Accounts Payable Analysis in Due Diligence: What the Numbers Reveal

Accounts Payable Analysis in Due Diligence: What the Numbers Reveal

Accounts payable analysis is often underweighted in due diligence. Teams focus heavily on revenue, EBITDA, and receivables. Payables get less attention. This is a mistake.

AP tells you how the target manages cash, how dependent it is on key suppliers, whether it is stretching payments to fund operations, and whether reported working capital is sustainable. These insights directly affect the net working capital peg and post-close cash requirements.

What AP Trends Reveal

The trajectory of Days Payable Outstanding (DPO) is one of the most informative metrics in working capital analysis.

Increasing DPO may indicate:

• Deliberate working capital optimization (positive if sustainable)
• Cash flow stress, with the target stretching payments to manage liquidity
• Negotiated payment term extensions with key suppliers
• Upcoming vendor disputes or supply disruptions from late payment

Decreasing DPO may indicate:

• Early payment discounts being captured
• Supplier pressure for faster payment (reduced leverage)
• Operational inefficiency in AP processing
• Voluntary acceleration before a sale to build supplier goodwill

The diligence team must distinguish between operational improvements and unsustainable stretching. A target that has extended DPO from 45 to 75 days in the 12 months before the transaction may be managing appearances rather than improving operations.

Vendor Concentration

Vendor concentration analysis mirrors the customer-side work. Key questions:

• What percentage of total purchases comes from the top 5 and top 10 suppliers?
• Are key supplier relationships contractual or at-will?
• Do any suppliers also have a related party connection?
• What happens if a critical supplier is lost post-close?

High vendor concentration creates supply chain risk. If a single supplier provides a critical input and has no contractual obligation to continue, the buyer faces replacement risk. This risk should be flagged in the diligence report and addressed through supplier agreements or transition service arrangements.

AP Aging and Overdue Balances

A detailed AP aging analysis reveals payment discipline:

Current balances. Amounts within normal payment terms. These form the core of the normalized working capital calculation.

Overdue balances. Amounts past contractual payment terms. Persistent overdue balances may indicate cash flow pressure, disputed invoices, or intentional payment delays.

Severely overdue balances. Items 90+ days past due. These require specific investigation. They may represent disputed amounts, obsolete accruals, or obligations the target has stopped paying.

Credit notes and rebates. Outstanding vendor credits and earned rebates that have not been applied. These are effectively cash equivalents and should be captured in the working capital analysis.

Accrued Liabilities and Cut-Off

The boundary between accounts payable and accrued liabilities affects working capital completeness. Diligence teams should verify:

Cut-off accuracy. Are goods received but not yet invoiced (GRNI) properly accrued? Incomplete GRNI accruals understate payables and overstate working capital at the measurement date.

Accrual completeness. Are recurring costs (utilities, services, freight) properly accrued at period end? Under-accrual is a common finding that increases reported earnings and inflates working capital.

Consistency. Are accrual practices consistent across reporting periods, or does the target change methodology near the transaction date?

Cut-off issues are among the most common findings in working capital analysis. A target that consistently under-accrues by $500,000 per month is effectively understating its liabilities and overstating EBITDA by $6 million annually. This directly impacts both the quality of earnings and the net working capital peg.

Working Capital Normalization

AP normalization for the net working capital peg requires:

1. Remove one-time items. Large, non-recurring payables (equipment purchases, one-time services) that do not represent ongoing trade obligations.

2. Adjust for timing. If the measurement date falls at an atypical point in the payment cycle, the balance may not represent normal operating levels.

3. Normalize DPO. If DPO has been artificially extended or compressed near the transaction date, adjust to a sustainable level based on historical trends and contractual terms.

4. Address seasonality. Businesses with seasonal purchasing patterns will have seasonal AP balances. The peg should reflect the normalized seasonal pattern.

Interaction with Debt-Like Items

Certain AP-related balances may qualify as debt-like rather than working capital items:

• Capital expenditure payables (amounts due for fixed asset purchases)
• Deferred consideration from prior acquisitions
• Taxes payable that relate to prior-period assessments
• Settlement obligations from disputes or litigation

The classification directly affects the purchase price mechanism. Items treated as debt-like are deducted from enterprise value at closing. Items in working capital flow through the true-up adjustment. The diligence team should clearly define the boundary and flag items where classification is ambiguous.

Data Requirements

Thorough AP analysis requires granular vendor-level data. Summary balances are insufficient. The data request should include:

• Vendor-level AP aging at the latest balance sheet date
• Monthly AP and DPO trends for 24 months
• Top vendor spend analysis
• GRNI and accrual reconciliations
• Payment terms by major vendor

Extracting this data efficiently from the target's ERP system early in the engagement prevents analytical bottlenecks and allows the team to focus on interpretation rather than data cleanup.