There are many ratios that can be used to assess how efficiently the resources of a business are being used by management. The three most frequently used efficiency ratios include Stock Turnover, Debtor Days and Creditor Days.
What does Creditor Days measure?
Creditor Days is also known as days payable outstanding.
Creditor Days measures the average number of days it takes a business to pay its suppliers who gave the business trade credit – creditors. Creditors are the suppliers who have sold items to the business on credit, and therefore the firm owes money to them.
The longer this time period is, the better the management is at controlling its Working Capital. The business delays cash payments as long as possible to longer keep Cash in the business. This can help to free up cash for the business to invest this money in other revenue-generating projects.
Creditor Days measures the average number of days it takes a business to pay its suppliers who gave the business trade credit.
How to calculate Creditor Days?
The figures for working out Creditor Days can be found in Profit and Loss Account (P&L Account) and Balance Sheet.
| Creditors (Accounts Payable) | |||
| Creditor Days = | ━━━━━━━━━━━━━━━━━━━━ | x 365 | |
| Cost of Goods Sold (COGS) |
Comment
Creditor Days is expressed in full days as a number.
If a business has USD$200,000 of Creditors (Accounts Payable) in Balance Sheet owed to its suppliers with USD$1,000,000 worth of Cost of Goods Sold (COGS), then Creditor Days is 73 days. This means it takes 73 days on average for a business to pay its suppliers.
The more time it takes for a business to pay its debts, the better it is for the business as repayments are prolonged. This can help to free up cash in the business for other use in the short-term.
Common Creditor Days: It is common to provide customers with 30-60 days trade credit, so Creditor Days in this range would seem acceptable. The firm’s ability to pay debts within a suitable timeframe is known as credit rating. A business is generally seen as having good credit rating, if it can pay debts within 30-60 days.
High Creditor Days: If the Creditor Days ratio is very high, it means that the business is taking too long to pay its creditors, so suppliers may impose financial penalties for late payments, hence harm the firm’s cash flow. Perhaps, the finance department wants to pay for supplies as late as possible, but the production department does not want to get in troubles with suppliers as production wants to have uninterrupted production process.
Low Creditor Days: If the Creditor Days ratio is very low, it means that the business is unnecessarily paying its suppliers too soon. This will reduce the amount of cash available in the business for other projects. Suppliers may continue demanding immediate payments in the future. A business paying cash promptly will have a very low Creditor Days result.
Example for Creditor Days
COMPANY A
Company A has Sales Revenue of USD$2,000,000 in 2020 and USD$2,500,000 in 2021. Cost of Goods Sold (COGS) was USD$1,000,000 in 2020 and USD$1,500,000 in 2021. Debtors (Accounts Receivable) were USD$200,000 in 2020 and USD$100,000 in 2021 while Creditors (Accounts Payable) were USD$200,000 in 2020 and USD$400,000 in 2021.
| 2020 | 2021 | ||||||
|---|---|---|---|---|---|---|---|
| Sales Revenue | $2,000,000 | $2,500,000 | |||||
| Debtors (Accounts Receivable) | $200,000 | $100,000 | |||||
| Debtor Days | 36 days | ➘ | 15 days | ||||
| Cost of Goods Sold (COGS) | $1,000,000 | $1,500,000 | |||||
| Creditors (Accounts Payable | $200,000 | $400,000 | |||||
| Creditor Days | 73 days | ➚ | 98 days |
In 2020, Company A has Creditor Days of 73 days. This means it takes 73 days on average for the business to pay its suppliers who gave the business trade credit. In 2021, Company A has Creditor Days of 98 days. This means it takes 98 days on average for the business to pay its suppliers who gave the business trade credit.The time period is longer which means that it takes more time for a business to pay its debts, therefore the better the management is at controlling its Working Capital in 2021.
How to improve Creditor Days?
Businesses can improve their Creditor Days by slowing down and extending debt payment period in several ways:
- Wait until the last day to pay the invoice. This is the easiest and the safest way to improve the Creditor Days ratio without having any negative impact on the business.
- Automate payments. Through the process of automating payments, a business can determine the optimal time to repay suppliers. The payment will be transferred to the suppliers from the business’s bank account on designated days, hence important payments will never be missed.
- Develop good relationship with suppliers. When a business has close and trustworthy relationships with suppliers and other creditors, they may be more willing to extend the credit period for a couple more days.
- Renegotiate payment terms. It is fine to try to get better terms from suppliers especially when a business is purchasing very large orders. In this way, the firm will have more time to repay its suppliers.
- Delay payments to suppliers. In case suppliers and other creditors will not agree to wait a few more days for their payments, the business might have no choice but to delay payments anyway. However, suppliers may not agree to allow it, so this causes a potential problem.
- Change the supplier. While some suppliers of raw materials are not flexible at all with their trade credit terms, some other suppliers may be more comfortable with giving extended trade credit periods. But, working with another supplier may negatively impact quality of raw materials.
- Implement Just-In-Time inventory control system. By introducing a system of just-in-time production, the firm will eliminate the need to hold large amounts of stock, hence improve stock control.
The efficiency position of a business can be enhanced by improving any of its efficiency ratios – increasing Stock Turnover, reducing Debtor Days and increasing Creditor Days.
