Average payment period (APP) is the length of time a hotel, resort, or company takes to pay off credit purchases. It is used for accounting purposes to track when payments are due so that no penalties or excess interest are accrued. It does not have an effect on the company’s working capital. Because of this, APP has little to no effect on a company’s valuation during a merger or acquisition. APP is also known as days payable outstanding (DPO).
What is Average Payment Period For?
APP is used to help companies manage cash flow. When APP increases, cash should also increase, although the amount of working capital stays the same. By lowering APP, companies can more effectively keep suppliers happy and work to negotiate trade discounts.
Benefits of Average Payment Period
Calculating APP helps accounting departments know when they need to take action to pay creditors. Knowing APP and working to decrease this metric helps companies keep suppliers happy and necessary supply relationships intact.
Limitations of Average Payment Period
Market trends can have an effect on APP. When the trickle-down effect of payments is working as it should, APP can naturally increase. Companies need to strike a balance between maintaining supply relationships and pushing to increase APP as much as possible to increase cash flow.
How is Average Payment Period Calculated
APP is calculated by first dividing total annual credit purchases by the number of days in a calendar year (365). The result of that calculation is then divided into average accounts payable. Average accounts payable is calculated by adding beginning accounts payable to closing accounts payable and dividing by 2.
Average Payment Period = Average Accounts Payable / (Annual Credit Purchases / 365)
Average Accounts Payable = (Beginning Accounts Payable + Closing Accounts Payable) / 2
Example of Average Payment Period Calculation
Beginning Accounts Payable = $148,000
Closing Accounts Payable = $160,000
Average Accounts Payable = ($148,000 + $160,000) / 2 = $154,000
Average Accounts Payable = $154,000
Annual Credit Purchases = $1,500,000
Calendar Days = 365
Average Payment Period = $154,000 / ($1,500,000 / 365) = 37.47
For the calculation above, the company’s average payment period is 37.47 days.