What is Days payable outstanding?
The Days payable outstanding or Payable, in short, is yet another important activity ratio that helps in understanding how well the company manages its Accounts Payables.
In the previous resource, we discussed the Payable turnover ratio. Similarly, even this ratio is an integral part of analyzing the overall efficiency of the company in managing its resources.
Days payable outstanding meaning
As part of business, companies make purchases on credit from various suppliers.
The amount outstanding to such suppliers is called as Accounts Payable.
Now, the Days payable outstanding basically indicates the number of days taken by the company to pay its Accounts Payable.
It helps in understanding if the company makes the payment to suppliers within a short period of time or otherwise.
Hence, the Payable Days helps in understanding the liquidity position of the company.
Days payable outstanding formula
The formula for Days payable outstanding is related to the Payable turnover ratio.
We take Average Accounts Payable in the numerator and Cost of Goods Sold (COGS) in the denominator and multiply it by 365 days.
At times, if available, Credit Purchase is also taken instead of Cost of Goods Sold (COGS) in the numerator.
Both, Credit Purchase and Cost of Goods Sold can be obtained from the Income Statement.
The amount outstanding towards the suppliers from whom goods/services have been procured on credit is recorded as Accounts Payable. It is shown as a liability on the Balance Sheet.
Hence, Average Accounts Payable is nothing but a simple average of Accounts payable balance as at current period-end and previous-period end.
Below are the important aspects which are relevant while calculating numerator and denominator.
Cost of Goods Sold (COGS) /Credit Purchases
- Only Cost of Goods Sold (COGS) has to be taken in the numerator at times it is difficult to identify exact credit purchase hence analysts may even use the cost of goods sold (COGS) as a proxy.
- Only credit purchase has to be considered that is any purchases made on cash basis will not be relevant.
Average accounts payable
- The average of both periods accounts payable has to be considered, and not mere closing accounts payable.
Let us calculate the DPO ratio using a hypothetical example
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Days payable outstanding example
Let us look at our 1st example.
We take Company A and Company B for calculating DPO
Values given in the examples below are in $ millions.
Consider the below-given income statement for both the companies.
To calculate Payable days, we need
- Cost of Goods Sold
- Average Accounts Payable
It is important to note that even Credit Purchase can be used instead of COGS depending upon the availability of information.
Cost of Goods Sold value for both the companies can be obtained from the income statement.
- Company A = $ 500
- Company B = $800
Now, let us also take a look at total assets for both the companies.
Average Accounts payable for both the companies can be obtained from the current liability section of the Balance Sheet.
Also, we should not take a mere closing balance of Accounts Payable.
Instead, an average of the past 2 year-end balance has to be taken.
But, in our example, we are given only one-period data.
Hence, given Accounts Payable balance can only be taken as Average Accounts payable.
- Company A = $300
- Company B = $400
Now that we know all the values, let us calculate the Days payable outstanding for both the companies.
DPO = ( Average Accounts Payable / Cost of Goods Sold ) * 365
- Company A = ( $300 / $500) *365 = 219 Days
- Company B = ( $400 / $800) *365 = 182.5 Days
What this means is that Company A takes around 219 days to pay off its Average Accounts Payable.
On the contrary, Company B takes 182.5 days to pay off its Average Accounts Payable.
Hence, it is clearly evident that Company A takes more time than Company B. This helps Company A in managing its liquidity position in a better manner.
Days payable outstanding for Walmart
In our next example, let us calculate Payable days using excel.
You can download the Payable Days template using below option.
Consider the below-shown Consolidated Income Statement of Walmart.
COGS
In the case of public companies, it is generally difficult to segregate Credit Purchases from COGS since the figure is not directly reported in the Income Statement.
Hence, for the sake of convenience, analysts generally use the Cost of Sales or Cost of Goods Sold(COGS) as a proxy for Credit Purchases.
Hence, COGS = $385,301
Also, consider the below-given Balance Sheet extract of Walmart Inc.
Average Accounts Payable
- Accounts Payable 2018= $46,092
- Accounts Payable 2019= $47,060
- Average Accounts Payable = ($46,092 + $47,060)/2
- Average Accounts Payable = $46,576
Now that we know all the values, let us calculate Walmart Payable days.
Payable Days= ( Average Accounts Payable / Cost of Goods Sold ) * 365
- ($46,576 /$385,301) *365 = 44.1 days
As clearly evident, DPO for Walmart is 44 days
What this means is that Walmart takes on an average 44 days to pays off its Average Account Payable balance during a year.
Now whether the ratio is good or bad depends upon the relative comparison.
Days payable outstanding interpretation
As we have already understood, DPO indicates how many days the company takes to make the payment towards its Accounts Payable.
High Days payable outstanding
- Most reputed companies, generally, get a higher credit period because of their Brand Image. Hence, naturally, the DPO of such companies would be higher.
- High DPO indicates the ability of the company to defer its payments.
- High Payable days indicates that the company is paying off its Accounts Payable balance less frequently.
- This may be an indication that the company may be running out of cash or it is finding difficult to meet its obligation with a given cash balance.
- Companies, at times, deliberately delay payment towards Account Payable balance.
- Hence, the company can make better use of cash available. This, in turn, increases the company’s liquidity position.
- But this strategy may indirectly affect the relationship with the suppliers. Hence, management has to be cautious while executing such strategies.
Low Days payable outstanding
- Low Days payable outstanding indicates that the company is making more frequent payments towards Accounts Payable.
- This indicates that the company has sufficient cash balance to make the payment.
- But, it also indicates that the company is inefficiently managing its liquidity position.
- Also, if the DPO is low, the company’s funds are utilized more frequently which otherwise could have been re-deployed in other profitable projects.
Trend Analysis
As already highlighted, any financial ratios will not give any clear picture when analyzed on a standalone basis.
How the ratio has more historically has to be analyzed. This is performed as part of Trend Analysis.
Let us look at how DPO has moved historically in the case of Apple.
As evident, Days payable outstanding for Apple is 115 days.
This indicates that the company takes almost 115 days to make any payment towards its Accounts Payable per year.
Such a high DPO is possible only when the Company have a strong Reputation & Brand Image in the market. Generally, suppliers would be ready to offer extended credit periods to reputed companies.
Hence, in the case of Apple, we can see that the DPO has increased from 92 days to 115 days.
This shows that the company is very efficient in managing its Accounts Payable. This also helps in increasing its overall liquidity position.
Comparison with similar companies
Similar to trend analysis, it is also important to understand the ratio profile of various companies under different sectors as well.
This helps in understanding the cross-sectional industry dynamics.
Walmart vs Home Depot
As you can see companies in the retail sector like Walmart and Home Depot have Days payable outstanding ratio which is in the range of 38 to 44 days.
Companies, on an average, take one & a half months to make the payment towards its Accounts Payable balance.
The similarity in DPO of both the companies indicates that the supplier from whom they make purchase typically provide a similar credit period.
It is also important to note that the DPO for both companies has been in the same range for the past 5 years.
Amazon
Amazon is into e-commerce, cloud computing, digital streaming, and artificial intelligence and other similar business.
Compared to companies like Walmart or Home Depot, Amazon has a relatively higher DPO.
Such a high DPO may be attributable to the Company’s Reputation & Brand Image in the market.
Nonetheless, Amazon Payable Days is 95 days.
Facebook vs Google vs Microsoft
When you calculate the Days payable outstanding for tech-based companies like Apple, Facebook, Google (Alphabet) and Microsoft, you will observe that the ratio varies from company to company.
Apple
As already discussed as part of Trend Analysis, Days payable outstanding for Apple has been increasing.
This indicates that the Company is able to manage its Accounts Payable balance in the most efficient manner. This also helps the Company in increasing its overall liquidity position.
DPO for Apple is as high as 115 days which is highest among other tech-based companies under consideration.
Days payable outstanding for Facebook is 42 days.
The ratio was 64 days back in 2014 but subsequently decreased gradually to the current 42 days.
Microsoft
In the case of Microsoft, we can see that DPO has been steady in the range of 70-76 days.
The company manages its Accounts Payable in a more efficient manner such that it avails a higher credit period.
Currently, the Microsoft Payable Days is 76 days.
Interestingly, DPO for Google is the lowest among all other tech-based companies under consideration.
Currently, Google Payable Days is 23 days.
Important considerations
Below are few important aspects one must consider while analyzing any company using Days payable outstanding. These are similar to what we discussed as part of Payable turnover ratio.
Credit Purchase vs COGS
As already highlighted, depending upon the availability of information analysts generally use COGS as a proxy to credit purchase in the denominator.
Average Accounts Payable
Also, it is important to take Average Accounts Payable balance and not mere closing Accounts Payable balance in the numerator.
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