In accounts payable (AP), strong cash flow management isn’t just a nice to have; it’s a must for maintaining liquidity, controlling spending and building strong supplier relationships. That’s why financial managers are constantly seeking ways to measure and improve how they manage cash flow. One of the most important metrics they use to do this is the AP days calculation.
AP days, sometimes called days payable outstanding (DPO), is a metric that gauges the efficiency of your procure-to-pay (P2P) cycle, and it applies to goods or services that are received before payment is made. In this article, we’ll explain the AP days calculation and discuss why it’s an important measure for today’s finance organizations.
What is the AP days calculation?
AP days is a financial calculation that tells you how long, on average, your company takes to pay its suppliers after receiving an invoice. While it may sound basic, this metric is a key indicator of how well your business manages its payments.
If your AP days are long, you’re likely taking extra time to pay bills. Slow payments may provide short-term cash savings, but they could hurt your relationships with suppliers or reveal inefficiencies in your operation. On the other hand, if AP days is short, it indicates fast payments to suppliers, which can make you a desirable customer and even increase your bargaining power – but it can also create issues with working capital.
When it comes to payment speed, it’s important to find a balance that benefits your business without straining vendor relationships, and knowing your AP days metric provides an excellent starting point for doing this.
How do you calculate AP days?
To calculate this important metric, use the AP days formula below:
AP Days = (Average Accounts Payable / Cost of Goods Sold) × Days in the Period
Here’s a brief breakdown of the factors that make up the AP days formula:
- Average accounts payable: The average amount owed at the start and end of a period, usually one year.
- Cost of goods sold (COGS): The total cost incurred to produce the items or services sold by the company in the period.
- Days in the Period: The total number of days in the period you’re measuring (365 for one year). This final step converts this ratio into the average number of days it takes to pay suppliers.
Why is it important to monitor AP days?
Tracking AP days can yield valuable insights for your business and provide several benefits.
Manage cash flow
Monitoring AP days on an ongoing basis can help you build confidence in your working capital position and know when it’s necessary to adjust payment schedules to preserve cash. This can be particularly important when business is slow or when funds are needed for expansion.
Fortify supplier relationships
There may be times when it makes business sense to pay your vendors faster than you are currently. When suppliers trust timely payments, they can be more likely to prioritize your business, offer better deals or provide additional benefits. By monitoring AP days, you’ll know when it’s possible to accelerate payments.
Gauge financial health
AP days can help identify issues or delays in the payment process. If your AP days fluctuate widely or generally run high, this could show process problems, cash flow challenges or risks of late payments, all of which can affect your credit rating or relationships with suppliers.
What are some ways to reduce AP days?
While you may not be able to change some financial metrics, you can often adjust your AP days if needed. The following strategies can help you reduce the time it takes your business to pay invoices from suppliers and vendors:
Focus on supplier communication
Improving AP days starts with quality communication. Make sure your suppliers understand your company’s payment terms, your process for submitting invoices and the payment methods you accept. By aligning on these fundamentals, you can help prevent misunderstandings and delays while giving your business and your suppliers a common framework to help solve any potential issues early.
Automate invoice processing
One highly effective way to cut down AP days is by streamlining how your business processes invoices. By setting up automated systems for capturing, processing and approving invoices, you can eliminate unnecessary delays, while at the same time reducing errors and freeing your staff from manual data entry. AP automation tools, which can be integrated directly within ERP systems such as NetSuite, are available to help you process invoices faster.
Streamline AP workflows
An efficient workflow is an important step for reducing AP days. To accelerate vendor payments, be sure to establish clear rules for receiving, processing and approving invoices. You can also integrate three-way matching, transaction coding and other AP functions within your ERP to gain a real-time view of your payables and rectify any delays before they grow into bigger problems.
Remember that payment terms may vary
Not all invoices have the same terms. To prevent unnecessary high or low payment cycle times, group invoices according to their payment terms and customize the approval processes for them. This can help you keep payments on time while avoiding paying certain invoices too quickly. In some cases, it may also help you take advantage of early payment discounts.
Conclusion
While the AP days calculation is sometimes overlooked, understanding it can directly impact your company's financial health. By consistently monitoring this key metric and implementing strategies to optimize it, you not only improve your cash flow but also forge stronger relationships with suppliers. The right tools and practices can help you gain insights and take actions that optimize AP days and strengthen your business.
When you’re ready to gain deeper insights into AP days and take control of this important metric, book a demo with our team to learn how we can help.
