What it means
When a company buys goods or services on credit, the amount it owes suppliers sits in accounts payable (money owed for purchases that have been received but not yet paid). Suppliers are in effect lending to the company for the period between delivery and payment.
DPO measures how long that period is on average. A longer DPO can help cash flow, because the company keeps the money in its bank account and can use it to fund operations or earn interest.
Some large retailers have long payment terms and collect cash from customers well before they pay suppliers, which means suppliers help to finance the business. This is a legitimate strategy when agreed in contracts, but it needs care.
There is a limit to how far a company should stretch its payments. Paying late can damage relationships, lead to late fees, cause suppliers to withdraw credit or demand cash on delivery, and it may lose early payment discounts.
A company that suddenly pays much more slowly may also signal cash problems to lenders and investors. DPO should be compared with the supplier terms and with competitors in the same industry.
A figure of 45 days is unremarkable if suppliers offer 45-day terms, but it is a worry if their terms are 30 days. Trends over time are also valuable, since a steadily rising DPO may mean the business is becoming stretched.
Companies can calculate DPO using the average payables balance over the period or the closing balance. Using the average smooths out seasonal peaks, while the closing figure shows the latest position.
Whichever method is chosen, it should be used consistently so that trends can be compared fairly. Finance teams combine DPO with other measures in the cash conversion cycle, which shows how many days cash is tied up between paying for inventory and collecting from customers.
The cycle equals days inventory outstanding plus days sales outstanding minus DPO. Improving DPO shortens the cycle, but the best results come from balanced decisions rather than extreme ones.
In practice
Real-world examples.
Example
A supermarket chain pays suppliers in about 60 days but sells most of its stock in 20 days. Cash from customers arrives well before the bills are due. The extra cash is used to fund new stores.
Example
A small manufacturer finds that its DPO has risen from 35 to 55 days over a year. The finance manager discovers that late payment is caused by a cash shortage rather than a choice. She talks to the bank about a short-term facility.
Example
A software reseller negotiates with its main supplier to extend payment terms from 30 to 45 days. With annual cost of goods sold of $3,650,000, each extra day is worth $10,000 of cash. The 15-day extension releases $150,000.
Formula
Calculation
DPO = (Average accounts payable / Cost of goods sold) x Number of days in the period
Worked example: a company has average accounts payable of $300,000 and annual cost of goods sold of $2,190,000. It uses a 365-day year.
Step 1: Cost of goods sold per day = $2,190,000 / 365 = $6,000
Step 2: DPO = $300,000 / $6,000 = 50 days
The company takes about 50 days on average to pay its suppliers. If its suppliers allow 45 days, the company is paying about 5 days late on average.Case study
Seen in the real world.
Pinecrest Foods is an illustrative, fictional distributor with annual cost of goods sold of $7,300,000, or $20,000 a day. Its accounts payable averaged $600,000, giving a DPO of 30 days.
The finance director reviewed the terms with each supplier and asked the main ones to extend terms to 45 days. Two agreed, and DPO rose to 40 days, with accounts payable of $800,000. That released $200,000 of cash without borrowing.
One smaller supplier objected and asked for an early payment discount instead of longer terms. The director compared the 2% discount for paying in 10 days with the cost of borrowing and accepted the offer for that supplier. The illustrative lesson is that DPO should be managed supplier by supplier.
Watch out
Common mistakes.
- Assuming a higher DPO is always better, when stretching payments too far can damage supplier relationships.
- Using sales instead of cost of goods sold in the formula, when payables relate to purchases and costs.
- Comparing DPO across industries, when payment norms differ widely between sectors.
Questions
People also ask.
What is a good DPO?
There is no universal number, but a good figure is usually close to the supplier terms and in line with industry peers.
How does DPO affect cash flow?
A higher DPO keeps cash in the business for longer, which improves short-term liquidity.
How is DPO different from DSO?
DPO measures how long a company takes to pay suppliers, while DSO measures how long customers take to pay the company.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%