Days Payable Outstanding – DPO Definition

Allocated Loss Adjustment Expenses (ALAE)

What are unpaid days – DPO?

Unpaid days to pay (DPO) is a financial ratio that indicates the average time (in days) a business takes to pay its bills and invoices to its commercial creditors, which include suppliers, sellers or other companies. The ratio is calculated on a quarterly or annual basis, and it indicates how well the company’s cash outflows are managed.

A business with a higher DPO value takes longer to pay its bills, which means it keeps the funds available for a longer period of time. This can allow the business to make the best use of available cash to maximize benefits.

Key points to remember

  • Unpaid Days to Pay (DPO) is a financial ratio that indicates the average time (in days) a business takes to pay bills and invoices.
  • Companies with a high DPO can use the cash available for short-term investments and to increase their working capital and free cash flow.
  • However, higher DPO values, while desirable, are not always positive for the business.

The formula for unpaid days is

The

DPO=Accounts payable×Number of daysCOGSor:COGS=Cost of goods sold =Start of inventory+PEnd of inventory begin {aligned} & text {DPO} = frac { text {Accounts Payable} times text {Number of Days}} { text {COGS}} \ & textbf {where:} \ & text {COGS} = text {Cost of goods sold} \ & qquad , , = text {Start of inventory} + text {P} – text {End of inventory } \ & text {P} = text {Purchases} end {aligned}

TheDPO=COGSAccounts payable×Number of daysTheor:COGS=Cost of goods sold =Start of inventory+PEnd of inventoryTheThe

How to calculate the DPO

To make a salable product, a business needs raw materials, utilities and other resources. In terms of accounting practices, accounts payable represent the amount that the company owes to its suppliers for purchases made on credit.

In addition, there is a cost associated with making the salable product, and it includes payment for utilities such as electricity and employee salaries. This is represented by the cost of goods sold (COGS), which is defined as the cost of acquiring or manufacturing the products that a company sells during a period (COGS = Starting stock + Purchases – End stock ). These two figures represent cash outflows and are used in the calculation of the DPO over a period of time.

The number of days in the corresponding period is generally considered to be 365 for a year and 90 for a quarter. The formula takes into account the average cost per day borne by the company for the manufacture of a salable product. The numerator figure represents overdue payments. The net factor gives the average number of days taken by the company to reimburse its obligations after receipt of the invoices.

Two different versions of the DPO formula are used according to accounting practices. In one version, the amount of accounts payable corresponds to the figure declared at the end of the accounting period, such as “at the end of the fiscal year / quarter ending on September 30”. This version represents the DPO value “on” of the date mentioned.

In another version, the average value of Beginning AP and Ending AP is taken, and the resulting figure represents the DPO value “during” that particular period. COGS remains the same in both versions.

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Unpaid days to pay

What do unpaid days tell you?

Typically, a business acquires inventory, utilities and other necessary services on credit. This results in accounts payable (AP), a key accounting entry that represents a company’s obligation to pay short-term liabilities to its creditors or suppliers. Beyond the actual amount payable, the timing of payments – from the date of receipt of the invoice until the money is effectively withdrawn from the business account – also becomes an important aspect of business. The DPO attempts to measure this average time cycle for outgoing payments and is calculated taking into account standard accounting figures over a specified period of time.

Companies with a high DPO can use the cash available for short-term investments and to increase their working capital and free cash flow. However, higher DPO values ​​may not always be positive for the business.

If the company takes too long to pay its creditors, it risks jeopardizing its relations with suppliers and creditors who could refuse to offer commercial credit in the future or offer it on terms which could be less favorable. for the company. The company may also lose discounts on timely payments, if any, and it may pay more than necessary.

A high DPO value can be beneficial if the business lacks money. A high DPD also helps if the business is better placed to delay payments than to make them on time, and then lend money by paying interest to continue business. Companies have to strike a delicate balance with DPO.

In addition, a business may need to balance its exit seniority with that of the inflow. Imagine if a company gives its customers 90 days to pay for the goods they buy, but only has 30 days to pay its suppliers and sellers. This mismatch will mean that the company will often be subject to liquidity.

The DPO value varies considerably across different industry sectors, and it is not worth comparing the value of different companies in the sector. The management of a company will compare its DPD to the average of its sector to see if it pays its suppliers too quickly or too slowly. Depending on various global and local factors, such as the overall performance of the economy, region and sector, as well as applicable seasonal impacts, the DPO value of a particular company can vary considerably from year to year. other, from one company to another and from one industry to another. .

The DPO value is also an integral part of the formula used to calculate the cash conversion cycle (CCC), another key metric that expresses the time it takes a business to convert resource inflows into cash flow from sales . While DPO concentrates on the current outstanding amount to be paid by the company, the CCC superset follows the whole cash cycle, because the cash is first converted into stocks, expenses and accounts payable, into sales and accounts receivable, then cash. When received.

Example of use of unpaid days

Leading retail company Walmart Inc. (WMT) had accounts payable of $ 46.09 billion and cost of goods sold of $ 373.4 billion in fiscal 2020. These figures are available in the company’s annual financial statements and balance sheet. Taking the number of days as 365 for the annual calculation, the DPO for Walmart comes to [ 46.09 / (373.4/365) ] = 45.05 days.

Similar calculations for technology leader Microsoft Corp. (MSFT) which had 8.62 billion dollars in AP and 38.97 billion dollars in COGS leads to a DPO value of 80.73 days.

It says that during the year ending 2020, Walmart paid its invoices in about 45 days after receiving the invoices, while Microsoft took about 80 days, on average, to pay its invoices.

A look at similar figures for online retail giant Amazon.com Inc. (AMZN), which had a PA of $ 34.62 billion and a COGS of $ 111.93 billion for the year. 2020, reveals a very high value of 112.90 days. Such high DPO value is attributed to Amazon’s business model, which has around 50% of its sales supplied by third-party sellers. Amazon instantly receives funds into its account for the sale of goods that are actually supplied by third-party sellers via Amazon’s online platform.

However, it does not pay sellers immediately after the sale, but can send cumulative payments based on a weekly / monthly payment cycle or based on a threshold. This working mechanism allows Amazon to keep cash for a longer period, and the main online retailer is left with a significantly higher DPO.

Limits of DPO

While the DPO is useful for comparing the relative strength between companies, there is no clear figure for what constitutes healthy days to pay, since the DPO varies considerably by industry, the competitive positioning of the company and its bargaining power. Large companies with strong bargaining power are able to enter into better contracts with suppliers and creditors, effectively producing lower DPO figures than they could have otherwise.

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