How to Calculate Debtor Days [Simple Guide – Step-by-Step]
What are Debtor Days?
Debtor days is a financial ratio that measures the average number of days it takes a business to collect payments from its credit sales.
In other words, it calculates how quickly a company can convert credit sales into cash.
Debtor Days Formula
The formula to calculate debtor days is straightforward:
Debtor Days = (Trade Receivables / Annual Credit Sales) × 365
Where:
Trade Receivables = the total amount of money owed to the business by its customers at a given point in time.
Annual Credit Sales = the total sales made on credit during a year.
The result of the calculation shows the average number of days it takes for a business to collect its debts.
Example Debtor Days Calculation
Let’s look at an example to understand how to calculate debtor days.
Imagine a business that has the following financial data:
Trade Receivables | £50,000 |
Annual Credit Sales | £600,000 |
To calculate debtor days:
Debtor Days = (Trade Receivables / Annual Credit Sales) × 365
Debtor Days = (£50,000 / £600,000) × 365
Debtor Days = 30.42
This means it takes the business around 30 days to collect payments from customers after making a sale.
Interpreting Debtor Days
Now that we can calculate debtor days, we need to understand what the output means.
Generally speaking:
Timeframe | Summary |
0 to 30 Days | Short collection period and an ideal range |
31 to 60 Days | Reasonable range for many industries |
60+ Days | Problematic and may require action to collect overdue accounts |
Industry Benchmarks for Debtor Days
While every business is different, it’s useful to know the industry average for debtor days for comparison:
Retail | Typically low, around 20-30 days, as most transactions are cash-based. |
Manufacturing | Often 30-60 days due to the nature of large credit sales. |
Construction | Can be 60-90 days, as payments are often delayed due to project-based billing. |
Why are Debtor Days Important?
Understanding and monitoring debtor days is important for a few reasons:
Cash Flow Management
Cash flow issues can arise from delays in receiving customer payments.
This can make it difficult for the business to run smoothly, as it may need the cash to pay suppliers, employees, and other debts on time.
Credit Control Policy
High debtor days could indicate that a business is offering overly generous credit terms to customers.
This might suggest that the business needs a review of their credit control policy, where they could reduce the payment terms offered.
For example, moving from 60 day credit payment terms to 30 day terms.
Financial Planning
By knowing how long it takes to get paid, businesses can more accurately forecast cash flow, which helps with budgeting and planning.
Managing Debtor Days
If a business’s debtors days are higher than they would like, there are several strategies they could implement to try and improve the situation:
Set Clear Credit Terms
Ensure that payment terms are clearly communicated to customers at the time of sale.
Many businesses use “Net 30” terms, which means payment is due 30 days after the invoice date.
Depending on industry and cash flow needs, a business could shorten payment terms to something such as “Net 15.”
Invoice Promptly
The sooner a business invoices their customers, the sooner they’ll be able to pay.
Delays in sending out invoices will naturally extend debtor days.
A business should invoice immediately upon completion of a sale or service.
They could also send electronic copies of invoices, rather than posting our paper copies, ensuring a quicker delivery to the customer.
Early Payment Incentives
A business could offer customers a discount for paying early.
For example, they might offer a 2% discount if they pay within 10 days, instead of the usual 30.
This can encourage quicker payments as customers seek a reduced total bill.
Efficient Credit Control
Business should ensure that they follow up on overdue invoices as soon as they become past due.
A polite but firm reminder can often prompt immediate payment.
If necessary, a more formal reminder could be sent, or a collections agency could become involved to chase the debt payment.
Effective Credit Checks on New Customers
Before providing credit to new customers, business should always perform a credit check to help assess their ability to pay on time.
If a customer has a poor credit history, they could be offered less favourable credit terms or be asked for payment upfront.
Debt Factoring
If a business is struggling with cash flow due to long debtor days, debt factoring can be an option.
This is where a business sells their accounts receivable to a third party (a factoring company) at a discount.
Although this provides immediate cash, it reduces the amount the business would have ultimately received.