Q&A - How can the debtor days ratio be calculated and interpreted?

The debtor days ratio focuses on the time it takes for trade debtors to settle their bills. The ratio indicates whether debtors are being allowed excessive credit. A high figure (more than the industry average) may suggest general problems with debt collection or the financial position of major customers. The efficient and timely collection of customer debts is a vital part of cash flow management, so this is a ratio which is very closely watched in many businesses.

The formula to calculate debtor days is:

An example of the calculation is shown below:

The data above indicates an improvement in debtor days – i.e. debtor days have fallen. That means that the business is converting credit sales into cash slightly quicker, although it still has to wait for an average of over two months to be paid!

The average time taken by customers to pay their bills varies from industry to industry, although it is a common complaint that trade debtors take too long to pay in nearly every market.

Among the factors to consider when interpreting debtor days are:

• The industry average debtor days needs to be taken into account. In some industries it is just assumed that the credit that can be taken is 45 days, or 60 days or whatever everyone else seems (or claims) to be taking

• A business can determine through its terms and conditions of sale how long customers are officially allowed to take

• There are several actions a business can take to reduce debtor days, including offering early-payment incentives or by using invoice factoring