Are you subsidising your competitors? A guide to understanding DPO.
What is DPO?
Days payable outstanding (DPO) is a financial ratio that measures the average time it takes for a company to pay invoices from its suppliers and vendors. DPO is calculated by dividing the accounts payable by the derivation of the cost of sales and the average number of days outstanding, and gives a measure of how well a company is managing its cash flow. A company’s cash conversion cycle is a key indicator of its financial health, yet few businesses fully comprehend the importance of DPO, how their DPO compares to their competitors and the impact this has on their cash conversion cycle.
Importance of DPO
Generally, a high DPO holds many advantages for the company. The longer it takes for a company to pay its creditors, the more cash it has on hand to deploy for managing operations, producing goods or used for other short-term investing activities. Now, more than ever, it is becoming increasingly important for businesses to optimise their cash flow if they are to prosper in these uncertain times. Given that working capital is the cheapest source of cash for businesses, it is critical for these companies to understand the impact DPO has on their liquidity needs. On the flip side, it is important to consider the impact long payment terms can have on supply chains. DPO walks the line between cheap sources of cash and keeping suppliers happy. If payment terms are too long, supplier failure becomes an all too often occurrence.
Creditor days continues to be high
Long payment terms dominate. Globally, the average DPO is 68 days. These long payment terms have unlocked millions of dollars in cash flow for corporates to make strategic acquisitions, generate interest and pay off cash flows. In recent years, there has been a slight downward trend in terms of DPO growth, down 0.7 days from record highs that appeared in 2016, possibly signalling a recognition among companies that their existing hard-line approach to suppliers was unsustainable.
Benchmarking working capital metrics
By comparing working capital metrics, including DPO, to their suppliers, customers and competitors, businesses can gain a great deal of insight into their supply chain ecosystem. A DPO that is below average for the industry, represents a missed opportunity to free up cash flow to fund strategic business initiatives. Worst still, by paying suppliers too early, companies may be indirectly funding their competitors! If a company’s payment terms are shorter than their suppliers’ DPO, or the company’s sales terms are longer than their customer’s days sale outstanding, this may in fact be the case. Benchmarking working capital metrics becomes crucial to optimising efficiency and competitiveness while meeting business objectives.
Say Company ABC pays its supplier Supplier XYZ on average in 35 days. A competitor of Company ABC, Competitor DEF, pays this same supplier in 60 days. By paying Supplier XYZ early, Company ABC is indirectly subsidising the longer payment requirements of its competitor Competitor DEF. As a result Competitor DEF has more working capital to pay off cash flows or invest in other short term investments- giving it a clear competitive advantage over Company ABC.
This is why it is crucial for businesses to understand how their DPO compares to their competitors. Contact us to learn how your DPO performance fairs against others in your industry and how our innovative platform can improve your supply chain, from working relationships to working capital.