Unlike a lot of other metrics, Days Payable Outstanding isn’t necessarily better the higher or lower it is. Too high, and it can start to irk suppliers. Too low, and you’re sacrificing cash-on-hand. So where is the good middle ground? To get there, we need to look at 2 other metrics
A high DPO is bad if you aren’t paying your vendors on time.
Before even contemplating whether your Days Payable Outstanding is strong, you need to know what your on-time payment percentage is. If you are below 90%, there likely needs to be an initial focus on improving that percentage, including confirming how close to the due date on-time payments are made (hint: the closer the better when it comes to improving DPO).
Skipping this step likely means improving the DPO at the expense of supplier relationships. While it may give short-term rewards, it will cause long-term problems when suppliers start tightening charging late fees and reducing payment terms.
Don’t forget to consider vendor payment terms
Speaking of payment terms, you may be paying your vendors on-time, but how good are your payment terms? Are they aligned with what similar companies are receiving from that vendor? While payment terms benchmarking has many variables that makes it difficult to provide a flat “x days is ideal” answer, if your vendors consistently accept your offered payment term without pushback (or if you just accept their default terms), then there is likely room for improvement.
Getting longer payment terms enables you to increase Days Payable Outstanding. You may even be willing to sacrifice your DPO a bit if it means getting early payment discounts. We have negotiated surprising payment term increases with little pushback, although the number one consideration vendors will make is whether you pay on-time, hence why it is key to get that house in order first.
How to calculate your ideal DPO number
Once you confirm your vendors are being paid on-time and you have negotiated strong(er) payment terms with your vendors, you should calculate your target Days Payable Outstanding as the average payment term for your spend, subtracting 2-3 business days (assuming you are paying with ACH or vCard, more if you are mailing a check).
Note that I didn’t say to average out the payment terms across vendors, you need to consider spend per vendor in that average. Consider a hypothetical company that has only 2 vendors: One at Net 30 and the other at Net 90. Someone might look at that and think the average payment term is Net 60. However, if Net 30 vendor gets $10 million of spend per year and the Net 90 has $1 million, the true average payment term when factoring in spend is 35.5 days.
Increasing Days Payable Outstanding can be one of the few metrics that show AP is successful beyond processing invoices and can help justify the department’s costs, but it requires looking at it strategically from multiple angles. Trying to increase DPO without carefully taking in the other aspects above may have short-term success, but long-term harm to the company’s reputation.