Wall Street Prep

Days Payable Outstanding (DPO): Formula and Meaning Explained

Days Payable Outstanding (DPO) Concept and Formula Explanation with Example Calculation in Excel

Learn Online Now

Days Payable Outstanding (DPO): Formula and Meaning Explained

Key Takeaways
  • Why is it necessary to track a companies’ days payables outstanding (DPO)?
  • If a company has a high DPO relative to its peers, what does this suggest?
  • Which type of companies tends to have higher DPOs?
  • Would a low DPO have a positive or negative impact on free cash flow?

Days Payable Outstanding (DPO) Meaning

The accounts payable (AP) line item represents the accumulated balance of unmet payments for past purchases made by the company. Here, the good or service has been delivered to the company as part of the transaction agreement, but the company has yet to pay.

During that stretch of time when the supplier awaits the payment, the cash remains in the hands of the buyer with no restrictions on how it can be spent. This tends to benefit the company’s profit margins, as well as increase free cash flows (FCFs).

The longer a payment is delayed, the longer the company holds onto that cash. Higher DPOs result in more near-term liquidity (i.e., cash on hand).

Since an increase in an operating current liability such as accounts payable represents an inflow of cash, companies strive to increase their DPO. While bills must eventually be paid, for now, the company is free to use that cash for other needs.

So how does a company achieve a high DPO?

If all companies could “push out” their payables, any rational company would opt for delayed payment to increase their free cash flows (FCFs). But the reason some companies can extend their payables whereas others cannot is tied to the concept of buyer power, as referenced earlier. In general, buyer power and negotiating leverage usually stems from:

  • Large Order Volume on a Dollar-Basis
  • High Frequency of Orders
  • Long-Term Relationship with Customer
  • Low Number of Potential Customers

The more a supplier/vendor relies on a customer, the more negotiating leverage that buyer holds.

For a company that constitutes low revenue concentration (i.e., minuscule percentage of total revenue) and low order volume, the inconvenience to the seller and disruption to operations from going out of their way to receive the cash payment could outweigh the benefit of serving that particular customer.

In this type of scenario, the seller could either cut off the customer or place restrictions on the customer (e.g., require upfront payment).

However, if the customer comprised a significant percentage of the seller’s total revenue, the seller can be forced to accept a request for delayed payment as the seller cannot afford to end its relationship with this customer and must comply with their requests.

  • Low DPO ➝ Low Bargaining Leverage (Less Free Cash Flow)
  • High DPO ➝ High Bargaining Leverage (More Free Cash Flow)
Days Payable Outstanding (DPO): Apple Example

An example of a company with high bargaining leverage over its suppliers is Apple (AAPL). As we can see below, Apple’s DPO from 2017 to 2019 has been in excess of 100 days – which is very beneficial to its short-term liquidity.

Additionally, the extended time afforded to Apple before cash is due to its suppliers is understandable given the amount of revenue generated by Apple for these suppliers (and the global branding and presence that benefits the supplier in numerous ways through association). In fact, suppliers compete intensely with each other in order to become the provider of components for Apple products, which directly benefits Apple when it negotiates terms with these suppliers.

DPO AAPL

Days Payable Outstanding of Apple (Source: AAPL DCF Model)

Days Payable Outstanding (DPO) Formula

The 1st portion of the formula to calculate DPO involves taking the average (or ending) accounts payable and dividing it by COGS. Then, that figure is multiplied by 365 days.

DPO Formula

One distinction between the DPO calculation and days sales outstanding (DSO) calculation is that COGS is used instead of revenue since to calculate DPO, COGS tends to be a better proxy for a company’s spending related to supplies/vendors. But note that the COGS is directly related to revenue, thereby revenue indirectly drives the A/P forecast. For this reason, while A/P is typically projected using DPO, it is also perfectly acceptable to project A/P as a simple percentage of revenue.

Excel Template Download

Let’s proceed with our tutorial on projecting accounts payable in Excel. To get started, download the file to follow along:

dl
Submitting ...

Let’s say a company has an accounts payable balance of $30mm in 2020 and COGS of $100mm in the same period. In addition, the company’s COGS is anticipated to grow 10% year-over-year (YoY) through the entire projection period.

To start our forecast of accounts payable, the first step is to calculate the historical DPO for 2020. DPO can be calculated by dividing the $30mm in A/P by the $100mm in COGS and then multiplying by 365 days, which gets us 110 for DPO.

DPO Calculation

For purpose of simplicity, we will just carry forward this assumption across the entire forecast. In reality, the DPO of companies tends to gradually increase as the company gains more credibility with its suppliers, grows in scale and builds closer relationships with its suppliers.

Using the 110 DPO assumption, the formula for projecting accounts payable is DPO divided by 365 days and then multiplied by COGS. For example, we divide 110 by $365 and then multiply by $110mm in revenue to get $33mm for the A/P balance in 2021.

The completed projections for A/P under the DPO approach are shown below.

DPO Calculation Done

As previously mentioned, A/P can alternatively be projected using a percentage of revenue. We can assume the company had $300mm of revenues in 2020, which will grow at 10% each year in line with our COGS assumption.

By dividing $30mm in A/P by the $300mm in revenue, we get 10% for the “A/P % Revenue” assumption, which we will extend throughout the forecast period. A/P can then be projected by multiplying the 10% assumption by the revenue of the relevant period.

Revenue Approach Formula

The forecasted figures under the DPO and revenue approach are equivalent, as shown in the screenshot posted below – this is because COGS and revenue are both growing at the same rate of 10%. Note that it is somewhat unrealistic, however, to always assume both COGS and revenue to grow at precisely the same rate.

Forecasting A/P under either approach would likely yield similar numbers assuming that the proper adjustments are made (e.g., industry background research, comparable peers benchmarking, management meetings, etc.) – however, a forecast driven off DPO would likely be viewed with more credibility compared to the % of revenue forecasting approach.

Comments
guest
0 Comments
Inline Feedbacks
View all comments
Learn Financial Modeling Online

Learn to build a 3-statement model using various supporting schedules and best practices.

Enroll Today
X

The Wall Street Prep Quicklesson Series

7 Free Financial Modeling Lessons

Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.