Days Payable Outstanding (DPO)
What it is:
How it works/Example:
For example, let's assume Company XYZ is a department store. If its cost of goods sold is $10,000,000 this year, and the balance sheet shows $7,000,000 of payables, then we can calculate that Company XYZ's DPO:
DPO this year = $7,000,000/($10,000,000/360) = 252 days
Let's compare this with last year, when Company XYZ had $6,000,000 of cost of goods sold. If the balance sheet showed $4,000,000 of payables, then Company XYZ's DPO last year was:
DPO last year = $4,000,000/($6,000,000/360) = 240 days
The increase in DPO indicates that Company XYZ is taking longer to pay for its suppliers.
Why it matters:
Accounts payable (A/P) are amounts owed to suppliers and other creditors for goods and services. If Company XYZ orders $1,000,000 in widget parts from its supplier and has 60 days to pay for those parts, it will increase its inventory account by $1,000,000 and increase its accounts payable by $1,000,000. When 60 days has passed and Company XYZ pays the invoice, it will reduce cash by $1,000,000 and reduce its accounts payable by $1,000,000.
A/P is a liability, and as such, it appears on the balance sheet. In particular, A/P is a current liability, meaning that the amount owed is expected to be paid within the next 12 months.
When accounts payable or DPO decrease, this is considered a use of cash, and as such, it reduces the company's working capital (defined as current assets minus current liabilities). When accounts payable or DPO go up, this is considered a source of cash because the company is taking longer to pay its invoices and thus not using cash as quickly.
Accounts payable is an important factor in a company's working capital. If it's too high, the company may soon be struggling to find the cash to pay the bills; if it's too low, the company may be unwisely directing its cash toward paying the bills too soon rather than enjoying the full grace period and investing that cash in the business instead. Changes in the DPO indicate which way this is trending and in turn how well management is retaining cash.
