Looking for some solutions, these insights and critical steps will help your accounts payable team help their CFO sleep at night.
Ensuring the business has enough cash is the thing that keeps CFOs up at night. Accounts payable departments can help their CFOs sleep a little better by doing a better job of measuring Days Payable Outstanding (DPO) – the average number of days it takes an organization to pay its liabilities.
Measuring DPO helps organizations ensure that invoices are neither paid too early nor too late.
Despite the outsized impact that DPO has on cash flow, only 30 percent of organizations track their DPO, according to the Institute of Finance and Management’s (IOFM) benchmarking data.
Not sure where your DPO stands? Here is a formula to determine your DPO:
- DPO = average accounts payable / (cost of sales / 365 days)
The lower the DPO ratio, the faster the organization pays its liabilities.
Among organizations that track DPO, 55 percent pay their suppliers in 30 days on average, while 14 percent of organizations pay suppliers in 31 days to 45 days, 6 percent of organizations pay suppliers in 46 days to 60 days, and four percent of organizations take more than 60 days, IOFM finds.
Twenty-one percent of organizations pay suppliers in less than 30 days.
The Perils of Not Tracking DPO
Paying suppliers too fast sends cash out the door that your organization may need for its day-to-day operations. This puts organizations at a financial disadvantage to their competitors in their industry. What’s more, fast payment is akin to providing your suppliers with a free line of credit.
High DPO may translate into having more cash on hand (free cash flow). But high DPO also may indicate that your organization is not taking advantage of early payment discount offers from suppliers. Early payment discounts offset an accounts payable department’s overhead. As an example, an organization with $1 billion in annual spend stands to capture $10 million a year in early payment discounts if they receive just a 1 percent discount on invoices paid 20 days early.
Put another way, a 1 percent discount for 20 days early payment translates into an 18.25 percent return – more than many organizations are earning on interest-bearing money market accounts.
What’s more, high DPO could lead to strained relationships with cash-strapped suppliers.
Accounts Payable Solutions – Critical Steps to Optimizing Cash
To be sure, global corporations can demand great credit terms from their suppliers. And they have less pressure to pay suppliers than a startup or mid-sized business with less clout in their industry.
But most small and mid-sized organizations must manage their DPO carefully, to optimize cash and eliminate potential disruptions to their supplier network. How can you walk this fine line?
- Measure your DPO. It is one of the most important metrics to CFOs, IOFM finds.
- Capture early payment discounts. If your DPO is high, consider putting your organization’s cash to work by capturing more early payment discounts from suppliers.
- Leverage cards to extend your DPO. Paying suppliers via certain virtual card programs enables organizations to instantly extend their DPO.
Want help optimizing your organization’s DPO?
Experts from ACOM Solutions can provide you with a no-obligation analysis of your DPO and help identify opportunities for improvement.