Accounts Payable Days: What It Is And How To Improve It

Accounts Payable (AP) Days or Days Payable Outstanding (DPO) is an essential measure in determining a company's financial health. Accounts payable days are inversely proportional to the accounts payable turnover ratio, which shows how many times a company has paid off its suppliers in a given period. Therefore, the higher the accounts payable days, the lower the turnover ratio, negatively impacting your vendor and investor relationships. In this day and age, where supply chains are prone to frequent disruptions, improving invoice processing and ensuring vendors are paid quickly and on time is of utmost importance. 

What Is Accounts Payable Days?

Plainly speaking, accounts payable days refers to the average number of days a company takes to pay their vendors. Therefore, accounts payable days is the time between receiving the invoice and payment. It depends largely on the volume of invoices processed and the speed with which invoices are processed. 

Accounts payable days are calculated as follows: 

Accounts Payable Days = Average accounts payable * Number of days / Cost of goods sold 

Here, the average accounts payable refers to the amount due to vendors on account of purchases, and cost of goods sold refers to the total value of direct costs of the goods sold in the same period.

The accounts payable turnover ratio indicates how many times a company pays back its vendors in a given period. It is inversely related to accounts payable days. The higher the accounts payable turnover ratio, the lower the accounts payable days.

Therefore, the accounts payable turnover ratio can be calculated as follows:

Accounts payable turnover ratio = Cost of goods sold / Average accounts payable

In terms of the accounts payable turnover ratio, accounts payable days can be calculated as follows: 

Accounts payable days = Number of days / Accounts payable turnover ratio 

Accounts payable days are a strong measure of the creditworthiness of a company. Stakeholders largely study it to determine the company’s financial position and future prospects. 

Factors Influencing Accounts Payable Days

Analyzing the effectiveness of a company processes based on accounts payable days isn’t simple nor straightforward. Multiple factors can affect the time a company takes to pay its vendors. 

Industry norms

The average accounts payable days largely depend on the industry a company is a part of. Manufacturing companies might have a largely different average accounts payable days than finance companies, depending on the type of vendors and complexity of accounts payable processes. The addition of 3-way invoice matching in the accounts payable process might also result in a longer processing time compared to a 2-way match or in the absence of any matching process. 

Payment terms

The payment terms are agreed upon between the vendor and the customer and specify when the customer should pay for the goods or services delivered by the vendor. These terms are mentioned in the invoice when it received. Negotiating longer payment terms enables companies to pay their vendors a little later than usual, increasing their accounts payable days. This would, however, not indicate poor financial performance. 

Company policies

Different companies have different policies on how often they process payment runs. Some companies prefer to process payment runs every day, while others process them weekly or biweekly. This process would also impact and can result in an increase or decrease in the accounts payable days. 

Importance of Accounts Payable Days

Accounts payable days helps a company to determine the state of its cash flows. Maintaining accounts payable days or DPO is significant for your company’s growth as large variations could negatively impact the company’s financial health. A large increase in AP days could be an indicator of cash flow issues demonstrating a company’s struggle to pay its suppliers. A decrease in AP days on the other hand, could mean the company is paying its supplier too fast. 

Consequences of low DPO

A low DPO indicates that your company pays back its vendors too fast. Though a low DPO builds trust among your vendors and stakeholders, paying off your vendors too quickly can limit the cash flow available with the company for investment opportunities. A low DPO accompanied by high accounts receivable days is even more dangerous as it means that the company is paying its suppliers earlier than they are able to collect funds from their customers. At the same time, a low DPO could also mean the company is able to utilize early-pay discounts from its suppliers. Hence, maintaining DPO at an optimal level is important for a company’s financial health.

Consequences of high DPO

A high DPO indicates that you take time to pay back your vendors. This leads to distrust among your vendors about your creditworthiness and financial wellness. Low trust among vendors creates challenges while negotiating with vendors and may not get you the best deals.

Example of Accounts Payable Days

Let’s consider a car manufacturing company purchasing raw materials from their vendors on credit. At the beginning of the year, the company owed its vendors $6,000,000 in accounts payable. By the end of the year, the company owed its vendors $4,000,000 in accounts payables. The overall purchases made by the company on credit from its vendors amounted to $45,000,000 over the year. Let’s calculate the accounts payable turnover ratio and accounts payable days for the company. 

The accounts payable turnover ratio for the company can be calculated as follows: 

Accounts payable turnover ratio = 45,000,000/ (6,000,000 + 4,000,000)/2 

Which comes out to be 9. 

Accounts payable days is related to the accounts payable turnover ratio as: 

Accounts payable days = 365 / Accounts payable turnover ratio

Therefore accounts payable days come out to be 40.55. 

This means the company pays off its vendors every 40 days. 

Best Practices to Manage Accounts Payable Days

Now that you know about the importance of maintaining accounts payable days, it is essential to know some best practices to improve DPO. 

Negotiate optimum payment terms from vendors

When an invoice is paid largely depends on the payment terms agreed upon with the vendor. An extended payment period allows you to take your sweet time before paying the invoice, whereas strict and short payment terms force you to pay the invoice as soon as it is received. This urgency can lead to unexpected manual errors, duplicate payments, and reduce the available cash flow for the company. Therefore, negotiating better payment terms with your vendors allow you to strategize to improve your accounts payable days. 

Optimize AP team duties

AP processes take time if the amount of manual work involved is high and limited personnel are available at your disposal. Planning payment runs effectively and assigning duties among your accounts payable teams with defined deadlines can help increase efficiency and responsibility, facilitating better vendor relationships. Having accountability among your team members also ensures each invoice is processed accurately, reducing manual errors. 

Implement AP automation software

Manual processes are generally time-consuming, causing delays in payments and, in turn, higher AP days. AP automation software allows you to reduce manual tasks for your employees, speeding up processing times and reducing errors. With less time spent on processing invoices, your team can better verify the validity of invoices and plan payment runs, ensuring vendors get paid on time. Some AP automation vendors, like ClearTech, automatically create payment runs based on invoice due dates and payment modes, thus lowering AP days. With ClearTech, you also get 100% accurate invoice digitization with a mix of OCR and managed services. 

Conclusion

Accounts payable days or days payable outstanding is the average number of days a company takes to pay back its vendors. Having a high DPO decreases the company’s creditworthiness and vendor trust. Having a low DPO can cause your company to have less cash liquidity. Thus maintaining accounts payable days is of utmost importance. Factors like industry, payment terms, and company policies affect a company’s accounts payable days. To maintain an optimum DPO, companies need to negotiate better terms with their vendors and optimize their AP processes by implementing automation. AP automation can ensure invoices are processed quickly and accurately, allowing companies to pay back their vendors on time. 

FAQs

• How do you calculate accounts payable days?

Accounts payable days are calculated by dividing the product of the total number of days and average accounts payable by the cost of goods sold by the company within the period. 

• What does accounts payable days tell you?

Accounts payable days indicate how many days a company takes to pay back its vendors on average. 

• What are the average days to pay accounts payables?

The average number of days to pay accounts payables largely depend on factors such as the industry the company is part of. However, any period longer than 90 to 120 days is considered a high DPO.