. A high value of DPO may jeopardize the relationship with the vendors and suppliers. If the payments are due for long, the suppliers may refuse to supply the required materials on time or the vendors may refuse services.

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