This article was updated in March 2023 to reflect current definitions and industry trends.
Debtor days measures how quickly cash is being collected from debtors. The longer it takes for a business to collect, the greater the number of debtor days. Or, in other words, when a customer makes a purchase from you, they will have a set amount of time to pay.
Even if you are a small or medium-sized enterprise owner, it is imperative that you understand how debtor days affect your daily operations and what you can do to reduce them.
What are debtor days?
Debtor days refer to the number of days customers are given to settle their accounts, and the choice on the length of this period is entirely up to each individual business. Debtor days are an exceedingly important factor in the overall prosperity of the company for a number of reasons that we will consider more closely.
The importance of cash flow
Cash flow is crucial in any business because it’s how you pay for the things necessary to make your business run. Such expenses like inventory stock or raw materials, employee wages, rent and other operating costs.
When customers make a purchase from your business, unless they are paying in cash, they will have a set timeframe by which to pay. These are referred to as debtor days and they generally vary in length from seven days to one calendar month.
Unlike profit, which is calculated at the time of sale, cash flow income is not calculated until payment is made; it is the difference between actual incoming and outgoing cash. So how can you decrease debtor days to improve cash flow?
The effect of a higher number of debtor days
The greater the debtor days, the longer the customer has to pay their bill with the company. What is the effect of this?
In short, the company will likely have their own bills or new expenses that require settling within this period, which means these expenses are paid by savings or credit which comes at a premium. The net result is that the company loses money because they invest more in their unpaid accounts receivable assets, which ties up cash that could be used elsewhere.
This could even result in lost opportunity costs and therefore are something to avoid.
The effect of a lower number of debtor days
The lower the number of debtor days, the less time customers have to settle their accounts with the business.
The result of this is better cash flow for the company and ensures the company is able to pay their own bills in a timely manner as to avoid the need for credit or penalty fees of their own.
This of course, facilitates financial health and prosperity long-term.
How to calculate debtor days
The right number of debtor days will depend on your business and your cash flow. Most SMEs use a formula to calculate how many debtor days they should allow for payments.
The most common formula is:
(Trade receivables / Annual credit sales) x 365
For example, if a business has $55,000 trade receivables and $455,000 annual credit sales, we get 44.12, So your consumers would have 44 days to pay their invoices.
Tips for reducing debtor days
All businesses have debtor days, and all at varying time frames. If you allow too few days for people to pay, then you may find that it becomes a deterrent, so that people decide not to buy from you. On the other hand there are those who will decide to buy from you knowing they cannot pay and will end up not reimbursing your business at all.
1. Be clear on payment terms
Be clear about payment terms. The receipts and invoices you give to consumers are incredibly important and valuable. They should break down the costs and make it clear when payments are due. An invoice can clear up any confusion among consumers so make them as clear and concise as possible.
2. Offer incentives
Many businesses will offer small discounts for those who pay early and up front. Getting the money all at once and in a hurry is often worth the slight discount you will have to afford your customer, and it can be a great motivator for getting that invoice paid quickly.
3. Charge late penalties
Charging an additional late fee is becoming increasingly the norm in business. Having a penalty for being late can also be a strong motivator to pay invoices on time. Outline your late payment charge on your invoice so your customers are aware of it.
4. Track invoices
Your accounts department needs to have a sound method of tracking invoices, detailing which ones are still outstanding, paid in instalments and not paid at all. They will also be in charge of administering early payment discounts as well as late fees, so it is imperative to have a sound system in place.
5. Have a follow-up system
Create a follow-up routine. Even some of the promptest customers forget payments from time to time, so introduce a timely follow-up routine that reminds customers when payment due dates are coming up. Send out reminders at different periods, depending on how long your debtor days are.
6. Offer B2B upfront payments to reduce debtor days
One of the most effective ways to reduce overall debtors days within a business is to enable upfront payments for your customers. Unleashed’s B2B eCommerce Store now offers immediate payment via Stripe – which is already proving popular among early adopters.
The functionality offers two-fold benefits: firstly, by improving cashflow from existing customers, and secondly, by opening new avenues for business without the risk (or time) involved in offering payment terms.
Even when simply presented as an option to current customers, early users of B2B Payments are finding a proportion of their regular business opts to pay immediately, reducing overall exposure to trade receivables risk. And when trading conditions dictate, or when a relationship with a client becomes sensitive to cashflow issues, the option to require upfront payments as standard is an option.