The ability to manage cash can be the difference between life and death for a company. Exerting control over inflows and outflows with diligently managed accounts payable days is an important practice to keep your business stable, protect the company’s future growth, and maintain employee confidence in the company’s short- and long-term objectives.
Smart cash-flow maintenance also helps to maintain good relationships with suppliers, opening avenues for discounts and easier negotiations. Regardless of industry, having good contacts is the best way to increase investment in your business interests.
Let’s look at the days payable outstanding (DPO)—also known as Accounts Payable days (AP days)—measurement and how it impacts cash flow.
First, let’s review the accounts payable process and how DPO fits in.
What are accounts payable?
Accounts payable (AP) are accounts in a general ledger that represent a company’s commitment to paying off short-term debts owed to suppliers or creditors after purchasing goods or services on credit instead of with cash up front. The company can acquire what it needs now, and pay suppliers within an agreed-upon time frame (usually Net 30 to 90).
On a balance sheet, accounts payable are listed under the company’s current liabilities, because goods were bought on credit. The debts have to be paid on time to avoid default.
Like any other liability account, accounts payable will have a credit balance. When an account payable is paid, accounts payable will be debited and cash will be credited. The credit balance in accounts payable should be the same amount as the vendor invoices that have been recorded but have yet to be paid.
The AP department in an organization is responsible for tracking and verifying invoices, communicating with suppliers, and making the scheduled payments.
Under the accrual method of accounting, expenses are reported when they are incurred, not when they are paid. The company that receives the goods or services on credit has to report the liability no later than the date they were received. That date is used to record the debit entry to an expense or an asset account.
The accounts payable process
The accounts payable process ensures that the transactions listed in your accounting system are accurate and legitimate. The most important information exists in the following documents:
- Purchase orders issued by the company
- Receiving reports issued by the company
- Invoices from vendors
- Supplier contracts and other agreements
The accounts payable department is responsible for the following monthly activities:
- Processing accurate and legitimate vendor invoices
- Accurate recording in the appropriate general ledger accounts
- The accrual of obligations and expenses that have yet to be completely processed
What are accounts payable days (days payable outstanding)?
To better keep track of payments, companies can fall back on a reliable formula to help them pay bills and other obligations on time.
Accounts payable days, also known as days payable outstanding (DPO), is a financial ratio that shows the average number of days an organization takes to pay its bills to suppliers.
A low DPO may be considered a healthy DPO, but this isn’t always the case. They can then use the cash they have on hand to make short-term investments, increasing their working capital and freeing up cash flow.
At the same time, a too-high DPO value may signal an inability to pay bills on time. It can indicate a general cash shortfall. Each business should aim for a DPO that best suits its context. If the number of payable days changes, it could indicate that the payment terms with suppliers have changed.
If a company is paying its suppliers quickly, it may mean that the suppliers are demanding fast payment terms, either because short credit terms are part of their business models or because they feel the company is too high a credit risk to allow longer payment terms.
Days payable outstanding formula
Companies calculate DPO by multiplying the average accounts payable (the total of the beginning accounts payable and the ending accounts payable) by the number of days in an accounting period. This formula reveals the total accounts payable turnover.
That number is then divided by the cost of goods sold (COGS). Also known as cost of sales, COGS is the cost of acquiring or manufacturing the products that a company sells during a period. The ratio indicates how well the company manages its cash outflows.
DPO and the cash conversion cycle (CCC)
DPO value plays a role in calculating the cash conversion cycle (CCC). This is a metric that expresses the amount of time that a company takes to convert inventory investments and other resources into cash flow from sales.
While DPO focuses on the company’s current outstanding payables, the CCC (also known as the net operating cycle or simply cash cycle) follows the entire timeline. This extends from when the cash is converted into inventory, expenses, and accounts payable through to sales and accounts receivable, and then back into cash in hand when received.
Public companies reference DPO in their annual financial statements, income statements, and balance sheets.
How DPO is used
A well-run accounts payable process affects every level of a company’s cash position. Paying bills on schedule helps to develop a relationship with suppliers and improves your credit rating. Suppliers may also deliver better privileges, such as higher discounts, in return.
A company’s DPO metric can be used to demonstrate credit worthiness to potential lenders or credit-based suppliers.
It’s important to find the right balance in determining the right number of accounts payable days for your business. We covered the dangers of a higher ratio in the previous section. But keeping DPO low restricts the amount of cash available to reinvest in future opportunities.
In contrast, increasing accounts payable days demonstrates to creditors that the company is not in a position to borrow cash for short-term capital. A weaker company may face liquidity issues.
AP automation technology can help you manage your DPO so you can maximize your working capital while maintaining good vendor relationships.
Firsthand insights from AP automation technology adopters
Whatever the state of your company, having a clear system to pay vendors at the right times is a vital component of any business. Order.co can help companies with tasks such as organizing payment schedules, easily creating informative reports, and tracking payment variances to avoid exceptions and delays.
Order.co also automates the ordering process, freeing up more time for important day-to-day operations. Automated, proactive delivery tracking provides timely updates about the status of your shipments. Customers can complete orders 95% faster than before they began to use Order.co.
Our users have seen transformative effects on their businesses since they started using Order.co. These organizations are using our automation to streamline their processes, speed up order fulfillment, and optimize supply spending.
Here are a few case studies:
Before implementing Order.co, Zerocater needed one or two business days a month just to record payments and manage invoices. With our platform in place, the number of invoices they needed to complete decreased considerably—from 200 invoice payments to Amazon each month to just three or four. This reduction made it easier to track spending and wade through the ordering process. (More than 80% of our clients pay just one invoice per week or month.)
The Zerocater team also took advantage of Order’s real-time analytics features to add substantial visibility to their budgets. Their managers can see where every dollar goes and handle issues proactively.
In their previous system, managers at SoulCycle had to jump through several unnecessary hoops to complete transactions. Each vendor site had its own rules and logins to keep track of. Users had to manually track transactions and its effect on their monthly budgets. This made payment reconciliation a long and challenging process.
Once the company began using Order.co, everything changed. Orders were fulfilled faster since employees could place orders from one approved catalog into one cart shared across every vendor. Reporting on expenses went from a five to six-hour monthly exercise to a fast single payment with one consolidated invoice.
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BLANKSPACES’ purchasing process was time-consuming, disjointed, and difficult to parse. Each month, purchases went unrecorded. Miscommunications between locations were common. But after working with Order.co, the purchasing workflow became simpler in a matter of minutes.
Acquiring supplies became much more cost-effective. The pre-established vendor network included with Order.co made setting up accounts payable schedules a breeze. In the words of facilities manager Elizabeth Nowlin, “Once we’ve added a product to Order.co, we know everything has been taken care of.”
Visibility and process are the first critical steps in attaining a successful DPO. By implementing a software system, you can optimize the procure to pay process and keep cash flow in check. To learn more about using Order.co to streamline your most important AP tasks, request a demo.
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