Creditor Days: An Interest-Free Overdraft for Your Business?
Ever feel like your business is constantly short on cash? One of the biggest hidden sources of funding is sitting right in front of you: your supplier payment terms.
Also known as Payable Days or Days Payable Outstanding (DPO).
It is a financial ratio that measures the average number of days a company takes to pay its suppliers & creditors for good & services purchased on credit. It reflects a company’s payment policies, cash management strategies & relationship with suppliers.
Why does it matter?
Because if you can agree to pay on credit to all or most of your suppliers for possibly 30 or 60 days, maybe even 90 days, that amounts to getting a substantial overdraft facility.
How much of an overdraft?
For a £1m turnover company (with an average gross profit margin of 35% & net margin of 10%) that could equate to an interest free overdraft for of more than £50k for 30 days, £100k for 60 days or £150k for days. A big boost to the money in your bank account!
Creditor Days Ratio or DPO Formula
Days Payable Outstanding (DPO), or as it’s also called, creditor days ratio (CDR), is an efficient formula that shows how long it takes for a company to repay its suppliers.
Creditor Days Ratio is often used together with two other ratios, Debtor Days (Accounts Receivable Days) and Stock Days (Stock/Inventory Turnover Ratio), to monitor your Working Capital, also known as Cash to Cash or the Cash Conversion Cycle.
You can calculate the CDR by applying the formula:
Creditor Days Ratio = (Trade Creditors/Purchases)*365
You might be wondering what the this means: In Purchases you should include cost of sales and overheads.
The reason for that is that if you make a purchase that does not directly relate to stock (such as stationery, for example), using only the cost of sales effectively ignores these purchases; so make sure you add these too in order to calculate the Creditor Days Ratio.
So, what does that mean in practice?
If the calculation shows a company takes a shorter period of time to pay suppliers than a rival, for example: on average slightly more than a week less to pay the invoices for purchases made than another company – Is this a good thing?
While you might think that this is a good thing, that’s not always the case. To maintain healthy Cash to Cash or Working Capital cycle, you will need to reduce the days it takes for clients to pay you, or you can achieve the same by delaying payments to suppliers – But the trick is: can you do both?
Delaying payments is not something that your suppliers will be pleased about! It’s therefore important to be able to keep a balance between increasing the time it takes your company to pay your invoices and keeping suppliers happy, for example by improving credit terms & maintaining good relationships with your suppliers.
Conclusion
If you are nervous about asking your bank manager for a formal Bank Loan or Overdraft, or just don’t want to pay interest, could this be an option?
If this resonates with you or you find it interesting, why not book a meeting to see what else we can do to help you?
