What is Days Payable Outstanding
If you’re in accounts payable, you probably hear about accounts payable days outstanding quite often. The common term, days payable outstanding is amount of time a buyer within a business takes to pay an invoice to a supplier.
How to Calculate Days Payable Outstanding
The days payable outstanding formula looks like this: DPO equals the ending accounts payable over the cost of goods (COGs) divided by the number of days to pay. To make it easy, let’s imagine you’re a finance director looking at year-end DPO. We know there are 365 payable days in the year. And the cost of goods sold is $36,500,000 (wow, what a coincidence!). So we can divide those two numbers to get 100,000. And this wonderful company you are directing had a total accounts payable balance of $10 million. So all we have to do now is divide that $10 million by $100,000 to get 100. That was your company’s DPO: 100 days. Whoa. That’s a long time to pay an invoice.
Managing Days payable outstanding the old way
The traditional way of managing days payable outstanding is a balancing act between waiting as long as possible to pay your invoices on one hand and maintaining your supplier relationships on the other.
The common school of thought around DPO strategy says that it’s optimal to increase your DPO to maximize cash on hand. That’s great advice in the short term. Waiting longer to pay your bills means you get to have cash on hand to pay for all of those things that don’t involve paying bills: like taking on large contracts, hiring new people, or giving employees raises. Your company probably has some strategic spending to do, and it’s always good to have a plan in place for any unforeseen emergency.
In practice, this means the “best” companies can take up to 60 days to pay their invoices. Often these are large enterprises that can use their clout to negotiate deals with their suppliers that let them pay their invoices as late as possible. Since they’re able to get those deals, their competitors work to get those deals too; why not? Even one day of extra cash on hand is a powerful advantage for a competitive company. That’s great news for large enterprises.
But you don’t have to look very hard to see who’s left out. Traditional DPO strategy treats suppliers as little more than an obstacle. It’s not a question of whether a buyer might wait to pay a supplier, but how long they can get away without paying. That leaves suppliers often waiting longer than two months to get paid; sometimes even longer. Smaller suppliers feel the biggest pinch when large global companies put the brakes on payments; they don’t have the cash flow to maintain or grow their own business. And pity the smaller businesses trying to extend DPO payments from their suppliers: chances are they’ll lose their supplier contracts.
That’s where digitalization comes in. Traditionally, with paper invoicing, if you made a contract with a supplier for payment in thirty days, and you don’t get the invoice until day 28, you’ve only got two days to decide how you’re going to pay for it. But if you can receive the invoice instantaneously after making a contract with your supplier for a thirty-day payment invoice, then you have an entire month to strategize how to pay it. All of a sudden you have strategic options; before you were just paying by the seat of your pants. You can decide whether you want to pay early with cash on hand, pay early through bank financing, or wait until the actual invoice is due.
What if we could change the entire paradigm?
So what can a supplier do? Traditionally, raising prices is one option. Which has a chain reaction along the entire supply chain, increasing prices and payment terms all the way down the line. But there’s another option. Offering price discounts for early payments lets a supplier choose to take less cash in exchange for ready cash – made possible by programs such as Tradeshift Cash. Between the two, early payment seems to grant better returns for suppliers.
Right now, the pay dynamic favors the largest enterprises. But what would it look like if we could make terms mutually beneficial for everyone? If you’re a small business, you don’t have the luxury of waiting to pay your invoices. Yes, enterprises should be able to manage their working capital to the best of their ability. But enterprises also shouldn’t view suppliers as obstacles to success. The technology is already available to connect suppliers and buyers together in stronger partnerships. Innovations in automation, blockchain technology, and artificial intelligence gives greater insight, transparency, and speed to supply chain transactions.
With it, we can significantly improve early pay options with dynamic discounting, giving both buyers and sellers the flexibility to agree to terms mutually beneficial. Dynamic discounting lets businesses leverage early payments to access funding models that make sense; it takes friction out of payments for small businesses and helps suppliers get paid much faster. This injects cash into the supply chain and increases trade options, leveling the playing field for buyers and suppliers of all sizes.
See how Tradeshift is transforming supply chain finance with Tradeshift Pay
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