Average payment period

Average payment period
See also

The average payment period (also called Days Payable Outstanding) shows the number of days the average number of purchases remains unpaid. In other words, it shows the average number of days the company has taken to pay its goods suppliers. According to the credit period allowed by the suppliers, it will indicate whether or not the company paid the suppliers on time. A low ratio can mean the firm's sound liquidity position, resulting in the company being able to take advantage of the supplier's cash discounts. A higher ratio could result in[1]:

  1. fewer discount facilities
  2. higher prices paid for the goods.

It is very important to compare the ratio with the ratio of different other companies in the same industry and to study the trend of this ratio in the company itself[2].

It needs to be as close as possible to the credit terms provided by the suppliers (usually 30 days), but some companies push out payables unethically as higher numbers tie up less of their money as it attracts more cash from their suppliers. If a company is genuinely cash-starved at a certain point in time, the appropriate course of action is to contact your suppliers to explain the situation and request for more time[3].

Average Payment Period Formula

The formula of the Average Payment Period is presented as[4]\[ Average\ Payment\ Period\ =\ \frac{Average\ Accounts\ Payable}{Average\ Daily\ Credit\ Purchases}\]

Example of The Payment Period

"\(\frac{Trade\ creditors}{Purchases} \cdot\ 365\)

If purchases for the year are £90,000 and trade creditors are £20,000\[\frac{£20,000}{£90,000}\ \cdot\ 365\ =\ 81.1\ days\]

Again this should be compared with previous years, with similar businesses, and the length of time that creditors allow for payment. Note that a business may deliberately delay payment of creditors for as long as reasonably possible. Large companies, in particular, may do this as they have stronger bargaining power than their smaller creditors. If the period has dramatically increased, it may be that the business is having difficulty in paying its bills. However, a large figure for creditors may just be due to an increase in purchases just before the date of the balance sheet, and this may have been in anticipation of increased sales, or to buy in before prices are increased."[5]

References

Footnotes

  1. M. C. Shukla, T. S. Grewal, S. C. Gupta, 2017, p. 24.51
  2. M. C. Shukla, T. S. Grewal, S. C. Gupta, 2017, p. 24.51
  3. J. Zieltow, A. G. Seidner, 2007, p. 61
  4. M. C. Shukla, T. S. Grewal, S. C. Gupta, 2017, p. 24.51
  5. D. Kay, J. Baker, 2007, p. 133

Author: Aleksandra Walawska