A CFO’s haphazard decisions about how promptly to pay bills can damage strategic relationships and cause organizations to miss out on business or investment opportunities.

Finding the liquidity sweet spot requires intentionally balancing customer payment terms and the average time between receiving and paying invoices from third parties. Doing so helps financial managers maintain alignment with strategic goals, market shifts and external economic conditions. The key to striking this balance lies in tracking and managing two corresponding measures: days payable outstanding (DPO) and days sales outstanding (DSO).

This article focuses on DPO because it’s critical to understand this measure and determine where your organization stands, compared to top performers. A high DPO can sabotage strategic supplier or vendor relationships, and a too-low DPO constrains liquidity.

What is days sales outstanding?

DPO measures how many days it takes a company, on average, to pay its creditors. It is calculated as the average accounts payable balance divided by the cost of goods sold (or operational expenses), multiplied by 365 days.

DPO helps companies analyze the duration of the procurement process from beginning to end. But DPO also serves an important role in managing cash flow. Organizations track and adjust their DPO to improve cash flow and working capital while protecting their balance sheet profile.

The first step is calculating DPO for your company and comparing it against benchmark data. APQC puts median DPO at around 40 days across all industries. Organizations at the higher end of the spectrum (in the 75th percentile) sit at around 50 days. The lower end (25th percentile) is about 30 days. 

Determine if your DPO is high or low for your industry and business by comparing your DPO against data from peer organizations. If it’s high, ask yourself, is it intentionally high? Is it part of a larger cash management strategy? Or are there red flags in your accounting department? Inefficient processes in accounts payable could drive your DPO up. Likewise, if DPO is low, find out why.

To free up cash, couple a high DPO with a lower DSO. In other words, for a stronger liquidity position, get money from customers quickly and pay suppliers and vendors slowly.

But be aware of how this affects supplier and vendor relationships. Vendors like being paid on time. Some organizations can train their vendors to tolerate longer terms, but vendors are more likely to do favors for customers who pay quickly. In a tight supply chain, prioritizing strategic supplier relationships makes sense.

Discounts for paying early are another consideration in managing DPO.

Payment policies and philosophies

Although some organizations have written policies about DPO and accounts payable, others have developed a more informal cash flow management philosophy or business practices. This varies by industry and depends on other contextual factors.

Some companies dictate swift payment to take advantage of early-pay discounts. Setting a policy for how payments are made also affects DPO. Checks take time to clear, pushing DPO up, while other methods post instantly.

As high inflation and interest rates have made cash harder to acquire, some companies have adopted a cash-hoarding mentality. Economic stabilization could see this trend start to reverse, particularly as supply chain sustainability is increasingly scrutinized, which puts pressure on firms to prioritize strategic partnerships. But careful management of cash flow and measures like DPO and DSO that affect it will never go out of style.

Perry D. Wiggins, CPA, is CFO, secretary, and treasurer for APQC, a nonprofit benchmarking and best practices research organization based in Houston, Texas. Data in this content was accurate at the time of publication. The most current data can be found here.

This article was written by Perry D. Wiggins from CFO.com and was legally licensed through the  DiveMarketplace by Industry Dive. Please direct all licensing questions to legal@industrydive.com.

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This article is for informational purposes. It is not designed or intended to provide financial, tax, legal, investment, accounting, or other professional advice since such advice always requires consideration of individual circumstances. Please consult with the professionals of your choice to discuss your situation.