Understanding Accounts Payable Days (APD) is an essential step toward effectively managing your business expenses. In this blog, we will show you how you can manage your AP days more precisely, and maintain a good balance between your finances and vendor relationships.
What is Accounts Payable Days?
Accounts Payable Days, also known as Days Payable Outstanding (DPO), is a financial metric that measures the average time, in days, a company takes to pay its invoices to suppliers. It is a key instrument in managing cash flow and maintaining good relationships with vendors. To be frank, no vendor will want to work with companies that don’t pay their bills on time!
However, many companies still struggle with optimizing their invoice management systems, due to the lack of understanding of how to effectively utilize and benefit from their DPO ratio position. This can be the result of a high workload or an inefficient process, making it seemingly impossible to pay invoices faster.
Given those circumstances, this blog will provide information about AP days, high and low DPO ratios, how to calculate the DPO ratio, and towards the end, equip you with helpful tips on how to optimize your AP days ratio. Let’s get started!
Accounts Payable Days ratio
It is important to understand why your business takes a certain amount of time to pay its bills and invoices. This information can provide you with valuable insights into your business operations.
Having a solid understanding of Accounts Payable Days ratios, and what it means to have a high or low ratio, helps ensure that your company maintains an effective balance between cash flow management and vendor satisfaction.
High AP Days ratio
When a company takes longer to pay its bills and creditors, it results in a higher Accounts Payable Days ratio. Generally, having a high ratio can be beneficial because it indicates that the company has surplus cash that could be invested in short-term opportunities. However, if the company takes too long to pay its creditors, it may harm its creditworthiness, and suppliers may refuse to provide further goods or services.
In essence, a high DPO can indicate one or two things: either the company has better credit terms than its competitors or it is struggling to pay its bills on time.
Low AP Days ratio
A low Accounts Payable Days ratio, on the other hand, indicates that a company pays its bills relatively quickly. This could imply that the company is not fully utilizing the credit period offered by its creditors.
Alternatively, a low DPO may suggest that the company’s credit terms are less favorable than those of its competitors. This could be due to a suboptimal credit history or a missed opportunity to renegotiate credit terms.
Some companies may have lower DPOs than their competitors because their suppliers offer discounts for early payment, such as 1/10, net 30, or 2/20, net 180. These terms mean that if the invoice is paid within a specified number of days (e.g. 10 or 20), the buyer can receive a percentage discount (e.g. 1% or 2%). This is an attractive option for some companies because it offers cost savings, and as a result, they may have lower DPOs due to these supplier contracts.
Provided that you have been informed about the meaning of having a high and low DPO ratio, we’ll tell you more about the average APD ratio next.
What is the average AP Days ratio?
The average AP days ratio is frequently used as a relevant KPI and key determinant by financial analysts to assess a company’s investment potential. The average APD ratio also serves as an indicator of business performance and reflects a company’s financial stability and future profitability.
The AP ratio is also frequently used in benchmarking to compare a company’s payment procedures with that of rivals within a similar industry. This is helpful to determine areas for improvement and track the actions of competitors, resulting in a better competitive strategy and threat anticipation.
The average Accounts Payable days ratio varies per industry. Different industries require distinct cash flow operations and some suppliers might offer longer payment periods due to the differences in agreements.
In terms of execution, 41.1% of rigid systems and technologies play a role in delayed payments and increase the cost per invoice. The average company spends 10.58 euros more on cost per invoice than top-tier companies. Benchmark results also show that the average company has a 50% paid-on-time rate in contrast to top-tier companies that experience a 77% paid-on-time rate.
It is not worth the effort comparing the DPO values of companies existing in different sectors. Pre-eminently, an organization’s administration will first calculate the DPO, and then compare its results to the average of other establishments within the industry. This helps to determine if a company is simply paying its vendors too fast or too slow.
With that being said, how do you actually calculate AP days? We’ll cover that next.
How to calculate Accounts Payable Days?
The calculation of AP days is actually quite simple. You can do that by multiplying your ending Accounts Payable for the period by the number of days and dividing that figure by the cost of goods (COG) sold.
Below you will find the formula for how to calculate Days Payable Outstanding:
Accounts Payable Days formula
Costs of goods sold (COG) refers to the costs a company encounters while manufacturing a product.
Accounts Payable Days calculation example
Let’s look at an example to visualize the formula above: A toy company has the reputation for paying its suppliers on time. It has an ending Account Payable of €40,000. Its cost of goods sold is €375,000.
Now let’s calculate the Days Payable Outstanding for Toy Company:
DPO = Ending Accounts Payable ÷ (Cost of goods ÷ Number of days)
Or, DPO = €40,000 / (€375,000 / 365 ) = 38 days.
Now that you know how to calculate your AP days, the last remaining question is how can we help you optimize this number. Bearing in mind the importance of a healthy AP ratio, this should be a top priority for your enterprise.
Many companies nowadays adapt and scale up by using AP software to optimize their AP ratio and fulfill business expectations. In the following section, we will discuss how you can capitalize on this technology and avoid a bad reputation with your suppliers.
AP Days optimization with AP Software
Inevitably, bottlenecks in the Accounts Payable process can cause companies to miss out on paying invoices on time, which leads to a high DPO and various other consequences. However, with AP automation software, businesses can avoid this by streamlining their processes in the following ways:
- Faster invoice processing with automation – AP software enables you to submit invoices from your suppliers directly via email, FTP, or even with your mobile phone. With that, you no longer need to scan the documents or send them via post. This can speed up the invoice process, and help you save precious time and money.
- Elimination of manual data entry – Countless hours of your staff are saved as no one has to type information from invoices into a software system manually. This enables your organization to pay invoices faster.
- Reduction of errors – Human involvement is reduced as AP software can extract, input, and validate data automatically, significantly decreasing the risk of human errors. The fewer errors encountered the smoother your AP process.
If you are still hesitant about whether you should use AP software to automate your invoice processing, you can always have a look at the Accounts Payable Automation ROI calculations.
These calculations will not disappoint you and neither will Klippa. Want to know why? Read a bit further to find out how Klippa helps companies.
Power up your Accounts Payable process with Klippa
Klippa SpendControl is a refined AP software powered by machine learning and OCR technology, with features that enable you to automate invoice processing. Not to mention, SpendControl can streamline your Accounts Payable process and optimize your Accounts Payable Days ratio.
The features that SpendControl offers to help you power up your AP department include:
- User-friendly mobile application and web environment for easy digitization and file upload
- Built-in data extraction capabilities driven by Klippa’s OCR technology with the highest accuracy
- Fully customizable approval workflows with smart business rules
- Options to assign responsibilities and certain tasks to specific members for approval and payment processing
- Multi-currency support
- Over 20 integrations with accounting and ERP software, such as Xero, NetSuite, and SAP for a better overview of your AP
- Built-in document fraud detection
With SpendControl you can ensure that you pay your suppliers on time, reduce fraud, streamline your AP processing, optimize your AP days, and most importantly cut back your overhead costs.
Are you ready to save time and money and gain clarity into your spending behavior?
You can simply start by scheduling a free demo below or contact our team of specialists. We are happy to answer all your questions and get you started with improving your AP days!