March 23, 2018      4 min read

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. Before making such a choice however, it is essential to understand in full how this period affects your business and your own ability to settle debt with your suppliers.

Essentially the lower the number of debtor days, the better the company’s cash flow will be and the less they will need to rely on credit from their own suppliers. This improves the financial health of a company and their ability to absorb any setbacks that might occur be it through failed payments from customers or the requirement to replace faulty stock at their own cost.

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 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.

Calculating the optimum number of debtor days for your company

For small to medium-sized businesses, the most popular formula to ascertain the optimum number of debtor days is as follows:

(Trade receivables / yearly credit sales) x 365

Once the number of debtor days has been established, they should be compared with other businesses in the industry to ensure they are in the right ball-park. This is because an inappropriate debtor days calculation and policy can make or break a company and its financial well-being.

How to decrease the number of debtor days effectively

Reduce the number of debtor days on the invoice

This is simple but can be very effective. Ensure you give your current customer-base the appropriate amount of warning to maintain trust and integrity.

Request an upfront deposit

A simple way of enticing commitment and obtaining some partial cashflow is to request a deposit upfront for any commodities or services being sold.

Simplify invoices

Ensure invoices are simple to read with the only payment terms being current and overdue. List all broken down costs and ensure payment methods and balances are very clear.

Consequences

Ensure there are consequences for payments. If a customer pays early or on time, perhaps look to provide a discount. If they pay late, ensure they are charged penalty fees. If they fail to pay in an appropriate timeframe, you might want to cease supply.

Research any long-term customers

Before entering into a business relationship, do your due diligence and research potential long-term customers. It may well be worth boycotting a potential business relationship if the company’s reputation eludes to poor credit history as it will only serve to jeopardise your own company’s financial well-being.

We have highlighted the differences between long and short debtor days, the effect of each and how you might alter the current policy in your company. When it comes to billing customers, it is imperative that any orders are accurately tracked so that bills and inventory stock balances are correct every single time. These tasks are made so much easier and less involved with a good inventory management software package. With the correct system, it is possible to integrate what is happening in your online store, your warehouse and at the point of sale so that no order is missed and no dollar is left unaccounted for.

Topics: ,