Late payments and bad debt can take a serious toll on your cash flow, so how can you encourage timely payments? One measure to look at is the debtor days ratio. This looks at the length of time it takes to collect payments from your clients or debtors. Here’s a closer look at the debtor days calculation, as well as how to reduce payment lags and restore cash flow.
What does debtor days mean?
The term ‘debtor days’ refers to how quickly your business collects payments from those who owe you money. The more days it takes for repayment, the higher the debtor days ratio. For example, imagine that you’ve submitted an invoice to a client for goods they’ve purchased. On the invoice, it states that the client (or debtor) has 15 days to make a payment. This means they have 15 debtor days.
Small businesses must pay careful attention to debtor days, because cash flow can be tight. Late payments can significantly impact your own ability to pay for inventory and supplies, jeopardising daily operations if you’re not careful.
How to calculate debtor days
Every business will have different rules when it comes to payment terms, but if you’re looking at how to calculate debtor days there are a few options to try. This includes several debtor days formulas, including the following:
Debtor days calculation:
(Trade receivables / Annual credit sales) x 365 = Debtor Days
Using this formula, imagine that your business has £5,000 in trade receivables and £25,000 in annual credit sales. You can plug this into the debtor days formula:
(5,000/25,000) x 365 = 73
Using this debtor days ratio, you can comfortably give your clients up to 73 days to pay their invoices. However, by using standard net 30 or net 45 payment terms instead, you’ll give your business a nice cushion to accommodate late payers while still maintaining your cash flow.
How to reduce debtor days
While it’s helpful to calculate the ideal debtor days ratio using formulas like the one mentioned above, it’s also a good idea to find ways to reduce payment times whenever possible. Here’s how to reduce debtor days.
Make payment terms clear: Avoid any confusion by issuing clear, straightforward invoices using a template that includes a breakdown of costs along with payment terms.
Charge penalties for late payments: While small businesses often shy away from penalising customers, persistent late payments can take a real toll on your operations. It’s increasingly common to charge late fees. However, be sure this is clearly stated on the invoice to avoid confusion.
Use automated invoicing software: software like GoCardless not only creates and issues invoices on your behalf, but can also schedule reminders and track payments in a central system. Sometimes even conscientious clients can forget about a bill, so automated follow-up messages about impending payment deadlines can reduce debtor days.
Run a credit check on new clients: If you’re extending credit to customers, treat them as any credit provider would be viewing their credit report first. For those with bad credit, it might be better to ask for prepayment.
The bottom line
Perhaps the best way to reduce debtor days is to provide incentive for timely payments. Consider offering discounts for prepaid debts to encourage clients to pay you as soon as they’ve received the invoice. Many customers prefer paying bills quickly to lighten their admin load, so you’ll encourage them to prepay with a slight discount. This not only encourages further business due to the discount but gives your cash flow a boost.
Overall, most businesses will find that a blend of tactics works best when looking at how to reduce debtor days.
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out more about how GoCardless saves you time and money with all ad hoc or recurring payments.