For procurement and accounting professionals, it can sometimes seem like more time is spent measuring and analyzing the efficacy and efficiency of a given task than is devoted to the task itself. Taking the time to understand and utilize metrics, however, is a key part of process improvement—and a smart investment of your time if the insights gained are properly applied. One such metric, accounts payable days—also called creditor days or days payable outstanding (DPO)—is an important part of achieving and sustaining effective cash flow management.
Defining “Accounts Payable Days”
Whether you call it accounts payable days, creditor days, or Days Payable Outstanding, this financial ratio measures the average number of days your company takes to pay its suppliers. It’s frequently used to express your company’s accounts payable turnover in a precise and easily digestible format.
As a metric, accounts payable days can provide insight into AP performance in several ways:
- Speedy DPO ratios (i.e., a low value) can indicate a reliance on many creditors with short terms. While this might indicate creditors view your organization as a potential credit risk, it’s not necessarily a black eye for your business. Some suppliers simply expect, and demand, short payment terms as part of their standard operating procedures.
- A steadily growing value for your average accounts payable days could mean you’re paying your suppliers more slowly than you have in the past. As with a very low DPO value, a higher DPO could indicate cash flow problems or other financial woes, but it can also be due to more benign reasons, like renegotiation of better terms with a large number of suppliers.
- High DPO can create opportunities to use cash on hand to make short-term investments or boost working capital. That said, waiting too long to pay can damage important supplier relationships, put your company in an unfavorable bargaining position at negotiation time, and prevent you from taking advantage of valuable discounts for on-time or early payment.
- Accounts payable days can provide you with critical guidance in balancing your accounts payable and accounts receivable processes. Offering your customers 45 day terms to make payment but operating with a DPO of 14 days when paying your own suppliers may land your company’s accounts in the red and leave you without any free cash to stimulate growth.
Conventional wisdom dictates that a “healthy” DPO is as low as can be reasonably borne while still allowing for adequate cash flow. But for companies like Amazon, with an estimated DPO of 95 days as of 2018, letting their payable balance ride means more cash flow for investment.
Calculating Accounts Payable Days
To find your average accounts payable days ratio, first you must calculate your total accounts payable turnover (TAPT)—sometimes called your turnover ratio—for the accounting period you’re measuring. Together, these two financial ratios make it easy to see how quickly you’re making good on your obligations.
From your financial statements and balance sheet, combine all purchases made from your suppliers during a given accounting period, then divide that value by the average accounts payable during that same time frame (usually a quarter or a year—in our example, we’ll use a year):
Total Purchases ÷ ((Beginning AP + Ending AP) ÷ 2) = Total Accounts Payable Turnover
Once you have your annual TAPT, divide it by 365 to find the average accounts payable days/DPO:
365 ÷ TAPT = Average Accounts Payable Days
For example, let’s say your company had a beginning accounts payable balance of $700,000 at the start of the year. The ending accounts payable balance was $735,000. Total purchases for the past year came out to $8,750,000. First, calculate your TAPT:
$8,500,000 ÷ (($700,000 + $735,000) ÷ 2) = 11.8
This indicates your company’s accounts payable turned over 11.8 times in the past twelve months. To convert this to average accounts payable days, simply divide 365 by your TAPT to get:
365 ÷ 11.8 = 30 days
Considerations When Calculating Accounts Payable Days
You may want to keep a few caveats in mind when calculating DPO:
- Standardize your methodology. Depending on your accounting practices, you may calculate both TAPT and DPO based on either the calendar or the fiscal year. In addition, most calculations are driven by the assumption of a 365-day year and a 90-day quarter.
- Be sure to include all the relevant cost data. You might be tempted to limit the numerator to cost of goods sold (COGS) when calculating TAPT. However, you’ll be overlooking all of the various additional administrative and operational expenses—such as staff wages, rent, insurance, hardware depreciation, and utilities—you accrued in the same period. As a result, both your TAPT and your DPO could be skewed, potentially throwing a spanner in the works for your financial modeling as a whole.
- Strategize based on your company’s needs. Conventional wisdom dictates that a “healthy” DPO is as low as can be reasonably borne while still allowing for adequate cash flow. But for companies like Amazon, with an estimated DPO of 95 days as of 2018, letting their payable balance ride means more cash flow for investment. This works because they collect payment instantly, but issue payment to their third-party sellers (who account for roughly half of their total sales) in periodic lump sums. Not every is Amazon, of course, but the value of this metric is contextual. Depending on your company’s financial health, goals for expansion, and position within the marketplace and its industry, your “sweet spot” may rest at a higher value than your competition.
- Don’t overlook the added power of automation and AI. Investing in a comprehensive software solution that includes AP automation makes tracking every metric easier. Complete and transparent data for all transactions across your supply chain, coupled with process standardization and continuous improvement driven by automation and artificial intelligence, lets you conduct more nuanced and accurate financial analysis across the board. It also helps reduce or even eliminate human error, and can reveal opportunities to renegotiate for better payment terms, discounts, and strategic partnerships with your most reliable suppliers.
Seize the Days (Payable)
Keeping your cash flow flexible and your suppliers happy can be a challenging balancing act. But if you regularly measure your average accounts payable ratio (and leverage the power of automation and intelligent software solutions), you’ll have the information and tools you’ll need to make smart, strategic decisions when it’s time to settle up.