Debtor days is one of those financial metrics that has long been considered a sacred cow. But if you're relying on this traditional KPI alone, you're not going to have the most accurate understanding of how your debtors are performing.
Of course, there is utility in knowing how long it takes for your customers to pay you. But there's a better way to evaluate your finance team than debtor days alone. There's a different metric we recommend to evaluate debtor management instead, and we're going to share it with you here.
→ What is Debtor Days?
→ How to Calculate Debtor Days
→ Limitations of Debtor Days
→ The Better Approach to Debtor Management
→ Introducing the Overdue Debtors Ratio
→ How to Calculate Your Overdue Debtors Ratio
→ The Best Way to Benchmark Overdue Debtors
→ 4 Simple Steps to Better Debtor Management
→ How to Implement the Overdue Debtor Ratio
→ From the Founder: Why Days Debtors is Dead
→ Key Takeaways of Debtor Days
Plus, get answers to these questions:
→ Is it better to have a shorter or longer debtor days number?
→ Why is the days debtors calculation a dead number?
→ Which debt management KPI is best to use?
Debtor days (or days debtors), a staple metric in debtor management, calculates the average time it takes for customers to pay their invoices. It's a pretty straightforward concept: the longer it takes for customers to pay, the higher your debtor days.
To work out your debtor days, simply calculate the average number of days between the date an invoice is raised to the date the invoice is paid.
(Your ERP software can do this for you; for example, in Xero run an Executive Summary or in MYOB check the Debtor Analysis tab.)
The problem with days debtors lies in its inability to account for diverse payment terms across different businesses.
For example, a business with 7-day payment terms will naturally have a lower days debtors figure than one with 45-day end-of-month terms. This discrepancy can lead to unfair comparisons and misrepresentations of debtor management performance.
In other words, using debtor days as your sole debtor metric is going to be unfair on the people who have got longer terms to deal with.
To overcome the limitations of debtor days, the secret is taking a values-based approach to debtor metrics instead of a time-based approach.
This is done by using what we call your overdue debtors ratio (or percentage), which is the proportion of your total debtor value that is past its due date.
Rather than focusing on how long it takes for invoices to be paid, this metric measures the proportion of overdue debtor value relative to your total debtor value. By shifting the focus from a time-based metric to a value-based one, it allows you to better assess how your debtors are performing.
To work out your overdue debtors ratio, simply divide the total value of your debtors by the value of your overdue debtors.
For example, if your business has $1M worth of debtors today and $200,000 of that is overdue, then you have an overdue debtors ratio of 20%.
With this figure, having customers with varying payment terms doesn't affect this benchmark – it doesn’t matter if your terms are seven days, 45 days, or anything else in between.
As you can see, measuring debtors based on the value of overdue invoices:
So, what percentage should you aim for when it comes to your overdue debtors ratio?
Ideally, 0%.
Yes, in an ideal world your business would have no overdue debtors. In reality, though, that figure may look different based on your business goals (and your team's levels of competency and capacity).
If an overdue debtors ratio of 0% seems unrealistic or unobtainable, as a starting point consider taking your current overdue debtors ratio and halving it. Progress is progress!
If you're ready to embrace a more nuanced approach than debtor days, here's how to integrate the overdue debtor percentage into your debt management strategy.
“I want to share some controversial news with you: Days debtors is dead.
What is days debtors? Days debtors is the calculation that looks at how long it takes your average customer to pay you – the date from when you raise an invoice to when the client pays the invoice. That will often be correlated to the terms that your business has.
If you’ve got an average trading terms of seven days before you get paid versus 45 days end-of-month, you’re going to have two very different day’s debtors calculations for those two businesses. The first one’s going to generally have a very short day’s debtors, and the second one’s going to have a very long day’s debtors. For the person working in the debtor management for each of those businesses, is one going to be better than the other?
If you give me seven days’ terms to work with, there’s a high probability I’m going to have a better day’s debtor number than the business that has 45 days end-of-month terms. And 45 days end of month being if you invoice somebody in today’s month, they’ve got to pay until 45 days after the end of the month you are currently in. That’s quite a long period of time between the date of the invoice and the due date for that invoice.
On this basis, that’s why I think the day’s debtors calculation for debtor management is a dead number.
That first business is always going to have the lower number, the second business is always going to have the higher number. But the people working in those businesses, the first business with 7-day terms might have a very lazy person working in there, and the second business with 45-day terms might have an exceptionally hardworking and efficient, diligent person working in that role.
Now I’m going to share with you a KPI that can put both of them on equal footing.
The better metric to use instead is, what is the percentage of my debtor value that is overdue?
This no longer correlates to how many days debtors I have. Now, it is simply how overdue is my total value of debtors. And I’m going to measure and benchmark my team on that value.
If I have a million dollars worth of debtors today, and $200,000 worth of that is overdue, then I’ve got a 20% ratio of overdue debtors. That doesn’t matter if it’s seven day terms or 45 day end-of-month terms, or anything in between.
But for debtor management in your business, you should be asking the people who are running the department – what is the percentage of my debtors that are overdue? And that is going to give you your best benchmark.
If you compare on a day’s debtor’s basis, that’s going to be unfair on the people who have got longer terms to deal with. That doesn’t mean you shouldn’t follow the statistic as a way of understanding your working capital cycle. But for performance, managing the people who work within your debtor process, look at percentage of debtors overdue relative to your total debtor value.
In summary, using debtor days alone as a measure of debtor performance is flawed. It measures the average time it takes for customers to pay invoices, but fails to provide an accurate assessment due to varying payment terms.
Instead, focusing on the percentage of overdue debtors offers a more equitable benchmark for evaluating debt management efficiency.
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