This article was updated in March 2023 to reflect current definitions and industry trends.
Debtor days measures how quickly cash is being collected from debtors. The longer it takes for a business to collect, the greater the number of debtor days. Or, in other words, when a customer makes a purchase from you, they will have a set amount of time to pay.
Even if you are a small or medium-sized enterprise owner, it is imperative that you understand how debtor days affect your daily operations and what you can do to reduce them.
Debtor days are important when guaranteeing there is sufficient cash flow in a business.
What are debtor days?
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. 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 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?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. Debtor days can easily be calculated by the formula in this blog.How to calculate debtor days
The right number of debtor days will depend on your business and your cash flow. Most SMEs use a formula to calculate how many debtor days they should allow for payments. The most common formula is:(Trade receivables / Annual credit sales) x 365
For example, if a business has $55,000 trade receivables and $455,000 annual credit sales, we get 44.12, So your consumers would have 44 days to pay their invoices.