Why are debtor days important?
In a nutshell, this metric shows the average number of days it takes for a company to receive payment for outstanding invoices. It measures how quickly cash is paid to a company for goods or services provided. Businesses that offer payment terms, usually when selling to other businesses, often don’t get paid by the due date on the invoice. In fact, a survey conducted by Moula found that 65% of SME customers don’t pay on time. This means that businesses offering payment terms of 15, 30, 60 or even 90 days have to wait even longer for their money to come in and negatively affect their cash flow.
Other research by Xero Accounting found that 53% of invoices to big businesses from SMEs are paid late. On average, these payments were 23 days late. So the greater the number days an invoice is paid after the payment due date, the worse it is for a business’s cash flow. Using the figures from their research, Xero estimates that late payments from big businesses to small businesses cost the Australian economy $7 billion per year. This is the result of small businesses not being able to invest in their growth while they are waiting for trade receivables to be paid. For many small business owners who provide payment terms, waiting to get paid causes stress and lowers overall business confidence.
How to calculate debtor days
The variables used in the debtor days calculation are accounts receivable and annual credit sales.
The equation for calculating debtor days is:
(Average Accounts Receivable/Annual Credit Sales) x 365 days
For example, if a company’s annual credit sales are $250,000 and its average accounts receivable are $25,000, its debtor days are 36.50. In this case, if the company’s payment terms are 30 days, it gets paid 6.5 days late on average. But if its payment terms are 15 days, it gets paid 21.5 days late on average. Since this metric is in the form of a ratio, it’s also called the debtor days ratio.
How to reduce debtor days
There are a number of ways to reduce debtor days. An important first step for getting paid on time is having credit policies and procedures in place. This includes taking steps to approve customers before granting invoice payment terms, having clear invoicing procedures and following up quickly when invoices are overdue. Learn more in How to Collect Late Payments and Avoid Bad Debt.
One common strategy for getting paid quickly is to offer early payment discounts. This is usually a small amount of 5% or less. It’s also important to avoid billing errors when creating invoices. When an invoice includes errors, a new invoice has to be issued which can add weeks to the time it takes to get paid.
Avoid late payments with Moula Pay
As high debtor days harm cash flow and limit the opportunity for growth, more small businesses are looking for solutions. Being aware of the conundrum buyers and sellers face in business-to-business transactions, Moula has created Moula Pay. Using this finance option, Moula Pay merchants get paid immediately while approved buyers get three months without paying interest and nine additional months, if needed, to repay the amount of the purchase.
In addition to becoming a Moula Pay merchant, a business can solve cash flow challenges with short-term unsecured business loans.