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What Is The Debtor Days Formula?
Debtor Days Formula refers to the expression used to calculate the average days required for receiving the payments from the customers against the invoices issued. It is calculated by dividing trade receivable by the annual credit sales and multiplying the resultant with the total number of days.
The term “debtor days” refers to the number of days that a company takes to collect cash from its credit sales, which is indicative of the company’s liquidity position and its collections department’s efficiency. It is also known as days sales outstanding (DSO) or receivable days. The debtor days ratio is calculated by dividing the average accounts receivables by the annual total sales multiplied by 365 days.
Key Takeaways
- The debtor days formula evaluates the average days required to obtain customer payments against the invoices.
- The calculation is done by dividing trade receivable by the annual credit sales and multiplying the result by the total number of days.
- A lower debtor day shows the company's earlier cash collection from customers and that the accounts receivables are good.
- In addition, it means it is not essential to be written off as bad debts.
- If there is an upward movement in the debtor ratio, more cash is needed as working capital to fund the business. Therefore, it is risky to expand companies.
Debtor Days Formula Explained
The debtor days formula provides the equation that helps compute the debtor days of a company or entity. When the result is obtained, the company has an estimate of the number of days they normally wait for the credit sales to convert into real cash.
The formula is as follows:
The receivable days formula can also be expressed as average accounts receivable by average daily sales.
The receivable days formula is represented as,
Debtor Days Ratio = (Average accounts receivable / Average daily sales)
To ensure the result obtained is correct, it is important to follow a proper series of steps.
The debtor days formula calculation is done by using the following steps:
- Firstly, determine the average accounts receivable of the company. The average accounts receivable is computed by adding the receivable amount at the beginning of the year with that of the end of the year and then dividing the result by two. Both information can be collected from the balance sheet of the company.
Average accounts receivable = (Opening accounts receivable + Closing accounts receivable) / 2 - Next, determine the total annual sales of the company, which is easily available as a line item in the income statement of the company. Further, the average daily sales can also be calculated by dividing the annual total sales by 365 days (number of days in a year).
Average daily sales = Annual total sales / 365 - Finally, the debtor days ratio calculation is done by dividing the average accounts receivable by the total annual sales and then multiply by 365 days. Receivable Days Formula can also be calculated by dividing the average accounts receivable by the average daily sales.
Debtor days formula = (Average accounts receivable / Annual total sales) * 365 days
or
Debtor days Ratio Calculation = (Average accounts receivable / Average daily sales)
Examples
Let’s see some simple to advanced examples of Debtor Days Calculation to understand it better.
Example#1
Let us take David's example, a garment retailer who often offers credit to his customers. David is known for selling to customers on credit with the expectation that these customers would pay back for the merchandise within the next 30 days. Although most customers pay for their goods promptly, some are late. Calculate the debtor days ratio considering that at the end of the financial year, the statements recorded the following accounts:
Given,
- Average Accounts Receivable: $30,000
- Annual total sales: $210,000
Below is given data for calculation of Days Sales Outstanding
Therefore, Debtor Days can be calculated as,
DSO = (Average accounts receivable / Annual total sales) * 365 days
= ($30,000 / $210,000) * 365 days
The DSO has gone up to 52 days due to some delinquent customers.
Example#2
Let us take another example of ABC Ltd, which reported a total annual sales of $2,500,000 for 31st December 2016. The accounts receivable at the beginning of the year was $900,000, and the balance at the year closing was $700,000. Determine the Days Sales Outstanding of ABC Ltd based on the given information.
Given,
- Total annual sales = $2,500,000
- Average accounts receivable = ($900,000 + $700,000) / 2 = $800,000
Given the table shows data for the calculation of Debtor Days Ratio of company ABC Ltd.
Therefore, DSO for ABC Ltd can be calculated as,
Days Sales Outstanding = (Average accounts receivable / Annual total sales) * 365 days
= ($800,000 / $2,500,000) * 365 days
Days Sales Outstanding for ABC Ltd will be -
DSO = 116.8 days ~ 117 days
Relevance and Use
The formula becomes one of the most important components for any company as the debtor days ratio increases beyond the stated trading terms and it needs to be controlled. It can be indicative of the fact that either the company cannot collect its debts from customers efficiently enough or maybe that the terms are being changed to boost sales. A lower debtor day is favorable as it indicates that the company can collect the cash earlier from customers and that the accounts receivables are good, which means that it is not required to be written off as bad debts.
On the other hand, if there is an upward trend witnessed in the debtor ratio, then an increasing amount of cash is required in the form of working capital to finance the business, which can be a problem for growing businesses. However, it is important to note that the average varies from industry to industry, although most businesses complain that debtors usually take too long to pay in almost every market.
Nevertheless, Days Sales Outstanding also comes with limitations, such as an analyst should compare it to companies within the same industry. Ideally, if the companies have the same business model and revenue, a comparison makes more sense.
Frequently Asked Questions (FAQs)
How do you increase trade debtor days?
What is the benefit of low debtor days?
How many debtor days are acceptable?
