Do you know how long it takes you to pay your small business’s invoices? The number of days between receiving an invoice and sending a payment plays a big part in your company’s cash flow. You can track how long it takes you to pay bills by calculating the days payable outstanding.
What is days payable outstanding?
Days payable outstanding (DPO) measures your business’s average payable period. In other words, the days payable outstanding shows how long it takes you to pay invoices. Usually, business owners look at the days payable outstanding quarterly or yearly.
DPO is a reflection of how well you manage accounts payable. Accounts payable is money you owe to vendors. The smaller the days payable outstanding, the faster you pay debts. The larger the days payable outstanding, the longer it takes you to pay debts.
Most businesses aim for a days payable outstanding of 30 days, meaning it takes about a month to pay an invoice. Depending on your industry, your average days payable outstanding could be different. Check with your industry standards to see where your DPO should fall. You may want to adjust your own invoice payment terms accordingly.
How to find days payable outstanding
You can find the days payable outstanding by using a simple formula. You will need three pieces of information:
- Ending accounts payable
- Cost of goods sold
- Number of days in the period
To find the days payable outstanding, decide the number of days in the period you want to measure. For example, if you want to look at the entire year, use 365 days.
This is the formula for days payable outstanding:
Ending Accounts Payable / (Cost of Goods Sold / Number of Days)
You can find the information you need on your financial statements. The ending accounts payable is the amount you owe at the end of the period you’re measuring. The ending accounts payable is on the balance sheet. The cost of goods sold (COGS) is on the income statement.
Why is days payable outstanding important?
As a small business owner, you juggle a lot of tasks. Though revenue is your main priority, you also need to step back and check your finances periodically. Your DPO can help you plan spending, forecast cash flow, and review payment terms.
A very short or long days payable outstanding can be bad for business. You need to balance the timing of your payments for a healthy cash flow.
Long days payable outstanding
You want the days payable outstanding to be as long as possible without making late payments. The longer you take to pay an invoice, the more cash you have on hand. Since you have more cash on hand, your finances are more flexible. A longer DPO is a good indicator that you are managing cash well.
While you want a longer days payable outstanding, make sure you pay bills on time. If you wait too long to pay creditors, you could get late fees and other penalties. Some vendors might refuse to work with you in the future if you pay late. And, you could damage your business credit score if you repeatedly make late payments.
Short days payable outstanding
To manage your small business cash flow, avoid a short days payable outstanding. The shorter your DPO, the more you are spending on bills at one time. If you pay invoices too quickly, you might not have enough cash on hand to cover other expenses. Your accounts payable process flow may be too rapid, and you could have to borrow money.
For example, you pay all your invoices at the beginning of the month. That same month, you need to pay employee paychecks. You do not have enough cash on hand to pay payroll because you spent it on the invoices. To pay employees, you may need to take out a short-term loan.
Paying invoices too quickly can leave you short on cash. But, sometimes, early payments can benefit your business. Look for vendors who offer early payment discounts. While you lose the money on hand fast, you end up paying less on the invoice. If you have enough cash to operate, taking advantage of early payment discounts is an easy way to save money.
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This article has been updated from its original publication date of February 2, 2017.This is not intended as legal advice; for more information, please click here.