22 Aug 2012 The cost of managing DPO
So you think DPO is important? Well it is of course but manging it effectively comes at a price and it may be higher than you think.
DPO (days payables outstanding) is an imoportant KPI for AP people but in many cases there is a hidden cost in keeping DPO figures high. It’s the often significant opportunity cost of not taking discounts.
DPO doesn’t manage itself. Without close control from the AP function, the payment of invoices would vary randomly from being paid immediately to remaining unpaid indefinitely. AP doesn’t just manage the matching process, they manage DPO – one of the key financial metrics, ensuring that invoices are neither paid early (reducing DPO) or too late and potentially incurring a penalty from the supplier. But how much does the management of DPO cost?
The size of an accounts payable team varies enormously but best practice, according to some benchmarks, would be a team of about 6 per $billion in terms of the value of spend. A $1 billion spend organization would have in the region of 6 people in accounts payable. In approximate terms that would cost $300,000 per year at a cost of $50,000 per FTE or $800 per day. This is the cost of managing DPO – at least it is the cost at first glance. Take another look.
There is another cost – the opportunity cost of not taking discounts from suppliers in return for early settlement. That discount could be in the region of 1% for settlement 20 days early. For that $1 billion spend organization, $10,000,000 a year about $30,000 per day. To put this opportunity cost in to perspective, this extra cost is no incremental cost on top of the cost of the department – this is four times the cost of the department.
And what of the cost of reducing DPO? It’s true that holding on to cash has it’s advantages. Send it out of the door and the business might need to borrow more to maintain business as usual. For cash rich companies, there’s loss of interest. But take a look at the return on investment a discount offers. The back of the envelope calculation goes like this: 1discount for 20 days earlier payment is the same as 1% interest earned in 20 days. In annual terms that 1% x 36/20 = 18.25%.
If you can get more than 18% on cash, supply chain finance is no use to you.