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 Debtor Days measure?
Debtor Days is also known as known as accounts receivable collection period.
Debtor Days measures the average number of days it takes a business to collect money from its customers who bought products on trade credit – debtors. Debtors are the customers who have purchased items on credit and therefore owe money to the firm.
The shorter this time period is, the better the management is at controlling its Working Capital. The business collects cash payments from its debtors faster.
Debtor Days measures the average number of days it takes a business to collect money from its customers who bought products on trade credit.
How to calculate Debtor Days?
The figures for working out Debtor Days can be found in Profit and Loss Account (P&L Account) and Balance Sheet.
| Debtors (Accounts Receivable) | |||
| Debtor Days = | ━━━━━━━━━━━━━━━━━━━━ | x 365 | |
| Sales Revenue |
Comment
Debtor Days is expressed in full days as a number.
If a business has USD$1,000,000 of Debtors (Accounts Receivable) in Balance Sheet owed by its customers with USD$5,000,000 worth of Sales Revenue, then Debtor Days is 73 days. This means it takes 73 days on average for a business to
Collect its debts from its customers who have bought items on credit.
The less time it takes a business to collect money from customers, the better it is for the firm as it improves its cash flow when customers pay fast. This can help to free up cash for the business to invest this money in other revenue-generating projects.
Common Debtor Days: It is common to provide customers with 30-60 days trade credit, so Debtor Days in this range would seem acceptable. The firm’s ability to collect debts within a suitable timeframe is known as credit control. A business is generally seen as having good credit control, if it can collect debts within 30-60 days. There is no right or wrong result – it will vary from business to business, and from industry to industry.
High Debtor Days: If the Debtor Days ratio is very high, it means that the business is taking too long to collect money from its debtors, so customer may finally not pay at all. A very high Debtor Days will cause liquidity problems. However, it may be a deliberate management strategy – customers will be attracted to businesses that give extended credit. Perhaps, the marketing department wants to increase credit terms for customers to sell more products, but the finance department wants all customers to pay for products as soon as possible.
Low Debtor Days: If the Debtor Days ratio is very low, it means that the business is demanding its customers to pay immediately. Some customers may seek other suppliers, if the credit period given to them is uncompetitive. A business selling almost exclusively for cash will have a very low Debtor Days result close to 0 days.
Example for Debtor 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 Debtor Days of 36 days. This means it takes 36 days on average for the business to collect its debts from those customers who have bought items on credit. In 2021, Company A has Debtor Days of 15 days. This means it takes 15 days on average for the business to collect its debts from those customers who have bought items on credit. The time period is shorter which means that the business collects cash payments from its debtors faster, therefore the management is better at controlling its Working Capital.
How to improve Debtor Days?
Businesses can improve their Debtor Days by speeding up debt collection period in several ways. The following list shows actions that can be taken from the least serious to the most serious:
- Be clear on payment terms. The invoices given to customers should be transparent when it comes to the costs and when payments are due. Invoices should be as clear and concise as possible.
- Improve credit control. Stay up to date with customer information by reformulating and revisiting all customers’ information and circumstances. Track invoices and set up a follow-up system. Proactively identify payment danger signals. Also, manage risks rethinking the amount of credit given to certain customers and restructure invoices that still remain unpaid.
- Give shorter trade credit to customers. The value of Debtor Days could be reduced by giving shorter credit terms such as 10 days instead of 60 days, 90 days or even 180 days.
- Offer debtors incentives to pay earlier. Give a discount to those customers who pay their bills before the due date. Encourage customers to use direct debit or autopay – transferring money directly from the client’s bank account on designated days. This saves customers time having to remember when to pay their bills, so they can avoid penalties for late payments.
- Charge penalties on late payers. Many banks and utility companies add a fine to those who pay their bills late. Also, governments impose additional payment on Income TAX bills for late payers.
- Refuse any further business with a client until payment is made in full. This may include stopping supplies temporarily or suspending orders completely until the whole payment is received. This could also involve refusing trade credit in the future to frequent late payers.
- Threaten legal action. The threat of suing a customer in court is extreme but is often used for clients who repeatedly pay late, or who do not pay at all.
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.
