Cash flow is a critical factor for any business. The time it takes for invoices to be paid is commonly referred to as debtor days, and this is a significant factor when determining the inflow of customer payments.
Managing this period so payments are punctual and consistent can be challenging. However, to accurately assess your business’s finances, you must understand how to calculate debtor days.
In this useful guide, we’ll explore the simple formula for calculating average customer payment time. Plus, we’ll look at strategies to accelerate and optimise cash flow. Leveraging market-leading supply chain technology and finance solutions can help your business on the path to consistent cash flow, and ultimately, sustainable growth.
Understanding debtor days
Nigel Thayer, Octet’s WA Director of Working Capital Solutions, explains how important it is for businesses to understand debtor days. “As an indicator and measure of cash flow, knowing your debtor days can help with cash flow planning, customer management and other internal issues.”
To calculate debtor days, businesses can average them based on monthly, quarterly, or annual data with a receivable days formula. This formula divides the average receivables ledger balance by average daily sales.
Here’s an example of how to calculate debtor days on a monthly average:
Debtor Days = (Total Accounts Receivable / Average Daily Sales)
- Total Accounts Receivable = (Accounts Receivable at the beginning of the month + Accounts Receivable at the end of the month) / 2
- Average Daily Sales = Total Annual Sales / 365 days
For example, John Smith & Co had $500,000 in accounts receivables for the last month. They also have annual sales of $4,000,000 (or $10,958.90 a day). Therefore their average debtor days is 45, and to maintain healthy cash flow, the business needs to collect its outstanding debts in at least 45 days on average.
This formula helps you determine the average debtor days, that is the average number of days it takes for your customers to pay their invoices.
Why do businesses monitor debtor days?
Monitoring debtor days is part of the overall management of your business’s finances, and understanding them allows you to follow trends and better plan operationally.
“The higher the debtor days, the greater the gap between incoming business revenue versus business outgoings (or costs),” Nigel explains. Common fixed and variable outgoings, including wages, fuel, rent, stock, and loan repayments, must be paid promptly for a business to sustain itself, so adequate and flexible cash flow is needed.
“Without sufficient working capital or access to funding, a business with higher debtor days could find it difficult to meet the business outgoings,” Nigel says. Serious financial issues can arise without active monitoring in this area, including bad debts and limited cash flow.
What affects debtor days?
Understanding your business’s debtor days can help to manage cash flow and indicate key trends. Take particular note of these factors which can impact the time it takes for customers to pay invoices, causing debtor days to be higher than usual:
- consistent customer disputes about work performance or delivery
- increases or decreases in revenue for the period
- inaccuracies in invoicing and delays in payment processing
- an anomaly in the receivables (one customer skewing the figures)
- absence of good receivables management or collection practices in-house
- the number of credit notes or refunds issued in that period
- generally slower-paying customers
- issues with technology and automation
- key staff turnover
How to accelerate payments and reduce debtor days
Reducing debtor days is easier once you’ve identified the factors impacting them. After determining the cause of an increase, these strategies can be useful in accelerating payments:
Collection procedures
“Establishing regular practices around follow-ups and reminders on overdue accounts (usually automated within your accounting software) can accelerate payments from your top list of customers,” Nigel says. Other strategies include credit guidelines, stop-credit procedures and allocating sufficient time and attention to collecting overdue accounts.
Strengthening customer relationships
Improving customer relationships can simplify the process of negotiating payments and managing debtor days. Ways to encourage better payment terms include open communication and accessible customer support, offering multiple payment options (including credit cards) and asking for customer feedback.
Automation solutions
It’s easy to lose track of receivables management amongst all the other considerations and priorities within a business. Taking advantage of technology and automation means reducing the effort — and improving the consistency — of your business’s finances. “Technology doesn’t replace the need for having an active relationship with your customers, but it does help you manage the customer cohort better from a payment collection perspective,” Nigel explains.
Debtor management solutions — like Octet’s debtor finance product and platform — can help. Our supply chain management platform, digital wallet and global network make automating and streamlining your finances easier.
“Gaining a reduction of even two or three debtor days can have a significantly positive effect on cash flow,” Nigel says. “Businesses should be adopting all, or as many of, these strategies as possible.”
Take control of your cash flow with Octet.
Managing debtor days is made easier with Octet. Speak to our team of working capital specialists about innovative debtor finance solutions and discover how leveraging intelligent technology can optimise and accelerate your cash flow.
Disclaimer: The following comments are only our views and should not be construed as advice. You should act using your own information and judgment. Although information has been obtained from and is based upon multiple sources the author believes to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the author’s own judgment as at the date of publication and are subject to change without notice.
