Efficiency Ratios: Debtor & Creditor Days (HL IB Business Management)

• Debtor days measures the average number of days it takes for a business to collect money from its debtors
  
  
• Businesses often provide a period of trade credit to customers
  • In the UK 30 to 60 days is typical
  • The growth of promotional 'buy now, pay later' deals has increased the level of debtors for some businesses
    
    
• It is calculated using the formula

• Businesses aim for a low or reducing ratio
  • This indicates efficiency in collecting outstanding debts from credit customers
  • Collecting debts promptly can improve cash flow

Ways to Reduce the Debtor Days Ratio

• Maintaining open communication with customers helps to address any issues promptly
   

Ways to Reduce the Debtor Days Ratio

• If these methods fail to persuade customers to pay their invoices on time a business has a range of further options. These methods should be pursued with caution as relationships with customers may be damaged
   

Further Ways to Reduce the Debtor Days Ratio

• Creditor days measures the average number of days a business takes to pay its creditors
  
  
• It is calculated using the formula

• Businesses generally aim for a high or increasing ratio
  • This indicates skills of negotiation in arranging extended credit terms with suppliers
  • Delaying payments to suppliers can improve cash flow
    
    
• However, taking longer than agreed to pay outstanding invoices may have negative consequences
  • Relationships with important suppliers may worsen
    • They are less likely to extend further trade credit 
    • Penalties may be issued for late payment 
    • Orders may be delayed until payment is received
  • Creditworthiness may worsen
    • A business may fail credit checks
    • Unable to place orders with other suppliers
    • Less chance of obtaining trade credit elsewhere
    • Could impact applications for borrowing e.g. loans

Ways to Improve the Creditor Days Ratio

• Larger businesses often employ a credit controller to manage negotiations about payments with their suppliers. This person has a range of methods which they can use to improve the creditor days ratio
   

Improving the Creditor Days Ratio

• Insolvency refers to the inability of a business to pay debts and continue trading
• Bankruptcy occurs when a business ceases to trade and the value of its possessions are distributed to its creditors
• The outcome of insolvency depends on the ownership type of the business

A Diagram Comparing Bankruptcy and Liquidation

Insolvency can lead to bankruptcy for unincorporated businesses and to administration or liquidation for companies
 

• Insolvency for a sole trader or partnership can lead to a legal declaration of bankruptcy by a court of law
  
  • The assets of the business and its owners may be sold to settle outstanding debts
    
    
• Companies may liquidate or enter into administration
  • Liquidation involves the selling of business assets to settle outstanding debts and dissolve a company
  • Administration protects businesses from administration whilst it attempts to settle debts and continue trading
    • • If administration fails a company faces liquidation