How to calculate debtor days

Debtor days, sometimes called the average collection period, turns the money customers owe you into a number of days of credit sales. A debtor, in business.gov.au's glossary, is anyone who owes the business money, and accounts receivable is the record of what customers owe in the short term.

Only unpaid customer invoices belong in the calculation. A loan to someone, or a refund you are waiting on from a supplier, may be money owed to the business, but it isn't accounts receivable.

Divide accounts receivable at the end of the period by credit sales for the period, then multiply the result by the number of days in the period. Credit sales must be above zero; a business that is paid on the spot for everything has no debtor days to measure.

Keep the period and the figures matched. If you use a quarter's credit sales, use the receivables balance at that quarter's last day and the number of days in that quarter.

• Accounts receivable: enter every invoice raised and every customer payment received up to the last day of the period, then take the balance from the balance sheet or the aged receivables report.
• Credit sales: total the invoices for credit sales in the period, less the sales credit notes and adjustments that belong to that period. Leave out cash, card and other sales paid at the time of sale.
• Both figures: take them at the amounts your invoices show, so they are on the same footing.

Books kept on a cash basis leave unpaid invoices out altogether, a limitation business.gov.au points out, so build the receivables figure from your list of unpaid invoices instead.

The estimate is above the payment terms in this example, which is a reason to inspect the aged list. It does not mean every customer is late or prove lateness on its own. The aged list below confirms which amounts are actually overdue.

business.gov.au explains payment terms as the conditions you set on when and how customers pay you. Its examples of when payment can be expected include up front, by instalments, on delivery or after 30 days, and its examples of credit terms include paying in 7, 14, 21 or 31 days.

When credit sales are reasonably steady, debtor days can be compared with your payment terms as an initial check. Use the aged list and invoice due dates to confirm whether payments are late: changes in sales timing can move the ratio even when customers pay on time. If different customers are on different terms, compare each group separately.

Most of the balance is either not yet due or only a little late, but the oldest groups need following up now. The older a debt gets, the harder it tends to be to collect.

Lower is generally better, because it means customers pay sooner relative to your sales, but there is no single right number. The useful reading is yours, set against the terms you offer and against your own earlier results. business.gov.au points out that offering credit can increase your sales as well as carrying risk, so pushing the figure down at any cost isn't the aim.

Where customers are on different terms, one overall figure can look healthy while one group pays late. Working it out for each group shows where:

Each group's figure is its own receivables divided by its own credit sales, times 30. For the builders, 30,400.00 divided by 24,000.00, times 30, gives 38.

Across all customers the result is 25 days, but with three sets of terms there is no single figure to compare it with. Split by group, trade accounts and small jobs sit in line with their terms, but builders are at 38 days on 30-day terms. They are the group to look at in the aged list, and possibly the one whose terms or credit limits need a conversation.

Compare each group with the same month last year as well as with last month, so a seasonal pattern isn't mistaken for a change in how customers pay. If your budget or cash flow forecast assumes customers pay within a set number of days, compare with that too.

A high figure isn't automatically bad either. A business that chooses to offer long terms to win larger customers will carry more receivables by design; the question then is whether it has the cash to fund them while it waits.

Customers who regularly pay late appear on business.gov.au's list of cash flow warning signs. Its guidance on getting paid suggests a clear routine:

1. Invoice straight after the sale, with your payment terms shown on it.
2. Once a payment is late, begin with a friendly reminder by email or phone.
3. If that doesn't work, send a letter of demand, then consider a debt collection service.

For new credit customers, business.gov.au suggests checking a customer's credit before offering terms and capping the credit you extend. To encourage earlier payment, it mentions early-payment discounts, fees for paying late and deposits on special orders.

Worked out monthly, debtor days uses the month's credit sales, the receivables at its last day and the number of days in it. A run of monthly figures shows the trend, and looking at which input changed tells you why the figure moved.

April's rise is the one to look into. Sales were the same as in March, yet receivables grew by 4,000.00, so money came in more slowly. The aged list at 30 April would show which customers held it up.

May's rise is different. Receivables fell back by 4,000.00, so customers paid down what they owed, but May was a quiet month. Receivables at the end of a month still include invoices from earlier months, so dividing them by one small month's sales pushes the figure up even when collections have improved.

That's why a single month can jump around. A rolling three months, using the credit sales for all three and the receivables at the last day, steadies it: 33,000.00 divided by 86,800.00, times 92, gives 35.

Apart from the level of sales, the things that genuinely move debtor days are:

• how quickly customers pay once an invoice falls due
• the terms you offer, and any change to them
• the mix of customers, when some groups are on longer terms than others
• how early and how firmly overdue invoices are followed up

A fall needs the same care. It can mean customers are paying sooner, but it can also come from a change in the month's sales rather than in how customers pay, as May showed in the other direction, or from an old balance cleared by a credit note, so check both inputs before you read it as good news.

One delay it can't show is the one before the invoice. Debtor days counts from the invoice, so work finished weeks before it is billed is cash waiting that never appears in the figure.

In a spreadsheet, give each month a row with its credit sales, closing receivables and days, then a column that divides receivables by credit sales and multiplies by the days. Make that column show a blank when credit sales are zero, so a month without credit sales doesn't return an error.

Work it out at each month end, once the month's invoices and payments are entered, and take the inputs from the same reports every time so the run of figures stays comparable. Keep the aged list and the sales total you used with each result, so a jump can be traced back later.

• A burst of invoicing in the last week of the period, which inflates receivables even if every customer pays on time.
• Strong sales growth or a seasonal peak, which does the same.
• One large invoice from a single customer.
• Credit notes or disputed invoices left sitting in the balance.
• Comparing a quarter's receivables with a full year's sales without adjusting the number of days.

Take trade receivables, or accounts receivable, from the balance sheet, divide by credit sales for the year ending on the balance sheet date, and multiply by 365. The profit and loss statement gives total sales, which may include cash and card sales, so use the credit sales figure from your own sales records where you can.

A yearly figure built on one closing balance is only a rough guide. If June is quiet for invoicing, receivables are low on 30 June and the result looks shorter than the year really was; if June is busy, the reverse. Where you have them, the average of the receivables at each month end gives a steadier figure.

If your sales records don't separate credit sales, total sales will do only when almost every sale is invoiced. The more of your sales are paid on the spot, the further total sales will pull the result below the true figure.

Debtor days and days sales outstanding (DSO) are the same measure under two names, and receivable days is another. Versions differ in the detail: some use total sales instead of credit sales, the average receivables balance instead of the closing one, or 360 days instead of 365. Check which version a figure uses before you compare it with yours.

Debtor turnover, also called receivables turnover, expresses the same thing as a number of times a year rather than a number of days: credit sales for the year divided by average receivables. Dividing 365 by the turnover gives debtor days, so a turnover of 8 is about 46 days.

Creditor days is the mirror image for what you owe. Divide accounts payable at the end of the period by credit purchases for the period, and multiply by the days in the period. business.gov.au's glossary counts lenders as well as suppliers among creditors, but as with debtor days, use only suppliers' unpaid bills here and leave loans out.

Read together, the two show who is funding whom. If customers take 45 days to pay you and you pay suppliers in 30, the business carries a 15-day gap from its own cash. If the figures are the other way round, suppliers are in effect funding part of your sales. Add inventory days, how long stock sits before it sells, and you have the cash conversion cycle: inventory days plus debtor days, less creditor days.