Days payable outstanding is a ratio that determines the average amount of time that a company needs to pay off its creditors. To calculate days payable outstanding, or DPO, the company's total amount of accounts payable are divided by the cost of sales during the same specified given time period. The number that is reached after that calculation is then multiplied by the number of days in the specified time period. Generally speaking, it is more favorable for a company to have a high DPO as long as it is eventually able to pay off its accounts payable.
It's fairly obvious that a company must be able to make its payments to those who provide it with services, but paying off those accounts too quickly is actually counterproductive. The longer a company takes to make those payments, the longer the money that is eventually used to make the payments can accrue interest. As this is the case, days payable outstanding becomes an important metric to determine the financial strength of a business.
Calculating the days payable outstanding is a two-step process. After the accounts payable is divided by the cost of sales, then this number is multiplied by the specified number of days in the time period being measured. Most businesses will determine the DPO in terms of a yearly measurement, so this last number is usually 365. Any number of days can be used, however, as long as the cost of sales and the accounts payable totals are taken from that same number of days.
For example, imagine that a company that has $1,000 US Dollars (USD) in accounts payable and $4,000 USD in cost of sales over the course of a year. To determine that company's DPO for that year, the $1,000 USD is divided by the $4,000 USD, yielding a quotient of 0.25. That number is multiplied by the 365 days in a year, which yields a total of 91.25. This is the company's days payable outstanding, which means that it takes the company approximately 91 days to pay off the creditors who provide the company with goods and services.
A company that can negotiate large lengths of time to pay off its suppliers increases its days payable outstanding. This is important because the longer the DPO, the more financing the company receives in the form of interest accrued from money gained in sales. Struggling companies may not have this luxury, as suppliers might demand payment in a much prompter fashion to avoid any chance of default. Companies like this have more strain placed on their working capital to sustain the business day to day.