What Are Debtor Days and Why Are They So Important to Your Company?

Debtor days, also known as days sales outstanding (DSO), are an important metric for businesses to follow. However, many ignore this metric as long as their clients and customers pay their debts.

This practice may seem honorable, but it can have a dramatic impact on your overall cash flow and financial health.

The standard debtor days meaning is simple: the number of days it takes for your customers to pay invoices.

What Do Debtor Days Mean for Your Business?

Low debtor days is beneficial for your business, and it means that you have:

• Higher cash flow
• More investing opportunities

Basic economics tells us that it’s better to have money in the bank today than it is tomorrow. Why? When money is in your bank account, it can then begin accruing interest. “In the bank” simply means that the money has been paid.

If you have the money in your account today, it’s possible for you to:

• Invest in growing operations
• Invest in new opportunities
• Leverage the money to save money on supplies

When your money is tied up in invoices, it’s not realized and it’s worth less to you. Money owed to you cannot be used, at this very second, for the betterment of your business. There's also the risk that the invoice will not be paid, leaving you with the potential that the money will be a loss.

Debtor days outstanding are important because any company must work to have more money in their bank accounts. For example, if you have an average of 45 DSO with $100,000 in invoices per month and reduce this average to 30 days, you can have $50,000 in a cash balance increase.

Imagine what your business can do if they trade debtor days to increase cash by this much:

• Hire new employees
• Invest money in research and development
• So much more

However, if you don’t have the cash, you’re in limbo and not able to leverage the cash to continue growing your business at such a high rate.

Reducing your debtor balance to a respectable level is one of the initiatives that every business should pursue. The extra cash in the bank and healthy cash flow are something businesses of all sizes should be working on to help keep operations running optimally.

Learning your DSO can be enlightening, and it’s a calculation that an accountant can perform for you, or you can use software to help. Of course, you can also run the calculations manually once you know the formula to use:

What You’ll Need to Calculate Debtor Days?

Businesses will need to gather a lot of data to properly calculate their DSO. Some of the information that you’ll need to have is:

• Receivables amount
• Credit sales

You'll need to go through your books to gather all of this information.

Debtor Days Formula

Once you have the information about your debtor days, you can easily run the following calculations to find your average DSO:

• (Accounts receivables average / credit sales) * 365

If you do not have credit sales available, you can use total sales amounts. The main issue with using total sales amounts is that it’s less accurate than if you use credit sales. Using your average accounts receivable will require you to calculate the average of your accounts receivable between the beginning and end of the period.

What Is a Good Debtor Days Ratio?

It depends. A good ratio in one industry may be 30 days and it may be 60 days in another. The ratio of payment may vary greatly, but many companies will try to keep their payment within 45 days or less.

Whether or not you can achieve this low payment time depends on many factors, which are outlined below.

Average creditor days and debtor days vary drastically due to a number of factors. For example, being paid in 60 days may be exceptional for some businesses and far higher than the national average for others.

The following factors will play a role in determining your average:

• Industry: Different industries have standards for payment. For example, if you sell high-value products and have lower clients, you are likely in an industry with a higher average day until payments are made.
• Discounts: Industries where it’s common for discounts to be applied for fast payments are far more likely to have lower averages than in an industry where discounts are not applied.
• Credit Norms: In industries where extending credit to customers is the norm, it’s almost certain that payment will be delayed.

However, there may also be other reasons for higher averages. For example, the person in charge of sending invoices may make errors, causing customers to dispute invoices and making payments take longer than necessary.

On top of this, proper collection systems may not be in place.

If the department in charge of sending invoices is dropping the ball and failing to send out prompt invoices, it will lead to delays, too. All businesses should review their average DSO and compare it with the industry average.

When your DSO is higher than normal or has risen in recent months, there are steps you can take to bring this number down.

It's in your best interest to reduce debtor days as much as possible. While you’re unlikely to get these days down to zero, you can take steps to improve your DSO.

Ways To Improve Average Debtor Days

1. Set up automatic invoice systems to send out invoices to customers immediately when work is complete, or orders are made.
2. Create reminder systems, which will send out reminders for any payments due at the durations that you set.
3. Check customer credit history to learn which customers are known to pay on time and which have missed payments in the past.

Automating invoices and reminders can save your business 90 minutes each day from pursuing non-payments. In a full week, most businesses will lose 8+ hours to workers trying to get customers to pay their debts.

If you use automation, it will help you reduce average DSO and do so without wasting manhours in the process.

It's always in your best interest to seek full payment as soon as possible. Sit down with business stakeholders to find a way to incentivize faster payments. Perhaps if a payment is made within 30 days, it will receive a 1% discount, but a late invoice payment may receive a 2% penalty.

Businesses will often pay faster if a discount is possible because it will help them better manage their cash flow and improve profit margins, too.

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• Cash flow reports
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