After a successful month with strong sales, you’re ready to start tallying up your income and paying your own bills. When you go to sit down with your bookkeeper and start looking through your books, you notice something that is going to make this process even more difficult: a large amount of your customers haven’t paid their bills yet.
When a customer makes a purchase from you, they will have a set amount of time to pay you. This is called the debtor days, and all business have them at varying lengths. If you allow too few days for people to pay, then you may find that it becomes a deterrent, and people decide not to buy from you. Or worse, people who know they can’t pay, decide to buy from you anyway and then can’t pay at all.
Your debtor days can make a big impact on your business and how you pay employees and other bills. Whether you’re a small- or medium-sized business owner, it’s vital that you understand how debtor days affect your daily operations and what you can do to narrow those days.
Importance of Debtor Days
Debtor days can vary in length depending on the company. If you have a long payment period, it means that you’ll have to use more credit upfront to pay for your own expenses. If your business wants to hire a new person or invest in new software, you may have to pay for those expenses up front and without the absolute promise of getting the money paid to you.
Businesses that have shorted debtor days tend to do better because their cash flow is stronger. Fewer purchases need to be put on credit cards, and business owners will feel more assured in their purchases.
Any outstanding invoice you have is not guaranteed until the money is in your bank account. Customers can return a product, dispute charges, or simply not pay at all. If your customers don’t pay you and you in turn can’t pay your suppliers, your business will be in serious trouble.
Debtor Days Calculation
The right amount of debtor days will depend entirely on your business and you’re managing your cash flow. Most small- and medium-sized businesses use a formula to calculate how many debtor days they should allow for payments. The most common formula is this:
(Trade receivables / Annual credit sales) x 365
Let’s say for example that a business has about $2,500,000 in trade receivables and pulls in about $20,000,000 in annual credit sales. If we plug that into our formula, we get 45.625, so roughly 45 days. Your consumers would have 45 days to pay their invoices.
Tips for Reducing Debtor Days
Short of coming to your customers’ houses and banging on their doors until they pay, there isn’t much you can do to force someone to pay their invoices early or even on time. Fortunately, there are a few things you can do to help encourage customers to pay early and increase your cash flow.
Check out these tips:
- Clear up any questions about payments: The receipts and invoices you give to consumers are incredibly important. They should break down the costs and make it clear when payments are due. An invoice can clear up any confusion among consumers so make them as clear as possible.
- Offer an incentive: Some businesses will offer small discounts for those who pay early and up front. Getting the money all at once and in a hurry is often worth the slight discount you will have to afford your customer, and it can be a great motivator.
- Charge additional late fees: Having a penalty for being late can also be a strong motivator. Outline your late payment charge on your invoice so your customers are aware of it.
- Track invoices: Your bookkeeper needs to have a sound method of tracking invoices, detailing which ones are still out, paid in installments and not paid at all. They will also be in charge of administering early payment discounts as well as late fees, so they need to remain on top of their jobs. If your bookkeeper can’t keep up, it may be time to look at other accounting options, such as a virtual CFO.
- Create a follow-up routine: Even the best customers forget payments from time to time, so instill a timely follow-up routine that reminds customers when payment due dates are coming up. Send out reminders at different intervals, depending on how long your debtor days are.
To improve debtor days is to improve cash flow. Before your customers make their final purchase, make sure they know how long they will have to pay your company. You might make it clear on your website or simply tell them before you begin providing a service or sending product.
Once you set your debtor days, stick to them. Business today is cutthroat, and the most successful businesses have a steady cash flow. Low debtor days mean a low level of risks and a high amount of cash flow. It also means less stress for your as a business owner.