Days Payable Outstanding (DPO)

How to Calculate Days Payable Outstanding (DPO)

The days payable outstanding (DPO) is a working capital metric that counts the number of days a company takes before fulfilling its outstanding invoices owed to suppliers or vendors for purchases made using credit, rather than cash.

On the balance sheet, the accounts payable (AP) line item represents the accumulated balance of unmet payments for past purchases made by the company.

The good or service has been delivered to the company as part of the transaction agreement – with receipt of the invoice – but the company has not yet paid the supplier or vendor.

During that stretch of time, when the supplier awaits the payment, the cash remains in the hands of the buyer, with no restrictions on how it can be spent.

The longer a payment is delayed, the longer the company holds onto that cash, which tends to benefit the company’s profit margins, as well as increase free cash flows (FCFs).

Therefore, a higher days payable outstanding (DPO) implies more near-term liquidity, i.e. increased amount of cash on hand.

Since an increase in operating current liability, such as accounts payable, represents an inflow of cash, companies strive to increase their DPO. While bills must eventually be paid, for now, the company is free to use that cash for other needs.

Calculating a company’s days payable outstanding (DPO) is a three-step process:

• Step 1 ➝ Calculate the company’s average (or ending) accounts payable balance
• Step 2 ➝ Divide the average (or ending) accounts payable balance by cost of goods sold (COGS)
• Step 3 ➝ Multiply the resulting figure by 365 days.

Days Payable Outstanding Formula (DPO)

The formula for calculating the days payable outstanding (DPO) metric is equal to the average accounts payable divided by COGS, multiplied by 365 days.

One distinction between the DPO calculation and days sales outstanding (DSO) calculation is that COGS is used instead of revenue, since to calculate DPO, COGS tends to be a better proxy for a company’s spending related to supplies/vendors.

But note that the COGS is directly related to revenue, thereby revenue indirectly drives the A/P forecast. For this reason, while A/P is typically projected using DPO, it is also perfectly acceptable to project A/P as a simple percentage of revenue.

What is a Good Days Payable Outstanding?

If all companies could “push out” their payables, any rational company would opt for delayed payment to increase their free cash flows (FCFs).

With regard to conducting trend analysis on a company’s days payable outstanding using historical data, the following are the general rules of thumb to interpret changes.

• Increasing Days Payable Outstanding (DPO) ➝ Increase in Liquidity and Higher Free Cash Flow (FCF)
• Decreasing Days Payable Outstanding (DPO) ➝ Decrease in Liquidity and Less Free Cash Flow (FCF)

Therefore, most companies strive to increase their days payable outstanding (DPO) over time.

But the reason some companies can extend their payables, while others cannot, is tied to the concept of buyer power, as referenced earlier.

In general, buyer power and negotiating leverage usually stem from the following sources:

• Large Order Volume on a Gross Dollar-Basis
• High Frequency of Orders (Repeat Customer)
• Long-Term Relationship with Customer (Source of Recurring Revenue)
• Low Number of Potential Customers (High Customer Concentration Risk)

In short, the more a supplier/vendor relies on a customer, the more negotiating leverage that buyer holds.

For a company that constitutes low revenue concentration (i.e., minuscule percentage of total revenue) and low order volume, the inconvenience to the seller and disruption to operations from going out of their way to receive the cash payment could outweigh the benefit of serving that particular customer.

In this type of scenario, the seller could either cut off the customer or place restrictions on the customer (e.g., require upfront payment).

However, if the customer comprised a significant percentage of the seller’s total revenue, the seller can be forced to accept a request for delayed payment, as the seller cannot afford to end its relationship with this customer and must comply with their requests.

• Lower Days Payable Outstanding (DPO) ➝ Low Bargaining Leverage (Reduced Cash Flow)
• Higher Days Payable Outstanding (DPO) ➝ High Bargaining Leverage (Increased Cash Flow)

Illustrative Days Payable Outstanding Example

An example of a company with high bargaining leverage over its suppliers is Apple (AAPL).

From 2017 to 2019, Apple’s DPO has been in excess of 100 days, which is beneficial to its short-term liquidity.

The extended time afforded to Apple before cash payment is due to its suppliers is understandable, given the revenue generated by Apple for these suppliers (and the global branding and presence that benefits the supplier in numerous ways through association).

In fact, suppliers compete intensely to become the provider of components for Apple products (i.e. a “race to the bottom” for pricing), which directly benefits Apple while negotiating terms with its suppliers.

^{Days Payable Outstanding of Apple (Source: AAPL DCF Model)}

Days Payable Outstanding Calculator (DPO)

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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1. Income Statement Assumptions

Suppose a company has an accounts payable balance of $30mm in 2020 and COGS of $100mm in the same period.

• Accounts Payable (A/P) = $30 million
• Cost of Goods Sold (COGS) = $100 million

In addition, the company’s COGS is expected to grow 10% year-over-year (YoY) through the entire projection period.

• COGS Growth Rate = 10% YoY

2. Days Payable Outstanding Calculation Example (DPO)

To start our forecast of accounts payable, the first step is to calculate the historical DPO for 2020.

DPO can be calculated by dividing the $30mm in A/P by the $100mm in COGS and then multiplying by 365 days, which gets us 110 for DPO.

• Days Payable Outstanding (DPO), 2020A = ($30 million ÷ $100 million) × 365 = 110 Days

For the sake of simplicity, we’ll carry forward this assumption across the entire forecast (i.e. “straight-line”).

In reality, the DPO of companies tends to gradually increase as the company gains more credibility with its suppliers, grows in scale, and builds closer relationships with its suppliers.

3. Accounts Payable Projection Example (DPO Ratio)

Using the 110 DPO assumption, the formula for projecting accounts payable is DPO divided by 365 days and then multiplied by COGS.

• Days Payable Outstanding (DPO) = 110x (“Straight-Lined”)
• Number of Days in Period = 365 Days

For example, we divide 110 by $365 and then multiply by $110mm in revenue to get $33mm for the A/P balance in 2021.

The completed output for the A/P projections from fiscal years 2021 to 2025 is as follows:

• Accounts Payable, 2021E = $33 million
• Accounts Payable, 2022E = $36 million
• Accounts Payable, 2023E = $40 million
• Accounts Payable, 2024E = $44 million
• Accounts Payable, 2025E = $48 million

4. Payables Forecast Example (Percentage of Revenue Method)

As mentioned in an earlier section, accounts payable (A/P) can alternatively be projected using a percentage of revenue.

We can assume the company had $300mm of revenues in 2020, which will grow at 10% each year, in line with our COGS assumption.

By dividing $30mm in A/P by the $300mm in revenue, we get 10% for the “A/P % Revenue” assumption, which we will extend throughout the forecast period.

A/P can then be projected by multiplying the 10% assumption by the revenue of the relevant period.

• A/P % of Revenue = 10%

The forecasted figures under the DPO and revenue approach are equivalent, as shown in the screenshot posted below, since COGS and revenue are both growing at the same rate of 10%.

Note that it is somewhat unrealistic, however, to always assume that both COGS and revenue will grow at precisely the same rate.

Forecasting A/P under either approach would likely yield similar numbers, assuming the proper adjustments are made (e.g. industry background research, comparable peers benchmarking, management meetings, etc.)

However, forecasting accounts payable (A/P) using the days payable outstanding (DPO) metric is far more likely to be perceived as more credible compared to the percentage of revenue forecasting method.