What is Accounts Payable Days and How to Calculate It?

Introduction

Accounts Payable (AP) Days, or days payable outstanding, represent the average time a company takes to settle its outstanding invoices with suppliers. This metric offers valuable insights into the efficiency of a business’s payment processes and overall financial health. By analyzing AP Days, businesses can assess their payables performance, pinpoint areas for improvement, and make informed decisions about future financial obligations.

This article will cover everything you need to know about accounts payable days, including what it is, why it matters, the formula for payable days, and how to calculate it. So, let’s dive in and explore this critical financial metric.

What Are Accounts Payable Days?

Accounts payable days are also commonly known as ‘Days Payable Outstanding (DPO)’, and they refer to the average amount of time that a company takes to pay invoices collected on goods purchased over a year or a specific period. This financial ratio is calculated to analyze the efficiency of the business. 

Think of accounts payable days as the counterpart to Days Sales Outstanding. While DSO is calculated by businesses offering credit to customers, AP days are relevant to businesses purchasing the goods. If your days in AP calculation is high, then it could indicate problems with your cash flow. 

Why is the Accounts Payable Days Calculation Important?

There are many reasons why you need to calculate account payable days or days payable outstanding. It is specifically helpful to a company’s leadership to assess the required improvements that the company needs like the following –

• Cash flow assessment 

  The time you take to pay your invoices indicates the company’s cash flow management. If you take longer to pay your suppliers, there could be many reasons for it. You could be saving money for other investments or even have low cash flow, leading to difficulty in making payments. Therefore, calculating DPO can help you assess your company’s situation.

• Maintaining supplier relationships

  Regularly extending your payment terms or making late payments could directly affect your relationship with your supplier. Their revenue and cash flow also depend on the timely receipt of payments from you. Therefore, you need to keep track of your accounts’ payables in days to ensure you are not straining your vendor relationships or losing suppliers because of it.

• Efficient management of capital

  Keeping track of your accounts payable days and paying on time can help you manage your finances better and avoid the need for external financing or expensive borrowing for short-term needs. 

• Improved financial analysis 

  Calculating accounts payable days can help you analyze your payment history and trends with regard to how long it takes you to pay back your suppliers. This calculation can then help you compare it with the industry benchmark to assess how your business is managing its finances and liquidity. 

• Strategic decision making 

  When you know your accounts payable days, you can conduct financial forecasts and plan for the future. For example, if you want to improve your cash flow, then based on your AP days, you might consider renegotiating payment terms or extending payment terms with your suppliers. 

Accounts Payable Days Formula

Now that we have established why it is important to calculate accounts payable days, we can learn how to calculate it. The formula for payable days is calculated by dividing the average AP by the cost of goods sold and multiplying it by the number of days in the period. Here is the AP days formula-

Before calculating AP days, you need to calculate the average accounts payable and average cost of goods sold. Here’s how:

• Average Accounts Payable – To calculate your average accounts payable, you need to add your AP balance at the beginning of the period you are calculating it for to the ending balance for the period and divide it by two.

  Average Accounts Payable = (Beginning AP Balance + Ending AP Balance) ÷ 2

• Average Cost of Goods Sold – You can calculate it by dividing the total COGS by the number of days in the period. This includes the direct costs that go into the production of goods sold by your company during a period of time. It usually includes direct material costs, direct labor costs, and manufacturing overhead costs.

  Average Cost of Goods Sold = Total COGS ÷ Number of Days in Period

Example of AP Days Calculation

Now, let’s use an example to calculate the days in AP calculation. 

Say we have a company called XYZ Inc. We need to calculate their accounts payable days for the year 2023. Here are the hypothetical figures:

• Accounts payable at the beginning of the year on January 1st, 2023 – $50,000
• Accounts payable at the end of the year on December 31st, 2023 – $70,000
• Cost of goods sold during the year 2023 – $500,000

Here is how to calculate AP days –

Step 1 – Calculate average accounts payable:

Average Accounts Payable = Beginning AP + Ending AP ÷ 2

Average AP = ($50,000 + $70,000) ÷ 2

Average AP = $120,000 ÷ 2

Average AP = $60,000

Step 2 – Calculate the average daily cost of goods sold:

Average Daily COGS = Total COGS ÷ No. of days in the year

Average Daily COGS = $500,000 ÷ 365

Average Daily COGS = $1, 369.86

Step 3 – Calculate accounts payable days:

Account Payable Days = (Average Accounts Payable/ Cost of Goods Sold) x No. of Days in Period

So, Accounts Payable Days = $60,000 ÷ $1,369.86

Accounts Payable Days = 43.81

Therefore, XYZ Inc. takes an average of approximately 44 days to pay its suppliers after purchasing goods or services.

How to Evaluate Accounts Payable Days

Once you calculate your accounts payable days, you need to understand what it means. What does it mean for your company if it is high or low? Let’s explore this now.

• High accounts payable days:

  Meaning – This means that your company is taking longer to pay its suppliers. This could be due to cash flow problems or even a strategic move made by your business to conserve working capital for other purposes. 

  Impact – A high number of accounts payable days could mean you have more short-term liquidity due to late payments and the conservation of cash. However, late payments often result in strained relationships with your suppliers and a risk of losing them or incurring late payment fees. 

• Low accounts payable days:

  Meaning – This means that you are paying your suppliers and vendors on time or relatively fast. It could indicate effective cash flow management, stronger relationships with your suppliers, or even strategic moves made by the business to take advantage of early payment discounts, etc. 

  Impact – Shorter AP days help you maintain better relationships with your suppliers, which can lead to more favorable terms, discounts, and priority treatment from them. However, very low AP days could indicate aggressive working capital management which could mean strained cash flow and financial flexibility. 

How HighRadius Can Help Reduce AP Days

Managing your accounts payable days can get quite tricky in the current business environment. However, today, technology solutions like the HighRadius Accounts Payable Automation Software can optimize your payables process. Automation can bring significant speed and efficiency to your current AP processes, leaving more time and resources to strategize for the future.

With our software, you can eliminate manual effort with AI-based invoice data capturing, reduce processing efforts with automated invoice processing and matching, centralize your monitoring with a smart AP workspace, automate approvals and workflows for invoices and spends, and also get 360-degree visibility with reporting and analytics. 

It is time to take your business to the next level with AP automation.

FAQs

1) What is a good AP day?

A good accounts payable days figure varies by industry and company but typically falls between 30-60 days. It reflects efficient management of supplier payments. However, what’s considered good depends on factors like industry norms, business models, and cash flow management strategies. 

2) What is the Accounts Payable Turnover Ratio?

The accounts payable turnover ratio measures how efficiently a company pays its suppliers by comparing the total purchases made on credit to the average accounts payable balance. The formula for calculating this ratio is –

Accounts Payable Turnover Ratio = Total Purchases/ Average Accounts Payable

3) What’s the Difference Between the DPO and the AP Turnover Ratio?

Days payable outstanding measures the average number of days a company takes to pay its suppliers after purchasing goods. Whereas the accounts payable turnover ratio measures how efficiently a company manages its accounts payable by comparing the total credit purchases to the average AP balance.