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Q&A - What is the “creditor days” ratio?

Saturday, January 08, 2011
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“Creditor days” is a similar ratio to debtor days and it gives an insight into whether a business is taking full advantage of trade credit available to it. This ratio estimates the average time it takes a business to settle its debts with trade suppliers.

As an approximation of the amount spent with trade creditors, the convention is to use cost of sales in the formula which is as follows:

An example of the calculation is shown below:

According to the data, the business is taking just over two months before it settles the bills it owes to its suppliers. Creditor days fell slightly from 64.1 days to 62.6 days.

In general a business that wants to maximise its cash flow should take as long as possible to pay its bills.  Ideally, the debtor collection period (as calculated by debtor days) should be shorter than the creditor payment period (creditor days) but this very much depends on the strength of negotiation power with customers and suppliers.

You can see a potential attraction to a business if it wishes to maximise its cash balances - stretch the time taken to pay suppliers.  However, there are risks associated with taking more time than is permitted by the terms of trade with the supplier. One is the loss of supplier goodwill; another is the potential threat of legal action or late-payment charges.



 

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