Average payment period
| Average payment period |
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| 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]:
- fewer discount facilities
- 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]:
Example of The Payment Period
"
If purchases for the year are £90,000 and trade creditors are £20,000:
Failed to parse (SVG (MathML can be enabled via browser plugin): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle \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]
Advantages of Average payment period
A low average payment period can be beneficial for the company as it indicates a sound liquidity position, allowing the company to take advantage of suppliers' cash discounts. Some of the advantages of an average payment period include:
- Better negotiation power with suppliers: Having sufficient funds to pay suppliers on time can result in improved negotiation power as the company can take advantage of cash discounts offered by suppliers.
- Improved supplier relationships: Paying suppliers on time can lead to better relationships with suppliers and make them more willing to give better deals in the future.
- Less risk of bad debts: Paying suppliers on time can reduce the risk of bad debts and enable the company to make more reliable financial projections.
- Improved cash flow management: An average payment period can help to better manage cash flows as it provides an estimate of when funds need to be paid out.
Limitations of Average payment period
- The Average Payment Period does not take into account the size of the total payment. It does not take into account whether or not the company is paying its suppliers late or in a timely manner.
- The calculation of the average payment period does not consider the credit period allowed by the suppliers, and therefore may not be a true indication of how quickly the company is paying its bills.
- The Average Payment Period only takes into account the company's purchases and does not include any other expenses such as interest payments, taxes, or dividends.
- The Average Payment Period does not take into account any discounts that the company may receive from its suppliers. This could lead to an overestimation of the company's payment period.
- The Average Payment Period may not be accurate if there is a sudden change in the company's payment policies or if the company has recently acquired a new supplier.
Introduction: This section will discuss other approaches related to the Average Payment Period.
- Negotiating Payment Terms: Taking the time to negotiate payment terms with suppliers can help reduce the Average Payment Period. Companies can negotiate for a higher credit period, extended payment terms, or discounts for early payments.
- Analyzing Payment History: Companies can analyze the payment history of their suppliers to identify areas where the payment period could be improved. By understanding the payment behaviors of their suppliers, companies can better plan their payments and improve their Average Payment Period.
- Automating Payment Systems: Automating payment systems can help reduce the time spent on processing payments and improve the Average Payment Period. Automating payment systems can help streamline the payment process, reducing the time spent on manual data entry and increasing efficiency.
- Optimizing Cash Flow: Optimizing cash flow by ensuring timely payments of invoices can also help reduce the Average Payment Period. Companies can use strategies such as early payment discounts to incentivize suppliers to accept payments earlier.
In summary, other approaches related to the Average Payment Period include negotiating payment terms, analyzing payment history, automating payment systems, and optimizing cash flow. Taking the time to implement these approaches can help companies reduce their Average Payment Period and improve their cash flow.
References
- Allen J. E., (2004)., Assisted Living Administration: The Knowledge Base, Second Edition, Springer Publishing Company, United States of America
- Banerjee B., (2012)., Financial Policy and Management Accounting, PHI Learning Pvt. Ltd., India
- Kay D., Baker J., (2007)., Solicitors' Accounts, 2007-2008, Oxford University Press, Great Britain
- Shukla M. C., Grewal T. S., Gupta S. C., (2017)., Advanced Accounts Volume–II, 19th Edition, Tom 2, S. Chand Publishing, India
- Zieltow J., Seidner A. G., (2007)., Cash & Investment Management for Nonprofit Organizations, John Wiley & Sons, United States of America
Footnotes
Author: Aleksandra Walawska
