Accountants and other financial analysts often use a DPO calculation to make critical financial decisions. Having an accurate DPO figure can help companies learn how to allocate income, manage short-term and long-term investments and develop positive relationships with outside business associates. By understanding the mathematics used to determine this figure, you can generate more accurate and useful material. In this article, we define what a DPO calculation is, explain why it's important, provide steps for how to calculate two different formulas and list some helpful tips for calculating it yourself.
What is a DPO calculation?
A days payable outstanding (DPO) calculation represents a mathematical ratio for how many days a company takes to pay important stakeholders like creditors, suppliers or vendors during a certain length of time. It gives a company the ability to compare this value with an expenses deadline in measurable terms. Accountants and analysts typically calculate a company's DPO every quarter, but they may also check it on an annual basis.
Here are some key terms to learn:
Accounts payable: This is the section of a company's financial records that outlines a company's short-term expenses to important stakeholders.
Accounting period (AP): The AP is the length of time throughout a year when an accounting department generates financial records. There are typically four accounting periods in a year.
Inventory: This is a company's assets it keeps in its facilities, including completed products and raw materials.
Balance sheet: This is a financial statement that details assets, income and expenses during one accounting period
Why is calculating DPO important?
Calculating DPO is important because it allows a company to measure cash flow, which is how much money it can spend or save for a certain length of time. For example, a high DPO value may affect a company's relationship with stakeholders who expect payments on a certain date. However, it can also indicate that a company has more cash to use for shorter investments, like a government bond, which shows a positive financial status.
A low DPO value, meanwhile, might show that a company spends cash more often, which may affect how much money its executives can use for other investments. This value can also show that a company can meet deadlines efficiently, meaning they may establish a strong relationship with those stakeholders. It may be helpful to measure a company's DPO against the average value number of its industry, as this ratio can indicate a company's financial status overall.
How to calculate DPO with the cost of goods
Manufacturers can use the accounts payable and the cost of goods sold (COGS), which includes all acquisition and manufacturing expenses, to calculate DPO. The formula looks like this:
Days payable outstanding = (accounts payable average x number of days) / cost of goods
Consider the following steps:
1. Identify the accounts payable average
The AP average represents a mean sum of all accounts payable values in a balance sheet for an accounting period. As this value can shift throughout an accounting period, it may be helpful to calculate a mean sum to better ensure an accurate DPO. To find an AP average, you can use the following equation:
Average accounts payable = (beginning accounts payable - ending accounts payable) / 2
First, subtract the accounts payable value at the end of an accounting period from the number at the beginning, then divide it by two. You can also replace the beginning and ending values with numbers from the first and last accounting period in a year to find an annual DPO.
Related: How To Calculate Average
2. Calculate cost of goods sold (COGS)
The COGS value represents the cost of sold items from a company's inventory during one accounting period. Finding this number allows you to calculate how many resources a company used from the date they purchased materials to the date an individual calculates a DPO. To find the COGS value, you can use the following equation:
COGS = (beginning inventory + total purchases) - closing inventory
Opening and closing inventory values indicate how many assets a company has in its facilities at the beginning of an accounting period versus the end. The total purchases number shows how many items a company sells during that same length of time. To solve the equation, add the opening inventory to the total purchases value, then subtract the closing inventory number from this sum. For example, if your opening inventory value is 70, your total purchases number is 90 and your closing inventory value is 40, then your overall COGS value might total 120.
Read more: How To Calculate the Cost of Goods Sold
3. Multiply the AP average by the number of days in an accounting period
Now, you can begin implementing numbers into the DPO formula. Review your financial statements to learn how long an accounting period is, then multiply that number by the AP average values you previously calculated. For example, if the length of time is 90 days and the AP average is $100, then the first half of this calculation might total a value of 9,000.
4. Solve the DPO formula
To learn a company's DPO, divide your previously multiplied sum by the amount you calculated for the COGS. Afterward, you can compare this number to a company's deadline for paying expenses. If you use the sums from previous examples, then you might divide the 9,000 value by the 120 COGS number, which provides a value of 75 days payable outstanding. This means it takes a company an average of 75 days to pay expenses during one accounting period.
How to calculate DPO with the cost of sales
Retailers can use the cost of sales, which describes all costs involved in offering services, to calculate DPO. The formula looks like this:
Days payable outstanding = accounts payable average / (cost of sales / number of days in accounting period)
Consider the following steps:
1. Identify the AP average
Use the aforementioned formula for calculating the AP average. To better ensure an accurate value, it's often helpful to recalculate this number for every DPO equation you process. Afterward, record the inventory purchases in digital locations that personnel can access in the future.
2. Determine the cost of sales
To identify the cost of sales, use the inventory purchases sum from your previous calculations. Finding this number can help you identify the cost of non-material items, like labor costs or personnel salaries. To find a cost of sales value, you can use the same formula that COGS requires. Be mindful to monitor inventory records or recount a company's assets to better ensure your beginning and ending values reflect the assets precisely.
3. Solve the DPO formula
Divide the cost of sales by the number of accounting period days. Then, divide this sum from the AP average value. For example, if your accounting period lasts for 120 days and your cost of sales is $8, then your sum in the first stage of the formula might total a value of 15. If you divide an AP average of $120 by this sum, your total DPO using the cost of sales might be 8 days payable outstanding.
Here are some examples of how to use a DPO calculation in the workplace:
Cost of goods example
A manufacturing company called Clare's Fine Wigs purchases supplies from three outside distributors. Its CEO prefers to maintain a high DPO so the company can invest some savings into new equipment. The company has as an AP average sum of $70,000 on its balance sheet for one accounting period, which is 90 days. Its accounting department determines a beginning inventory value of 5,000 and an ending inventory value of 2,500, followed by a $100,000 total purchases value, which allows them to identify a COGS value of $102,500.
Using these values, the accounting department multiplies the AP average sum of $70,000 by the 90-day-long accounting period. Then, they divide this sum by the COGS value of $102,500 to total 60 days payable outstanding. The executive team determines this number is optimal and makes plans to maintain it in the future.
Cost of sales example
A retailer called Jimothy's Goods borrows money from an outside creditor to maintain several store locations. Its CEO prefers to maintain a low DPO so the clinic can maintain positive communication protocols with the creditors. The bookkeeper determines an AP average sum of $90,000 on its balance sheet for one accounting period, which is 90 days long.
Afterward, they determine a cost of sales by adding a beginning inventory value of 200,000 to a $2,500,000 total purchases value, then subtracting the ending inventory value of 100,000 from this sum. Next, they divide the following sum of 2,600,000 by the 90 days-long accounting period. Then, they divide the AP average amount of $90,00 by this sum to total three days payable outstanding. The CEO decides this number is too low compared to industry standards, so the executive team makes plans to raise the total DPO value to seven days.
Tips for calculating DPO
Consider the following tips for calculating DPO:
Use spreadsheet software. Investing in spreadsheet software can help you calculate sums more efficiently. It can also allow you to develop clear financial reports to measure a company's status after an accounting period ends.
Have a colleague participate. Ask a coworker or peer to review your work or calculate DPO themselves so you can compare answers. This may help ensure your team can generate a more accurate DPO and prepare more effective financial reports.
Seek online resources. There are multiple online resources that use computer algorithms to calculate DPO. After identifying your figures, you can use one of these applications to double-check them.
Take an accounting class. Community colleges and other educational organizations offer for learning how to calculate DPO and similar accounting protocols. If you're interested in starting a business, it may be helpful to gain these skills in a group setting.