There are several factors to consider when analyzing a company’s DPO. These include:
• The company’s DPO relative to its industry
• Trends in the company’s DPO over time
A high DPO (low payables turnover) means the company is paying its suppliers slowly. This means the company will require less financing for inventory. However, a very high DPO could also mean the company is forfeiting discounts for early payment, incurring fees for late payment, and harming relationships with suppliers.
Thus, the highest DPO isn’t always the optimal DPO. But assuming no harm is being done, a high DPO is preferable to a low DPO.
Industry factors
DPO varies across industries; credit terms that are considered standard in one industry might be unacceptable in another industry.
Even within a specific industry, such as retail, DPO can vary markedly across firms. In 2021, for example, DPO ranged from 31 (Costco) to 69 (Target). Costco clearly paid suppliers more quickly than its peers did, with Target’s suppliers having to wait more than twice as long for payment.
Why might a company have a higher DPO than its industry peers? There are several possibilities:
• The company has superior accounts payable processes (operational excellence)
• The company has negotiated better payment terms (negotiation)
• The company is delaying payments because it is short on cash (financial distress)
• The company is delaying payments to inflate operating cash flow (manipulation)
• The company’s DPO is calculated differently than the DPO of other firms (accounting)
Trends in DPO
While comparing a company’s DPO to that of its peer firms is helpful, analyzing DPO over time can also reveal important trends. For example, if a company’s DPO has increased substantially for years, the company might be delaying payment of its suppliers. This could be because:
• General economic conditions have deteriorated (e.g., there’s a recession)
• The company is experiencing financial difficulties
• The company has negotiated more favorable credit terms with its suppliers
• The company is manipulating its operating cash flow
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