Days payable

Days payable is an indicator showing the number of days it takes a company to pay its suppliers on an average. It gives a good idea on how a company is dealing with its current liabilities. In order to calculate days payable we need to take the number of days in accounting period and divide it by the payable turnover.

Payable turnover

In order to measure days payable we need to first obtain the payable turnover. Payable turnover is basically an average number of times that a company is paying its accounts payable during an accounting period. It shows credit terms extended to a company. To calculate it, first we need to adjust cost of goods sold by the change in inventory - this will give us the value of the purchases. The next step is to divide purchases by the average accounts payable value. The result is the payable turnover number.

Days payable calculation

Lets suppose we are running an advertising company. To obtain our days payable there are two steps that need to be taken:

• first we need to calculate our payable turnover value as follows.

$Payable\ turnover\ =\ {\frac {Cost\ of\ goods\ sold\ \pm \ Change\ in\ inventory}{Average\ accounts\ payable}}$

$Payable\ turnover\ =\ {\frac {21,750.00-95.00}{\left(2,750.00+3,187.00\right)/2}}={\frac {21,655.00}{2,968.50}}=\ 7.3\ times$

• Once we have the payable turnover we can start calculating days payable.

$Days\ payable\ =\ {\frac {Days\ in\ accounting\ period}{Payable\ turnover}}$

$Days\ payable\ =\ {\frac {365\ Days}{7.3}}=50\ Days$

Analysis and interpretation

The Payout turnover equal to 7.3 times and Days payable of 50 days are both saying that the credit terms our company's receives from its suppliers is rather good. Our company's suppliers are waiting quite a long time to be paid and we have more time to use the cash. It is crucial for the company to asses that number with the number of days it takes to collect its receivables. If the time we collect our receivables is higher we can have difficulties with cash flow thus running the operations. The other thing we need to take under consideration is our suppliers' satisfaction. Higher days payable means better position with cash, but also less happy vendors. This can result in damaging our reputation in the eyes of other top suppliers thus discourage them from making business with our company. It can display for example in prices being a little higher or terms slightly stiffer. The complete opposite can be expected by a company with swift-payment reputation. To sum up, the desire of having more time for using the cash needs to be balanced in every company with a need to keep its vendors happy and maintain good relationships with them.

Examples of Days payable

• Days payable for a retail business is typically shorter due to the high volume of transactions and the need for quick payments. For instance, a retail store may have a days payable of 30 days, which means that suppliers are paid within 30 days on average.
• A manufacturing business may have a longer days payable due to the need to pay suppliers in order to produce its products. For instance, a manufacturing company may have a days payable of 60 days, which means that suppliers are paid within 60 days on average.
• A services business may have a longer days payable due to the need to pay suppliers for services that may take longer to be performed. For instance, a consulting company may have a days payable of 90 days, which means that suppliers are paid within 90 days on average.

Advantages of Days payable

Days payable is a useful metric that helps measure a company’s ability to manage its accounts payable. It gives insight into a company’s financial health and liquidity position. The following are some of the advantages of measuring days payable:

• It provides a snapshot of the company’s cash flow position by showing how quickly it is paying off its creditors.
• It gives an indication of the company’s creditworthiness and its ability to manage its debt.
• It helps identify potential financial risks, such as cash flow problems, that could affect a company’s ability to pay its bills.
• It can also be used to compare a company’s performance to that of its competitors.
• It can help inform decisions about whether to offer customers discounts for early payment or to extend payment terms.

Limitations of Days payable

Days payable is a useful measure for determining how efficiently a company is managing its current liabilities, however it is not a perfect measure and has a few limitations. These include:

• It does not take into account the types of suppliers or the terms of the payments. For example, a company may have a large number of suppliers but may be paying them all on different terms, such as net 30, net 45, etc. Days payable would still show the same number regardless of the terms.
• It also does not take into account the amount of money being paid to each supplier. A company may have a large number of suppliers but may be paying them all a very small amount, which would not be reflected in the days payable calculation.
• It also does not take into account any discounts that may be given for paying early. This could result in a company appearing to have a longer payment period than it actually does.
• Finally, it does not take into account the cash flow of the company and whether or not it is able to pay its suppliers in a timely manner.

Other approaches related to Days payable

Days payable is an important metric for evaluating a company’s financial health. Apart from calculating Days Payable as mentioned above, here are some other ways to measure this metric:

• Average Payment Period (APP): This metric measures the average number of days it takes a company to pay its suppliers. It is calculated by dividing the total payable balance by the total amount paid in the accounting period.
• Cash Conversion Cycle (CCC): This metric measures the amount of time it takes for a company to convert its inventory into cash. It is calculated by subtracting the average collection period from the average payment period.
• Average Collection Period (ACP): This metric measures the average number of days it takes a company to collect payment from its customers. It is calculated by dividing the total receivable balance by the total amount collected in the accounting period.

In summary, Days Payable is an important metric that can provide insight into a company’s financial health. It can be calculated in multiple ways, including Average Payment Period, Cash Conversion Cycle, and Average Collection Period.

Days payable — recommended articles

Payables turnover — Average collection period — Average payment period — Activity ratios — Defensive interval ratio — Burn Rate — Cash Flow-to-Debt Ratio — Asset coverage ratio — Solvency ratios

References

• Berman K., Knight J., Case J., (2013), Financial intelligence, Business Literacy Institute, Inc., United States of America
• Crosson S. V., Needles Jr. B. E., (2014), Managerial accounting, South Western Cengage Learning, United States of America
• Needles Jr. B. E., Powers M., Crosson S. V., (2011), Principles of accounting, South Western Cengage Learning, United States of America

Footnotes

Author: Kamil Juszczuk