Key takeaways
- Days Payable Outstanding (DPO) measures the average number of days a company takes to process invoices and pay suppliers, while Days Sales Outstanding (DSO) represents the number of days it takes to bill and receive customer payments.
- Effective cash managers seek to simultaneously extend DPO and reduce DSO metrics, improving working capital.
- Beyond reducing dependence on external financing, effective DPO and DSO management strengthens supplier and customer relationships.
Working capital is the force that drives your business, and it maintains its health through effective cash flow management. Days Payable Outstanding (DPO) and Days Sales Outstanding (DSO) provide valuable insights into your company’s financial operations and are predictive of future cash flows. By implementing effective payment and collection strategies that improve these metrics, your business can maintain liquidity, ensure smooth operations and strengthen relationships with suppliers and customers.
What is Days Payable Outstanding (DPO)?
Days Payable Outstanding is a financial metric that measures the average number of days a company takes to process and pay supplier invoices. Extending DPO effectively means holding cash longer, which can improve working capital.
Calculating DPO
To calculate DPO, follow these steps:
1. Gather these three numbers:
- Number of days in the period: typically 365 for annual calculations (some industries use 360), 90 for quarterly or 30 for monthly
- Total accounts payable (AP) at the end of the period: the amount your business owes to suppliers
- Cost of goods sold (COGS) for the period: the direct costs attributable to the production of the goods your business has sold
2. Use this formula: DPO=(Accounts Payable/Cost of Goods Sold) * Days
Impact of DPO on cash flow
A high DPO indicates that your business is taking a long time to pay suppliers. Extended payment timelines improve liquidity and provide more flexibility in managing other financial obligations. An easy way to do this while remaining sensitive to suppliers is to focus on paying invoices on their due dates, and not earlier.
Conversely, a lower DPO signals that your company might be paying its suppliers too quickly. While this might strengthen supplier relationships, it can inhibit effective cash management.
Understanding DPO helps your business assess and optimize payment practices and tools. This knowledge enables you to balance efficient cash flow management with healthy supplier relationships.
Our team can help you develop strategies for cash flow management and working capital that work best for your business.
What is Days Sales Outstanding (DSO)?
Days Sales Outstanding (DSO) measures how quickly your business converts credit-driven receivables into cash. While optimal DSO varies across industries, a lower number indicates more effective collection practices. These processes—such as prompt invoicing, clear payment terms and efficient follow-up—strengthen cash flow and reduce accounts receivable (AR) aging, which may result from customer cash flow issues. In general, a DSO cycle of 30 days or less is considered standard for most business to business (B2B) trade, indicating that the company’s cash is coming in at a reasonably efficient rate and can be used to create new business within a reasonable time frame.
DSO also reflects the efficiency of your cash application process—how accurately and quickly your organization matches received payments to specific invoices and posts them to your accounting system. For example, your customers might pay you in less than 30 days, but if it takes 10 days to post them to the accounting system, DSO gets extended while the goal is to reduce it. Posting receivables is a crucial step in the order-to-cash cycle for maintaining accurate financial records.
Calculating DSO
To calculate DSO, follow these steps:
1. Gather three numbers:
- Total accounts receivable (AR) at period end: what customers owe you
- Net credit sales for the period, excluding any cash sales
- Number of days in the period: typically 365 for annual calculations (some industries use 360), 90 for quarterly, 30 for monthly
2. Use this formula: DSO = (Accounts Receivable/Credit Sales) * Days
While optimizing DPO and DSO metrics is financially beneficial, successful businesses balance these goals with maintaining strong relationships. The aim isn’t simply to delay all payments and accelerate all collections, but rather to manage cash flow in alignment with your business values and customer/supplier expectations. Companies with strong supply chains often negotiate transparent payment terms that benefit both parties rather than simply extending payments unilaterally.
Benefits and strategies to optimize DPO
- Negotiate favorable payment terms with suppliers. For example, ask them to extend payment periods without penalties.
- Request early-payment discounts from suppliers. This reduces bottom-line costs while improving supplier relations.
- Implement efficient AP processes, including AP automation. This can help ensure timely and accurate payments.
- Monitor AP aging carefully. Tracking payment timing helps avoid settling invoices before they’re due.
Strategies to optimize DSO
- Invoice and bill customers electronically. Digital bills reduce costs while increasing efficiency, accuracy and security. This starts the clock for your payment terms sooner.
- Invoice immediately after delivering goods and services. Your payment terms don’t start until they receive your invoice.
- Implement effective credit policies. This can help your business extend credit only to creditworthy customers.
- Monitor AR aging carefully. Consider accepting card payments from customers with high AR aging before pursuing collection.
- Automate AR with technology. This improves AR efficiency and accuracy and helps to improve your DSO and accounts receivable management.
We’re here to help
J.P. Morgan offers comprehensive payables and receivables solutions to support your business needs. Contact your J.P. Morgan representative or visit our treasury solutions page to learn more.
JPMorgan Chase Bank, N.A. Member FDIC. Visit jpmorgan.com/commercial-banking/legal-disclaimer for disclosures and disclaimers related to this content.
