Common Misconceptions About Days Payable Outstanding
What is Days Payable Outstanding’?
- Days Payable Outstanding is a measure of business liquidity, specifically how swiftly a company pays its Creditors or bills. It’s also known as Creditors Days.
- It’s almost a moral dilemma for businesses to decide how regularly they pay their Trade Creditors. Paying less often/stalling creditor payments can lead to differences between the provider of goods/services and the business. However, if you pay your short-term creditors on or within agreed time limits, you might be losing out compared with your peer group. It’s a paradox that such efficiency is more expensive for the business, as it requires a higher level of working capital.
- High Days Payable Outstanding ‘can become an issue that can impact Brand too. Many large companies in the past have taken advantage of their scale, knowing that they are such a significant part of their suppliers’ business that they can leverage off such dynamics and withhold payment – often for periods of 60+ days. This has backfired in recent times, though – companies have received adverse publicity from such practices.
How are the Days Payable Outstanding calculated?
The standard calculation is;
Average Trade Creditors / (Cost of Goods Manufactured or Purchased or Cost of Sales) *365
Both Creditors and Turnover figures are available in company accounts.
What does the Days Payable Outstanding indicate?
The calculation shows, on average, how many days’ credit a company is taking before it pays its trade debts. An increasing number can be an indication of a business’s short-term funding position worsening.
Suppliers to a company showing such a trend should be wary of trading with these companies on over-generous credit terms. Should the company be heading towards significant liquidity difficulties, the supplier may not get paid.
The risks of mismanagement of creditors Days Payable Outstanding
Many businesses have growing turnover, profitable products, and customers and yet still run into short-term financing difficulties. Ultimately, if such a situation results in huge unpaid creditors, business management will be buoyed by increased turnover and continue to ramp up sales and marketing efforts. However, it may not be efficient enough to collect from its Debtors for these sales, and it may over-invest in inventories and hire staff too rapidly. Untimely, a failure to collect debts then puts a strain on paying its creditors.
It’s, therefore essential that a company maintains a robust and realistic working capital forecast throughout high growth. Besides, Management should recognize the difference between long-term and working capital needs to meet its regular and fluctuating working capital needs.