Debtor days can substantially impact your business. Whether running a small, medium or large enterprise, it’s important to understand how debtor days affect your daily operations.
The debtor collection period, or debtor days refers to the time it takes for cash to be collected from your company’s debtors. The longer it takes for your creditors to pay, the greater the number of debtor days your business has.
This is significant because debtor days represent cash owed for goods and services already provided by you. Debtor days will influence your available cashflow for purchase of new inventory stock and how your employees and other expenses are paid.
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?
Have Clear Payment Terms
Cash flow is often calculated monthly because most billing cycles tend to be monthly. In general, suppliers will typically allow around thirty days to pay. However, in a cash-intensive business with a rapid turnover of inventory stock, it may operate on a seven-day payment cycle, therefore, you would calculate cashflow on this basis.
Whatever the billing cycles your business operates under, it is important that payment terms and conditions are both clear and up front. Equally, receipts and invoices should break down costs and make it clear when payments are due.
Remember, payment terms with shorter timeframes can adversely affect your business. Allowing too few days for clients to pay may act as a deterrent where customers choose not to buy from you and opt for suppliers with longer debtor terms.
Have a rigorous method of tracking invoices and detailed procedures to identify which of these are outstanding, paid in instalments or just bad debts. Develop a follow-up process for late payments. Some of your best customers can occasionally forget payments, or struggle with their own cash flow issues.
Instil timely follow-up routines to remind customers about upcoming payments and invoice due dates. Send out reminders at different intervals relative to the predetermined debtor day terms.
Local government ‘rates’ notices and many utility companies commonly offer incentives for early, up front or on-time payment. It is often worth the slight discount you will offer customers to have the money paid on time and in a lump sum.
Charge Late Fees
Penalties for being late with payment can also be a strong motivator to encourage customers to pay on time. Be sure to clearly outline any late payment charge on your invoice so that customers are aware of it.
It certainly builds good relationships with long-term customers if you are flexible with payment terms. This may be warranted occasionally as a one-off show of good will but don’t make it a habit. Set your debtor days and stick to them.
You are in business to stay in business and to do this successfully is to maintain a steady cash flow. The lower your debtor days, the lower your level of risk. Resulting in higher cash flows and less stress for your as a small business owner.
Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.