Debtor days, also known as day sales outstanding (DSO), is a financial metric that measures the average number of days it takes a company to collect payments from its customers. It is calculated by dividing the average accounts receivable by the company’s annual credit sales and multiplying by 365.
A lower debtor days ratio indicates that a company is collecting payments from its customers more quickly, which can improve its cash flow and profitability. A higher debtor days ratio, on the other hand, can indicate that a company is having difficulty collecting payments from its customers, which can lead to cash flow problems and financial distress.
The average debtor days ratio for businesses in different industries varies, but a good target is to keep debtor days below 45. However, the specific target for a particular business will depend on factors such as the industry, the company’s credit policy, and the payment terms it offers to its customers.
Here is the formula for calculating debtor days:
Debtor days = (Average accounts receivable / Annual credit sales) * 365
For example, if a company has average accounts receivable of $1 million and annual credit sales of $5 million, then its debtor days would be 73 days.
Here are some factors that can affect a company’s debtor days:
- The industry the company operates in: Some industries, such as retail, typically has longer debtor days than others, such as manufacturing.
- The company’s credit policy: A company with a lenient credit policy, such as offering long payment terms, will likely have longer debtor days than a company with a stricter credit policy.
- The payment terms the company offers to its customers: If a company offers its customers 30-day payment terms, it will likely have longer debtor days than a company that offers its customers 15-day payment terms.
Debtor days is an important metric for businesses to track because it can impact their cash flow and profitability. By keeping debtor days under control, businesses can improve their liquidity and financial health.
How Debtor Days affected the company’s financials?
Debtor days can affect a company’s financials in a number of ways, including:
- Cash flow: A longer debtor days period means that a company has to wait longer to receive payments from its customers, which can lead to cash flow problems. This can make it difficult for a company to meet its financial obligations, such as paying its bills and making payroll.
- Profitability: A longer debtor days period can also hurt a company’s profitability. This is because the company has to tie up more of its cash in accounts receivable, which means that it has less cash available to invest in other areas of the business, such as research and development or marketing.
- Credit rating: A longer debtor days period can also hurt a company’s credit rating. This is because lenders look at a company’s debtor days as a measure of its financial health. If a company has a long debtor days period, it may be seen as a riskier borrower, which can make it more difficult for the company to obtain loans or other forms of credit.
In general, a shorter debtor days period is better for a company’s financials. This is because it means that the company is collecting payments from its customers more quickly, which can improve its cash flow and profitability. However, it is important to note that the optimal debtor days period will vary depending on the industry and the company’s specific circumstances.
Here are some tips for reducing debtor days:
- Offer early payment discounts. This can encourage customers to pay their invoices early, which will shorten the debtor days period.
- Be clear about your payment terms. Make sure that your customers understand the payment terms that you offer, and that they are aware of the consequences of late payments.
- Follow up with customers who are late with their payments. This will help to ensure that you receive payments on time.
- Use a collections agency. If you have a customer who is consistently late with their payments, you may need to hire a collections agency to help you collect the debt.
By following these tips, you can help to reduce your debtor days and improve your company’s financial health.