trade payables turnover (days): calculation and interpretation

Trade Payables Turnover (Days Payable Outstanding) – Calculation & Interpretation

1. Scope

This note covers the trade‑payables turnover ratio and its companion measure, Days Payable Outstanding (DPO). They are one of the three financial‑efficiency ratios required by the Cambridge International A‑Level Business (9609) syllabus (section 10.2). The other two ratios – Inventory Turnover and Trade‑Receivables Turnover – are treated in separate notes; brief reminders are provided for context.

2. What the Ratio Shows

• How many times a business pays off its average trade payables in a year.
• How effectively the firm is using credit supplied by its suppliers.
• The impact on short‑term cash availability and on supplier relationships.
• Its role in the overall working‑capital (cash‑conversion) cycle.

3. Key Terms & Symbols

Symbol	Definition / Assumption
CP	Credit purchases – purchases made on credit only. Assume all purchases are on credit unless the question states otherwise.
APo	Opening trade‑payables balance (start of the period). Include only trade payables – exclude tax accruals, provisions, etc.
APc	Closing trade‑payables balance (end of the period). Same exclusion applies.
AP̅	Average trade‑payables = (APo + APc) ÷ 2
TP Turnover	Trade‑payables turnover (times per year)
DPO	Days Payable Outstanding – average number of days taken to pay suppliers

4. Formulae

1. Trade‑payables turnover $$TP\ Turnover = \frac{CP}{\overline{AP}}$$
2. Days Payable Outstanding (DPO) – the inverse expressed in days $$DPO = \frac{365}{TP\ Turnover}$$

5. Step‑by‑Step Calculation

1. Obtain credit purchases (CP) from the profit‑and‑loss statement or notes.
2. Read the opening and closing trade‑payables balances from the balance sheet.
3. Calculate the average payables: $$\overline{AP}= \frac{AP_{o}+AP_{c}}{2}$$
4. Compute the turnover using the formula in §4‑1.
5. Convert the turnover to days with the DPO formula in §4‑2.
6. If the business is highly seasonal, replace the yearly average with a quarterly or monthly average for greater accuracy.

6. Worked Example

Data (Company XYZ – year ended 31 December 2024)

Item	Amount (£)
Credit purchases (CP)	480 000
Opening trade payables (APo)	60 000
Closing trade payables (APc)	90 000

1. Average trade payables $$\overline{AP}= \frac{60\,000+90\,000}{2}=75\,000$$
2. Trade‑payables turnover $$TP\ Turnover = \frac{480\,000}{75\,000}=6.4\ \text{times per year}$$
3. Days Payable Outstanding $$DPO = \frac{365}{6.4}=57\ \text{days (rounded)}$$
4. Cash‑flow implication (optional)

   Average daily credit purchases = CP ÷ 365 = £1 315 per day.

   Cash retained by delaying payment 57 days ≈ £1 315 × 57 ≈ £75 000, which would appear as an increase in cash flow from operating activities.

7. Putting the Three Efficiency Ratios Together – The Cash‑Conversion Cycle

The syllabus expects candidates to calculate the overall working‑capital cycle using:

$$\text{Cash‑Conversion Cycle (days)} = \text{Inventory Days} + \text{Receivables Days} - \text{Payables Days (DPO)}$$

• Inventory Days = 365 ÷ Inventory Turnover
• Receivables Days = 365 ÷ Trade‑Receivables Turnover
• Payables Days = DPO (calculated above)

Numeric illustration (using the same company)

Ratio	Turnover (times)	Days
Inventory Turnover	4.0	365 ÷ 4 = 91 days
Trade‑Receivables Turnover	8.0	365 ÷ 8 = 46 days
Trade‑Payables Turnover (DPO)	6.4	57 days

Cash‑Conversion Cycle = 91 + 46 – 57 = 80 days. A shorter cycle (fewer days) means cash is tied up for less time, improving liquidity and reducing the need for short‑term financing.

8. Interpretation & Strategic Significance

• Higher DPO (more days)
  • Increases short‑term cash availability – useful for financing growth, covering unexpected expenses, or improving cash‑flow forecasts (syllabus 10.3).
  • May indicate weak bargaining power, loss of early‑payment discounts, or risk of damaging supplier goodwill.
  • When DPO is higher than the industry average, comment on the trade‑off between cash benefit and supplier relations.
• Lower DPO (fewer days)
  • Shows prompt payment, which can strengthen supplier relationships and secure better credit terms.
  • Reduces cash on hand; the firm may be forgoing a source of short‑term financing.
  • Useful when the firm wishes to maintain a reputation for reliability, especially in industries where early‑payment discounts are significant.
• Link to other syllabus areas
  • 10.3 Cash‑flow forecasting – DPO directly affects the cash‑outflow schedule and the amount of cash that can be forecast as available.
  • 10.4 Finance & accounting strategy – A high DPO may reduce the need for short‑term borrowing, influencing financing decisions.
  • Business strategy – Managing the working‑capital cycle is a strategic choice; firms may deliberately lengthen DPO to fund expansion without raising external finance.

9. Limitations of the Ratio

• Seasonality – Quarterly or monthly averages give a more realistic picture for businesses with strong seasonal purchase patterns.
• Credit‑policy changes – A sudden shift from cash to credit purchases (or vice‑versa) can distort the ratio unless the numerator is adjusted.
• Different fiscal year‑ends – Ensure periods are comparable when benchmarking against another firm.
• Non‑operating payables – Exclude accruals such as tax liabilities or provisions; use only trade payables for the denominator.
• Cash‑flow statement linkage – DPO alone does not show the actual cash outflow; always interpret it alongside the cash‑flow from operating activities.

10. Exam Tips for Cambridge A‑Level Business (9609)

1. Read the question carefully – it may ask for the turnover ratio, DPO, or both.
2. State any assumptions explicitly (e.g., “All purchases are on credit”, “365‑day year”).
3. Show every calculation step; marks are awarded for method as well as the final figure.
4. When interpreting, link the ratio to:
   • Cash‑flow management (cash saved or required).
   • Supplier relationships and discount opportunities.
   • The overall working‑capital (cash‑conversion) cycle.
5. Use comparative language: “Higher than the industry average suggests the firm is using supplier credit more aggressively, improving cash flow but potentially risking supplier goodwill.”
6. If a cash‑flow statement is provided, calculate the cash saved by the DPO and comment on its significance.

11. Cross‑Reference to the Other Efficiency Ratios

For a complete analysis of the working‑capital cycle, calculate the two companion ratios:

• Inventory Turnover – Turnover = Cost of Sales ÷ Average Inventory
• Trade‑Receivables Turnover – Turnover = Net Credit Sales ÷ Average Trade Receivables

Having all three ratios at hand allows you to compute the cash‑conversion cycle in one step (see §7).

12. Why It Matters – A Quick Summary

Days Payable Outstanding is a key indicator of how a firm finances its operations through supplier credit. A higher DPO can improve cash‑flow forecasts and reduce reliance on short‑term borrowing, but it must be balanced against the risk of harming supplier relationships and losing discount opportunities. Understanding DPO, together with inventory and receivables days, equips students to evaluate a firm’s working‑capital management, its financing strategy, and its overall business strategy – all core requirements of the Cambridge A‑Level Business syllabus.