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Days Payable Outstanding Definition
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.
A Little More on What is Days Payable Outstanding
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.
References for Days Payable Outstanding
Academic Research on Days Payable Outstanding
An analysis of working capital management efficiency in telecommunication equipment industry, Ganesan, V. (2007). Rivier academic journal, 3(2), 1-10. This study uses financial data from telecommunication equipment companies to analyse the relationship between working capital management and profitability. The study finds that inefficient working capital management negatively affects profitability, but does not significantly impact the profits of the examined companies.
The effect of credit market competition on lending relationships, Petersen, M. A., & Rajan, R. G. (1995). The Quarterly Journal of Economics, 110(2), 407-443. This paper examines credit markets and finds that Creditors are more likely to lend to credit-constrained companies in more concentrated markets.
The effect of working capital management on firm’s profitability: Empirical evidence from an emerging market, Charitou, M. S., Elfani, M., & Lois, P. (2010). Journal of Business & Economics Research, 8(12), 63-68. This study examines the effects of working capital management on profitability in the emerging market of Cyprus. After looking at ten years of data from companies on the Cyprus Stock Exchange, the authors conclude that good capital management leads to greater profitability.
Financing the chain, Seifert, R. W., & Seifert, D. (2011). International commerce review, 10(1), 32-44. This paper looks at reverse factoring, in which the seller receives payment sooner and the buyer can make payment later thanks to a lender (factor) who finances the transaction. The authors ask if reverse factoring can lead to greater coordination of financial management.
Supply chain finance, Camerinelli, E. (2009). Journal of Payments Strategy & Systems, 3(2), 114-128. Supply-chain managers can guide the financial operations of their firms by mapping out logistics and operations. This can help the firm get financial services that can improve its working capital management.
Supply chain finance: applying finance theory to supply chain management to enhance finance in supply chains, Gomm, M. L. (2010). International Journal of Logistics: Research and Applications, 13(2), 133-142. It is now accepted that logistics and supply chain management (SCM) have great potential for improving bottom line results. This paper proposes a framework for investigating the financial issues in logistics and SCM and shows that taking a supply chain perspective on financial issues offers great opportunities for SCM professionals. SCM can not only contribute to improvements in sales, cost of sales, and the invested capital, but also has the potential to improve the capital cost rate as a long neglected supply chain driver of shareholder value.
· Working capital management and firm profitability, Knauer, T., & Wöhrmann, A. (2013). Journal of Management Control, 24(1), 77-87. This paper addresses existing empirical literature on the association profitability of a company and the management of capital.
· An empirical investigation of association between financial ratio use and small business success, Thomas III, J., & Evanson, R. V. (1987). Journal of Business Finance & Accounting, 14(4), 555-571.
· Working capital management and performance of SME sector, Gul, S., Khan, M. B., Raheman, S. U., Khan, M. T., Khan, M., & Khan, W. (2013). European Journal of Business and management, 5(1), 60-68.
· Supply chain finance: applying finance theory to supply chain management to enhance finance in supply chains, Gomm, M. L. (2010). International Journal of Logistics: Research and Applications, 13(2), 133-142. Effective logistics and supply chain management (SCM) can increase a company’s profitability. This paper shows that considering SCM in financial decisions can improve revenue and lower costs, thereby increasing shareholder value.
· Working capital management and firm profitability, Knauer, T., & Wöhrmann, A. (2013). Journal of Management Control, 24(1), 77-87. Effective management of a company’s daily assets and liabilities (working capital management) frees up cash and is crucial for success. However, it is unclear how working capital management affects a company’s profitability. This paper looks at research on the relationship between working capital management and profitability and finds that working capital management generally has a positive impact on profitability.
· An empirical investigation of association between financial ratio use and small business success, Thomas III, J., & Evanson, R. V. (1987). An empirical investigation of association between financial ratio use and small business success. Journal of Business Finance & Accounting, 14(4), 555-571. Viewing financial data as ratios rather than as individual figures can reveal important information. This, in turn can lead to more sound management decisions.