A rough measure of the average length of time it takes for a company’s debtors to pay what they owe is the “debtors’ days” ratio, or average debtors’ payment period.
Debtors payment period = (Trade debtors / Sales) X 100
The estimated average debtors’ payment period is calculated as follows.
The figure for sales should be taken as the turnover figure in the profit and loss account. The trade debtors are not the total figure for debtors in the balance sheet, which includes prepayments and non-trade debtors. The trade debtors figure will be itemized in an analysis of the debtor’s total, in a note to the accounts.
The estimate of debtor’s days is only approximate.
- The balance sheet value of debtors might be absolute higher or low compared with the “normal” level the company usually has.
- Turnover in the profit and loss account is exclusively of value added tax (VAT), but debtors in then balance sheet are inclusive of value added tax (VAT). We are not strictly comparing like with like.
Sales are usually made on normal credit terms of payment within 30 days. Debtors’ days significantly in excess of this might be representative of poor management of funds of a business. However, some companies must allow generous credit terms to win customers. Exporting companies in particular may have to carry large amounts of debtors, and so their average collection period might be well in excess of 30 days.
The trend of the collection period (debtor’s days) over time is probably the best guide. If debtor’s days are increasing year on year, this is indicative of a poorly managed credit control function.