Average days payable

Average days payable measures the average number of days it takes for a company to pay its suppliers.

Average days payable is an important metric because it gives entrepreneurs insight into how best to optimize cash flow over time, and investors and creditors a window into how efficiently your accounts payable is managed compared to the industry average.

An unusually high or low number, or erratic fluctuations over time, can indicate that cash flow is low and can have investors or creditors question the financial health and stability of a company.

Most businesses aim for a relatively low average days payable because it indicates that they can meet their financial obligations. However, if average days payable is too low, it may be a sign that a business is not benefitting from its suppliers’ longer payment terms.

A number that is too high, on the other hand, could mean that a business is paying suppliers beyond the accepted collection period, and potentially paying interest on its purchases. This could also be a predictor of cash flow problems and have an impact on the business’s credit rating.

How do you calculate average days payable?

To calculate average days payable, take all outstanding payments over a given period and divide them by the total purchases made during the same time period. This will give you an estimated number of “days on hand,” or how long it took from when the goods were purchased until they were paid for. It will also provide insight into whether some vendors are being paid faster than others.

Average days payable formula

Average days payable calculation example

Let’s say a company has an average accounts payable of $25,000 over a year. Meanwhile, its purchases on credit for the same period amount to $200,000. Average days payable for the business would be calculated as follows:

Days in the period = 365

Average accounts payable = $25,000

Purchases on credit = $200,000

This means that the company takes, on average, 45.6 days to pay an account.

Average days payable calculator

We are currently updating this tool. You can manually calculate your ratio by following the above instructions.

What does an increase in average days payable mean?

An increase in average days payable means a business is asking its suppliers to wait longer for payment. For example, some companies intentionally stretch out their payments to keep valuable capital in the company longer—effectively using the money designated for suppliers to make investments, pay other suppliers or service debt. For lenders, this is often a red flag that the company is struggling with cash flow.

However, it is possible to increase payment terms if the company has a good relationship with its supplier.

What does a decrease in average days payable mean?

A decrease indicates that a company is paying its suppliers faster than it needs to.

Many suppliers are willing to negotiate discounts in exchange for shorter payment terms. For example, a supplier may offer a 2% discount to a company that pays its bills in 15 days rather than 60.

A decrease in average days payable improves the company’s operating margins. It also can strengthen a relationship with a supplier by demonstrating that it is a stable and reliable customer. In the future, if you find yourself needing to increase payment terms, the supplier may be more willing to extend your payment period.

What kinds of businesses need to optimize average days payable?

As a metric, average days payable offers insight into the financial health of your company, but it is especially useful for businesses that rely on supply chains.

Consider a bakery that operates in a tourist town. Like most bakeries, it purchases raw materials, such as flour, sugar and baking equipment, from a variety of suppliers, but unlike others, its business fluctuates: tourists frequent the town during the warm weather months with most absent during the other months.

The bakery can optimize cash flow through its payment terms and increase or decrease average days payable depending on the time of year. In the low season, they could shorten their days payable from 60 to 15 days because they’re buying fewer supplies and have more cash on hand. That faster payment would put them in a good position to request a discount from their supplier, which would improve their operating costs.

The busy season would require another tactic. Because they need extra inventory and their cash flow is stretched, they could increase their average days payable up to 60 or even 90 days That extension period would allow the bakery to use supplier money to finance more immediate expenditures.

While adjusting average days payable is acceptable in the marketplace, it’s important that every entrepreneur communicates with suppliers when they want to make a change to their payment terms.

If a supplier finds they are being paid later and later, without it being properly communicated, they could turn around and make their payment terms more restrictive, or they could demand cash on delivery for every purchase.

What is the standard average days payable?

Your business should compare your average days payable ratio to other organizations in the same industry. This will give you valuable information about where improvements might need to be made to accounts management practices and policies.

Standards will vary across sectors. For example, construction companies will typically set out longer payment terms due to the complexity of their sector’s supply. Tech companies may allow for shorter terms because they don’t have as many physical supplies to procure.

To find out the standard in your industry, you can consult the North American Industry Classification System (NAICS) via Statistics Canada. Your industry code will help you find average days payable ratio and other metrics.

If your company’s metric is significantly different than the industry average, it’s important to investigate why: it might be a sign of a competitive weakness, i.e., you may be paying slower than your counterparts or faster than you need to.

Staying within—or even beating—the industry average could be an advantage, particularly if you’re in a competitive sector and it’s easy for your customers to do business elsewhere. If you offer to pay faster than your competitors, vendors may offer a price adjustment or special consideration in exchange.

How to improve average days payable

Average days payable does not stand on its own. It’s just one metric on a company’s financial dashboard that helps in making business decisions in the short and long term.

Best payment practices include:

• reviewing average days payable ratio every month to detect trends and drive action, as necessary
• setting payment terms between 15 and 90 days. Longer terms may mean you’re not proactively managing cash flow; shorter terms may indicate you’re incurring cost without much benefit
• increasing payment terms when you require more cash flow
• decreasing terms when your cash flow is optimized and you want to take advantage of better operating margins
• building strong relationships with vendors so payment terms can be an available lever if you need to optimize your company’s financial health

Being aware of your average days payable ratio is essential for any successful business owner who wants their company to remain financially healthy in the long run—especially if those businesses operate within competitive industries where tight cash flow control is necessary for survival. By regularly monitoring these figures and making adjustments accordingly, entrepreneurs can ensure that customer relationships and payment terms are upheld without any compromise to their overall financial stability.

Next step

Take the guesswork out of business planning with BDC’s free guide, Monitoring Your Business Performance.