What is the Creditor Days Ratio?
The creditor days ratio shows the average number of days your business takes to pay suppliers. It is calculated by dividing creditors by the average daily purchases.
What is the Formula for Creditor Days?
Creditor days are calculated using the formula shown below.
- Creditors is given in the Balance Sheet and is normally under the heading Trade Creditors or Accounts Payable.
- Purchases is found in the income statement. Assuming inventory levels to do change substantially over the year, purchases can be estimated by taking the total of cost of sales and overhead costs
How is Creditor days calculated in practice?
|Cost of sales||176,000|
|Profit before tax||44,000|
|Profit after tax||35,000|
|Other fixed assets||90,000|
In the example above the cost of sales is 176,000 and overheads are 135,000 giving total purchases of 311,000, and trade creditors are 70,000. The creditor days ratio is calculated as follow.
Days = Creditors / (Purchases / 365) Days = 70,000 / (311,000 / 365) = 82 days
It takes the business on average 82 days to pay its suppliers.
In the above example it is assumed that other creditors does not relate to purchases, for example it might relate to deposits or deferred income, and it is therefore excluded from the calculation.
If you are using purchases for a different period then replace the 365 with the number of days in the management accounting period. For example, if monthly purchases are 18,000 and month end creditors are 19,000 the creditor days is calculated as follows.
Days = Creditors / (Purchases / 30) Days = 19,000 / (18,000 / 30) = 32 days
What does the Creditor Days Ratio show?
If your Creditor Days are increasing beyond your suppliers normal trading terms it indicates that the business is not paying its suppliers as efficiently as it should be. For example if your normal terms are 30 days and your Creditor Days ratio is 60 days the business on average is taking twice as long to pay suppliers as it should do.
Any downward trend in the Creditor Days ratio means that an increasing amount of cash (possibly from overdrafts) is needed to finance the business, this can be a major problem for an expanding businesses.
Useful tips for using Creditor Days
- The creditor days should be the same as your Terms of Trade with suppliers. If the days ratio is continually higher it means the business is paying its suppliers late which could eventually lead to supply problems. If the days ratio is trending lower than the normal terms of trade it could indicate that suppliers are being paid too early, reducing the amount of cash available in the business, or it might possibly be due to early settlement discounts being taken from suppliers.
- A cash business should have a much lower Creditor Days figure than a non-cash business.
- Typical ranges for the creditor day ratio for a non-cash business would be 30-60 days.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.