One month ago, few people could have fully anticipated the scenario in which we now collectively find ourselves: Businesses and borders shuttered throughout the world, economic uncertainty for many workers, and a global economy edging toward recession. Many organizations are understandably concerned about liquidity and cash flow, as they evaluate how they can continue to pay their operating expenses.
This month, we examine days payable outstanding (DPO), a measure that reflects the average number of days that it takes an organization to pay its creditors. DPO is a metric that directly linked to cash management and liquidity. Organizations track and adjust their DPO to improve their cash flow and working capital while protecting their balance sheet profile.
Data from APQC’s Open Standards Benchmarking® database shows that organizations falling within the 75th percentile for this metric have an average DPO of 53 days, while the median have a DPO of 40. The fastest-paying organizations are those in the 25th percentile, with an average DPO of 30 days (see chart). These numbers have risen across the board since 2017. In that year, organizations in the 75th percentile paid within 46 days. Firms in the median paid within 30 days, and those in the 25th percentile within 27 days.
Every organization’s DPO will be a product of its industry, its relationships with suppliers, its strategy, and its business needs. A higher DPO is more advantageous for the buyer (and disadvantageous for the seller). If a buyer can wait longer to pay its bills, it can put any excess cash reserves to work on short-term investment opportunities. And, despite low overall funding costs, large companies have been paying their bills later and later to do just that.
There are conditions under which a lower DPO might be better. For example, some organizations pay early to take advantage of early-pay discounts or to avoid penalties for paying late.
Had we found ourselves in a typical April, my advice would have been that a good DPO is, all else being equal, somewhere in the range of the median in the figure above. This April is no ordinary one, however. To preserve the ability to keep paying employees and better manage operating expenses, companies may need to consider extending DPO as long as reasonably possible to ensure optimal cash flow.
Lengthening an organization’s DPO requires a delicate balancing act. While there are good reasons for extending DPO, waiting too long to pay suppliers could potentially damage relationships or lead suppliers to put in place credit restrictions. Extended payment terms tend to hurt the ability of suppliers to grow and run their businesses, which also have operating expenses to cover and employees to pay.
COVID-19 is not the first major disruption to global business and it certainly won’t be the last. In times of disruption and uncertainty, relationships with suppliers can make or break a company’s ability to continue doing business.
As a finance chief consider adjustments to DPO, he or she should coordinate with suppliers — especially those with whom they have strategic and mutually-beneficial relationships. Having transparent conversations with suppliers about the current revenue stream is the best play; suppliers will appreciate being party to the organization’s major business decisions.
As a company increases its DPO in coordination with suppliers, it will want to couple this move with a decrease in days sales outstanding (DSO) to bring cash in more quickly. If a business can extend DPO while decreasing DSO, its liquidity and cash reserves will improve. But it is also no easy feat, especially with large sectors of the economy virtually shut down.
Prudent organizations are taking steps to protect themselves and their employees in this difficult time. Adjusting DPO is one strategy that organizations will likely be leveraging to manage their cash flow if they haven’t already. But it is incumbent on every organization to remain cognizant of the tradeoffs and balances that need to be struck.
Perry D. Wiggins, CPA, is CFO, secretary, and treasurer for APQC, a nonprofit benchmarking and best practices research organization based in Houston, Texas.