Cash flow, as any business owner will know, is critical for the ongoing operation and success of a business. Debtor days, however, can often be just as impactful but are unfortunately overlooked by many companies. That is until working capital becomes too stretched that the late payments and associated unexpected costs are put under the financial microscope. Putting a reasonable limit on the number of debtor days will help you manage cash flow and your customers manage expectations.
In this blog, we’ll outline everything you need to know about debtor days.
Debtor Days – what are they?
The simple definition is that debtor days measure the average time that a business takes to get paid. Another way to think about it is as a day’s sales in accounts receivable.
In other words, it’s just a way of referencing the number of days between the issuing of your customer’s invoice and the date on which payment is collected. If, on average, it takes 17 days for your invoices to be paid, then your debtor days is 17.
Average payment term in New Zealand
Most businesses provide a payment term of somewhere between 21 and 30 days, but despite the friction of payment processing significantly reducing in recent years, almost half of invoices are still paid late and almost 10% are paid more than a month late.
Calculating debtor days
It’s not actually difficult to calculate your debtor days. First, you will need to get some data from your accounts receivable department.
Ask your team for the average accounts receivable amount for a specific period, such as a month. This can be found by taking the incoming payments during that period, adding them up and then dividing them by the number of payments to get the average.
Next you need your total annual company sales for that period and then divide it by the number of days in the month, so you get the right average daily sales.
Your debtor days are then your average accounts receivable divided by your average daily sales. Or in formula form:
Debtor days = (average accounts receivable / average daily sales)
For the debtor days ratio, however, you will need to take that number and multiply it by 365 (for the number of days in the year).
Debtor days ratio = (average accounts receivable / total daily sales) x 365
Of course, this calculation can be adjusted to reflect monthly, quarterly or annual calculations as well.
For example, if your business’s sales for the year was $750,000 with $100,000 in average account receivables, your debtor days ratio calculation for that period would be: (100,000/750,000) x 365 = 48.6.
Debtor days ratio
As a business owner, knowing your debtor days ratio gives you an indication of how quickly debts need to be collected on average to maintain healthy cash flow. In the above example, 48.8 days on average.
Understanding the Importance of Debtor Days
Debtor days can and are used as a way of measuring a company’s liquidity. If the number of days it takes for invoices to be settled continuously exceeds the normal amount, this can indicate a negative trend in your cash flow situation. Cash flow disruption can obviously cause operational issues as you may struggle to cover necessary expenditure.
Rising Average Debtor Days
If your average debtor days continue to rise, your payment collection processes may need to be revisited. Either the issue is on your customer’s side, for example credit issues, or your processes need to be streamlined.
Decreasing the number of debtor days is a good thing for cash flow as long as your customers are not feeling pressure to settle payment too quickly.
Remember to account for seasonal fluctuations and other external factors that could affect average payment time if you’re looking at narrow time periods.
Dealing with Debtor Days as a Business Owner
It’s important to compare your debtor days with your payment terms. If your debtor days are 50 days but your terms require payment of 30 days, then there is an issue that may be attributable with your accounts receivable or the customers themselves. If your debtor days are within your terms but cash flow is still tight or disrupted, then your terms may need to be adjusted.
As mentioned briefly above, debtor days can be influenced by external factors out of your control. You may have a large enterprise client that makes payment on its terms. Or there could be industry-specific norms that you are not aware of.
Either way, having a strong understanding of and your thumb on your debtor days will help you predict and manage cash flow.
Should you offer extended payment terms?
Small and medium enterprises are generally more vulnerable to late payments. Our SME Growth Index research has indicated in the past that liquidity and cash flow are among the high contributors to small businesses seeking financial business restructuring.
Can you improve average debtor days?
There are a few different ways in which you can improve your company’s average debtor days.
1. Effective Payment Collection System
This can include everything from clear terms of payment on your invoices, multiple payment options, a responsive collections services line and invoices being issued on time.
2. Discounts and Penalties
Another strategy is to offer customers discounts for early invoice payment and, if agreed to from the outset, penalties for late fees.
How Invoice Finance Can Help with Cash Flow
Invoice Finance from a reputable lender such as ScotPac can and has helped unlock capital tied up in unpaid invoices for businesses across Australia. This financial solution allows businesses to access and leverage up to 95% of the value of outstanding invoices prior to customers settling their debts.
Depending on the specific agreement terms, invoice finance providers can even offer collections services taking the stress of following up on payments out of your hands.
Improve Cash Flow for Your Business with ScotPac
The specialist team here at ScotPac knows just how critical reliable, steady cash flow is for a small or medium sized business. Our breadth and depth of customisable business solutions ensure that businesses of all types can access a workable financial solution that meets the particulars of their needs. It’s about unlocking value to speed up your business’s growth in a sustainable way.
We’ve been helping our clients add fuel to their rockets of success for over 30 years in both New Zealand and Australia. So, if you’re experiencing cash flow management issues or are worried about your debtor days, give our team a call today.