The Monthly Metric: Days Payable Outstanding
The Monthly Metric has covered several supply management analytics, particularly in the financial realm, that require looking beyond a composite number. Such measurements are calculated from several moving parts, and a “poor” reading is not necessarily a sign of trouble.
Days payable outstanding (DPO), which measures how quickly companies pay bills, fits that criteria. While it has been a traditional gauge of a company’s cash flow, in recent years, DPO has accounted for other dynamics of the bill-paying process, including (1) ensuring that documents match, (2) managing working capital and (3) navigating supplier relationships. During the coronavirus (COVID-19) pandemic, those accounts-payable responsibilities became even more critical, and surveys tried to monitor changes in payment terms between companies, suppliers and customers.
Few, if any, industries have had to keep more DPO plates spinning than health care, as hospitals and other facilities scrambled to source personal protective equipment (PPE) and other medical equipment, often from non-traditional suppliers. The Hospital ISM® Report On Business® includes a Days Payable Outstanding Index, and it suggested in March that, after months of relatively quick payments so as not to risk supply continuity, some accounts-payable departments might have slowed down to review documents and processes.
“Sometimes, when there’s a burden on the supply chain on the front end, that leaves accounts payable to clean up on the back end,” says Nancy LeMaster, MBA, Chair of the Institute for Supply Management® Hospital Business Survey Committee. “There was so much going on early in the pandemic to get new suppliers and products — now that (COVID-19 cases) are subsiding and hospitals aren’t sourcing from Timbuktu, it’s time to take a breath, clean up the data and systems a bit so suppliers can get paid more efficiently.”
The Hospital ISM® Report On Business® will be further examined later, but first is a look at the DPO metric, which indicates average time (in days) in which companies pay bills. That figure has escalated in recent years, and the most powerful companies often negotiate for more wiggle room, regardless of financial status.
Meaning of the Metric
The most common DPO formula entails dividing accounts payable by cost of goods sold (COGS) and multiplying by the number of days measured. For example, if accounts payable on a company’s end-of-year balance sheet is US$8.5 million, and it had a COGS of $67 million, its DPO would be 46.3:
($8.5 million / $67 million) x 365 days = 46.3
Companies with the most clout can negotiate extended payment terms with suppliers; one of the most notable examples is Apple, Inc. The Cupertino, California-based technology giant has the market position and supplier base to negotiate the most company-friendly payment terms, and in several quarters since 2017, its DPO has exceeded 100 days.
A high DPO can be a problem if a company is not paying suppliers on time. For larger companies that have no such cash-flow conundrum, longer payment terms, in effect, provide it interest-free financing of operations by “borrowing” from suppliers. A less-powerful company must balance working-capital management with not alienating suppliers.
“Some mega-organizations have a lot of leverage,” LeMaster says. “But for a small business, it can be a real challenge if money doesn’t come for 60 days or 90 days.” Consistently long payment terms can deny smaller companies the cash flow to hire workers, make capital improvements and take on large orders.
In recent years, DPO figures have risen. According to the Working Capital Scorecard by The Hackett Group, a Miami-based business consultancy, the average DPO in 2019 was 55.5, nearly 10 days longer than a decade ago.
As COVID-19 took hold last year, research by ISM found that majorities of surveyed companies reported no changes in payment terms with suppliers or customers — a contrast to the Great Recession of 2008-09. Is that because average DPO couldn’t go much higher?
Regardless of the reason, those survey findings were positives, ISM CEO Thomas W. Derry said last year. “CPOs I’ve talked to say they are taking a more nuanced approach (that is the result of dialogue, not a mandate,” he said, adding that strong supplier ecosystems had emerged as a critical asset for companies.
DPO in the Health-Care Sector
In this trend, hospitals could be an outlier, LeMaster says: “I don’t think we’ve seen a lengthening of contract terms due to big companies setting those terms. In hospitals, the driver behind the DPO number is more often operational issues versus contract-payment terms.” In health-care sourcing, LeMaster says, suppliers have more leverage than in other industries. Many physicians, surgeons, nurses and engineers have preferred suppliers — and are more interested in getting products on time than in the payment terms.
“While it’s changing a little bit, hospitals don’t set stringent payment terms that you see in the manufacturing sector,” LeMaster says.
A bigger factor in payment delays, she says, is first-time match rate, where discrepancies between POs, invoices and receiving reports keep money from being sent. “That three-way match is necessary to get the bill paid,” she says. “If the invoice doesn’t match the PO, or the amount of product that was received doesn’t match the quantity shipped, those documents have to be manually reviewed, which adds time to the payment process.”
That could have been a factor in the Hospital ISM® Report On Business® Days Payable Outstanding Index increasing 13 percentage points in April, reaching strong expansion territory at 57 percent. (Report On Business® data consists of diffusion indexes that measure monthly changes in growth rates; a reading above 50 percent indicates expansion, below 50 contraction.)
A months-long scramble for PPE and other medical supplies likely put a premium on purchasing-document accuracy. In April, hospitals could have had a chance to manually review match rates, delaying payments and raising the Days Payable Outstanding Index.
“(April) could have been that time where accounts payable figures it out on the back end,” LeMaster says. “It will be an interesting index to watch because of the contraction and rebound. Were those anomalies? The future data will tell us.”
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