Days Payable Formula: Are You Paying Your Vendors Too Fast?

Getting ready to apply for a commercial loan, but not sure if your financials will receive an approval from the bank? This is part of a series of posts explaining financial equations and ratios so that you feel more prepared when you talk to the bank about your loan request. Next up: Days Payable.

What Is Days Payable?

Days Payable measures how long in days it takes a company to make payments to its vendors and suppliers. By comparing a business's Cost of Goods Sold to its current Accounts Payable balance, businesses can get a sense of how long it takes to make full payments to their trade creditors in an operating year. The larger the number, the longer a company takes to make payments on its open Accounts Payable. Here's how you can calculate it:

Why Is It Important?

Days Payable is important to track so you know how long it takes you to make payments to your vendors. Even though your business may have recorded the expense on your Profit & Loss statement, that doesn't mean you have paid for the goods that you are selling. Days Payable is a tricky ratio to monitor, because there can be room for improvement if the ratio is either too big OR too small.

A Days Payable number that is high can signal cash flow or operational problems in a business, but a small Days Payable number could mean that you are paying your vendors faster than you should. A lot of small business owners pay bills like their personal expenses, as soon as they receive an invoice. However, that depletes cash that could be used to cover payroll, pay for an unexpected repair, or make a timely debt repayment. The goal of Days Payable is to stretch your payment terms as much as possible to hold onto working capital, as long as you can pay your vendors back timely.

Example of the Days Payable Formula

ABC Company has annual business COGS of $1,000,000 and an Accounts Payable balance of $83,333. Its Days Payable would be:

What would happen if that company could extend payment terms with its vendors to 45 days on average? By doing some reverse math, that business could increase its working capital by almost $40,000 to cover other short-term expenses, or even purchase equipment and other assets!