Serious debts can have a significant impact on a business's cash flow and financial health. When trying to evaluate how long it takes your business to collect payments or debt, look no further than the formula for debtor days. This can be useful in streamlining processes and addressing payment lacks. Keep reading for our short guide to what the debtor days calculation is, how to undertake one yourself, and some examples.
What are debtors?
When a company invoices a customer for a product or service provided the latter has a certain amount of time to make the payment towards the invoice. The customer becomes the debtor, i.e. an entity that owes a company cash for a product or service they provided.
What is the debtor days calculation?
Debtor days, or debtors days ratio, describe how quickly a company collects payments from debtors. It measures the average number of days required for a business to receive payments from its customers. If your business has a large number of debtor days, cash is in short supply and the company will likely have to invest more in its unpaid accounts receivable asset.
How to calculate Debtor Days
Which debtor days formula is right for your business depends on the context of your calculation and the period you are calculating for. These are two common ways of calculating your business's debtor days ratio:
Monthly Debtor Days Formula (Count-back method)
This method accounts for monthly fluctuations and is often used for smaller periods. The count-back method can be useful for companies whose sales change significantly throughout the year. It can help understand how monthly fluctuations impact debt collection. However, the calculation process is quite complicated.
Yearly End Debtor Days Formula
This method helps you determine whether your debtor days have got shorter or longer this year vs last year. You calculate debtor days by dividing accounts receivable by the annual sales for 365 days. The formula for the Year-End Method is as follows: Debtor Days = (accounts receivable/annual credit sales) * 365 days.
Accounts receivable is the amount of money owed to a company for goods or services delivered or used but not yet paid for by customers. Annual credit sales are the sales transactions for which the payment will be made at a later date.
Debtor Days Calculation Examples
Company X has GPB 10,000 in trades receivables and GPB 50,000 in annual credit sales. Using the Yearly End Debtor Days Formula, the calculation would look as follows: Debtor Days = (10,000/50,000) x 365 = 73.
Using this debtor days ratio, Company X can comfortably give their clients up to 73 days to pay their invoices.
Interpreting your company's debtor days
In principle, the higher your debtor days are, i.e. the longer it takes for your company to get paid, the less available cash your company has to use. This can have an effect on your ability to make investments, or even to pay your own bills. After calculating your debtor days, it is worth comparing them to your payment terms. Reducing debtor days can be a sign of increased efficiency in your business.
Debtor days can vary depending on the industry you are in and the efficiency of eg your billing process. Of course, having incentives, such as discounts, for your customers to pay early can help decrease debtor days.
Debtor Days FAQs
- Why are debtor days important?
Being aware of your business's debtor days can improve your understanding of your business when it comes to managing expectations around payment times and the effectiveness of your cash collection.
- What does an increase in debtor days mean?
A larger number of debtor days means that your company has to invest more cash in its unpaid accounts receivable asset. A smaller number implies means smaller investment in accounts receivable is required, which ultimately leaves your business more cash available for other uses.
- Is debtor days the same as the debtor collection period?
Debtor days are also known as the debtor collection period.