When I am sat in a client board meeting, we regularly discuss the KPIs set for the business. One of the standard KPIs provided within each set of Monthly Management Accounts is the measurement of Debtor Days, but it is often the KPI that is the most misunderstood.
What are Debtor Days?
Debtor days provide a clear picture of your company’s credit and collection efficiency.
This metric, also known as “days sales outstanding (DSO),” measures the average number of days it takes for your business to receive payment after a sale.
The lower the number of debtor days then this shows that your customers are paying promptly, improving your cash flow. Conversely, a higher debtor days number can signal potential issues with payment collection or overly lenient credit terms.
By monitoring debtor days regularly, businesses can identify trends, improve cash flow, and ensure they have sufficient liquidity to cover operational expenses.
Why Are Debtor Days Important?
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Cash Flow Management: Debtor days impact your working capital. Quicker payments mean more cash is available for reinvestment or operational needs.
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Credit Risk Assessment: Tracking debtor days helps identify customers who may struggle to meet payment deadlines.
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Business Sustainability: Consistently high debtor days may indicate inefficiencies in your invoicing or collections process, which could harm your business in the long run.
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External Measurement: In every business sale I have been involved in, Debtor Days are a due Diligence question.
How do I calculate Debtor Days
The formula for debtor days is straightforward:
Components:
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Accounts Receivable (AR): The amount of money owed to your business by customers.
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Total Credit Sales: Revenue generated from sales made on credit (exclude cash sales).
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Number of Days: Typically, 365 days for a full year or a relevant period for shorter calculations.
Step-by-Step Guide to Calculate Debtor Days
Let’s walk through an example:
Example:
A business has the following data for the year:
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Accounts Receivable: £50,000
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Total Credit Sales: £300,000
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Number of Days: 365
Step 1: Apply the Formula
Step 2: Perform the Calculation
Step 3: Interpret the Result
The business’s debtor days are approximately 61 days. This means, on average, it takes the company 61 days to collect payment from its customers.
Tips to Reduce Debtor Days
If your debtor days are higher than desired, and I used the example above because I don’t like to see Debtor Day above 60 days, here are some strategies to improve:
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Streamline Invoicing: Send invoices promptly and ensure they’re clear and accurate. You may want to consider more than 1 billing cycle per month, or agree milestone payments on longer term projects.
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Set Clear Payment Terms: Communicate payment deadlines upfront and consider offering early payment discounts.
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Follow Up on Overdue Payments: Establish a systematic approach to remind customers of outstanding invoices.
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Use Technology: Implement accounting software such as Xero to automate invoicing and payment reminders.
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Credit Checks: Conduct thorough credit checks on new customers to minimise the risk of late payments. I am always surprised at how many small businesses just accept orders without running credit checks on customers.
Calculating debtor days is an essential part of managing your business’s financial health. By understanding how long it takes for your company to collect payments, you can identify areas for improvement and take proactive measures to optimise your cash flow.
Regularly monitoring this metric and implementing best practices, for example within a monthly board meeting, can significantly enhance your financial stability and long-term growth. Understand your debtor days and take control of your cash flow!
