10 financial concepts you should master
Here is lesson six in unwrapping essential financial concepts and how they will help you run your business.
This measures how many days on average it takes you to pay an invoice. The formula for creditors’ days is how much you owe suppliers on a given date, divided by purchases from creditors for the period (exclude wages because they are not creditors) and multiplied by 365.
Let us say, for example, you owe your suppliers $9000 on a given date and over the year you pay out $100,000. You divide $9000 by $100,000 and multiply that by 365. That means you take 33 days on average to pay.
For most private business creditors’ days are usually around 30 but that will vary from industry to industry. Most pubs, for example, must pay breweries within seven days but other suppliers to the pubs might be paid within 30 days. It is industry specific.
There are two ways to look at creditors’ days.
The higher the number the better it is for the company making the payment. Companies, after all, need to conserve cash. A lower number might suggest the business can be more aggressive in pushing out its payments. If you are collecting your accounts receivable at 60 days but paying your suppliers on 30 days, you have to find the cash to fund the 30 days in between.
It is also an indication of a company’s creditworthiness in the eyes of its suppliers and creditors, telling us how long suppliers and creditors are willing to wait for payment.
A company that is especially slow to pay its bills (100 or more days, for example) may be seen as having trouble generating cash or may be seen as effectively trying to finance its operations by using suppliers’ funds.
Accountants say the creditors’ and debtors’ days should be similar so that the business owner is not out of pocket for too long.
Debtors’ day works the same way as creditors’ days. It can be calculated by taking accounts receivable at a point of time, dividing by total sales and multiplying by 365. So if a company has accounts receivables of $400,000 and sales of $3,000,000, you would divide $400,000 by $3,000,000 and multiply by 365 to get debtors’ days of 49.