With this DPO calculator (Days Payable Outstanding), you can easily calculate how long it takes for a company to pay its bills. This metric will help you to analyze the efficiency of the company in question.
In this article, we will explain what is DPO, which stands for days payable outstanding, and how to calculate DPO. Moreover, we will also show you how to apply DPO in company analysis to help you understand the purpose of calculating DPO. Keep reading, and you will learn how to calculate DPO and use it to analyze the efficiency of any company.
What is DPO? The DPO meaning
Days payables outstanding, DPO in short, is a measure of how fast a company pays its bill. It tells you the average amount of time a company takes to settle the money it owes to its suppliers.
It is considered one of the activity ratios used to measure how effective the company is running and how well it is utilizing its working capital. In the next section, we'll show you how to use the DPO definition with a practical case.
How to calculate DPO using the days payable outstanding formula?
As the days payable outstanding calculation is most widely used when analyzing a company, let's explore this concept using a hypothetical company - Alan's Amazing Anglegrinders.
Alan's Amazing Anglegrinders reports the following information:
- Accounts payable in 2019: $150,000
- Accounts payable in 2020: $200,000
- Inventory in 2019: $200,000
- Inventory in 2020: $400,000
- Cost of goods sold in 2020: $150,000
The days payable outstanding calculation simply requires 3 inputs:
- Average accounts payable;
- Purchases; and
- Days in the company's accounting period.
We will now go through each of the inputs one-by-one.
- Average accounts payable
Accounts payable is the money the company owes to its supplier. To derive the average accounts payables, we need to take the average of the beginning accounts payable and the ending accounts payable:
average accounts payable = (beginning accounts payable + ending accounts payable) / 2
For example, to calculate the average accounts payable for Alan's Amazing Anglegrinders in 2020, you need to take the ending accounts payable for Alan's Amazing Anglegrinders in 2019, which is its beginning accounts payable in 2020, and its ending accounts payable in 2020.
Hence, the average accounts payable in our example will be
($150,000 + $200,000) / 2 = $175,000.
Calculating the purchases of a company is a lot more complicated. As the value of
purchases is defined as the amount of inventory that a company purchases from its suppliers in a particular year, it can be derived using the following equation:
purchases = ending inventory - beginning inventory + cost of goods sold
The equation itself is actually quite intuitive. The amount of inventory being purchased by the company should equal the ending inventory minus the beginning inventory plus how many inventories are sold in a year.
purchases in our example should be
$400,000 - $200,000 + $150,000 = $350,000.
- Days in the company's accounting period
In most situations, the accounting period is referred to as the company's fiscal year. Therefore, it is safe to assume that there are
365 days in an accounting period.
After deriving the 3 inputs, it's time to calculate the DPO of the company using the DPO definition. You can calculate DPO using the following days payable outstanding formula:
DPO = (average accounts payable / purchases) * days in accounting period
According to the DPO formula, the DPO of Alan's Amazing Anglegrinders is
($175,000 / $350,000) * 365 = 182.5 days.
What is the purpose of calculating DPO?
As mentioned previously, the days payables outstanding calculation is a very useful method for analyzing a company's operation. Specifically, there are 3 main benefits to understand the DPO meaning:
- Days payable outstanding helps us to understand the effectiveness of a company in managing its working capital
When analyzing a company's efficiency in its operation, it is important to consider its working capital. Having a high DPO essentially means that the company can pay its bills and obligations to its supplier slower, hence retaining the company's cash for other usages. It can improve the company's working capital position.
Although working capital is usually a small amount compared to the company's total assets, improving the working capital of a company can have a significant impact. For instance, **having a high DPO will allow the company to retain the cash and invest it in some short-term investments to improve its ** free cash flow.
- Days payable outstanding allows us to understand when to expect your return as a supplier
If you are a supplier, it is also useful to understand the days payable outstanding formula as it can help you in evaluating the quality of your buyers. If the buyers have a very high DPO, it means that it will probably take longer to receive payments from them. This can have detrimental effects on the operating cash flow of your company.
- Days payable outstanding is an important part of calculating the cash conversion cycle (CCC)
The cash conversion cycle is a useful metric when evaluating how fast a company turns its sales into cash. The CCC is calculated using 3 components, namely days sales outstanding, days inventory outstanding, and days payable outstanding. So, to calculate the CCC, you first need to understand the DPO formula.
In conclusion, DPO plays an important role in understanding how effectively a company is being run. However, as DPO can only tell you how the company manages its payable expenses, which is a small part of the whole story. It is essential to also consider other metrics, such as the days sales outstanding, to give you a better view of the company's operational effectiveness.