IB Business Management HLTopic 3 — Finance and AccountsPaper 1 & 2HL only~9 min read
Debtor Days and Creditor Days
Most business-to-business sales are on credit, so money leaves and arrives on a delay. These two ratios measure those delays in days. Put them side by side and you can see, in one glance, whether a firm is being paid before it has to pay — or after.
What you need to know
Debtor days = how long customers take to pay the business. Aim low.
Creditor days = how long the business takes to pay its suppliers. Aim high, within reason.
Debtor days uses credit sales revenue on the bottom; creditor days uses cost of sales.
Both are multiplied by 365 to turn a fraction of a year into days.
If debtor days are shorter than creditor days, cash comes in before it goes out — a real advantage.
Stretching creditor days too far damages supplier relationships and the firm’s credit rating.
Debtor days
Debtors are customers who have taken the goods but not yet paid. Giving 30 or 60 days of trade credit wins business, but every one of those days is money the firm has spent and not yet recovered.
Debtor days
(debtors ÷ credit sales revenue) × 365
WORKED EXAMPLE 1
Calculating debtor days
Kabir Cycles is owed $46,000 by trade customers at the year end. Credit sales revenue for the year was $480,000. Calculate the debtor days. [2]
Step 1: divide debtors by credit sales revenue46,000 ÷ 480,000 = 0.09583Step 2: multiply by 3650.09583 × 365 = 34.9834.98 daysCustomers take about 35 days to pay. If the firm’s stated terms are 30 days, some customers are already running late.
Creditor days
Creditors are suppliers the business has not yet paid. Taking longer to pay is a free source of short-term finance, which is why a higher figure is usually seen as good here — the opposite of debtor days.
Creditor days
(creditors ÷ cost of sales) × 365
WORKED EXAMPLE 2
Calculating creditor days
Kabir Cycles owes suppliers $38,000 at the year end. Cost of sales for the year was $312,000. Calculate the creditor days. [2]
Step 1: divide creditors by cost of sales38,000 ÷ 312,000 = 0.12179Step 2: multiply by 3650.12179 × 365 = 44.4644.46 daysThe firm takes about 44 days to pay. That is longer than the 30 days most suppliers ask for, so relationships may be under strain.
Putting the two together
This is the part that earns analysis marks. Compare the two numbers. Kabir collects in about 35 days and pays in about 44 days, so for roughly nine days it is holding money that will eventually go to suppliers. That gap is free working capital.
The shaded strip is the window when the cash is sitting in the firm’s own bank account.
If debtor days are longer than creditor days, the business is lending money to its customers and borrowing to do it. Say that sentence in an evaluation and you are straight into the top band.
Cutting debtor days
Method
How it works
Tighten invoicing
Send invoices the same day, state the due date clearly, and chase before and after it
Check creditworthiness
Run credit checks and set sensible credit limits before offering trade credit
Offer a discount for early payment
A small discount can be cheaper than an overdraft, and customers respond to it
Make paying easy
Several payment methods and automated reminders remove excuses for delay
Withhold further supply
Stop new orders until the old invoice is settled — effective but risks the relationship
Threaten legal action
A last resort. Small claims procedures exist, but the customer is usually lost
Chase gently first. Every method further down that table applies more pressure and does more damage. Use the cheapest, friendliest option that works.
Improving creditor days
Build the relationship. Regular contact and reliable behaviour make suppliers willing to extend terms.
Protect your own credit rating. Pay other agreements on time so lenders and suppliers see a safe customer.
Negotiate, don’t just delay. Agreed 60-day terms are finance. Unagreed 60-day payment is a broken promise.
Use your value as a customer. Long-standing, high-volume buyers have room to ask.
What goes wrong if you push too far
Suppliers withdraw trade credit or add late-payment penalties.
Orders get delayed until payment clears, which can stop production.
The firm fails credit checks and struggles to find new suppliers or loans.
Insolvency and bankruptcy
When these ratios go badly wrong for long enough, a business runs out of money to pay its debts. That is insolvency. What happens next depends on the type of ownership.
Insolvency is a cash problem. Bankruptcy and liquidation are the legal outcomes of leaving it unsolved.
Insolvency means the business cannot pay its debts and carry on trading.
Bankruptcy is a legal declaration by a court. For a sole trader or partnership, the owners’ personal assets can be sold, because liability is unlimited.
Liquidation means selling a company’s assets, paying what can be paid, and closing the company down.
Administration protects a company for a period while it tries to settle debts and keep trading. If it works, the firm survives. If not, liquidation follows.
Exam tip
Debtor days uses credit sales. If a case study gives total revenue and credit revenue, use the credit figure.
Creditor days uses cost of sales, because that is what suppliers were paid for.
Always multiply by 365 last, and give the answer in days to two decimal places.
Compare the two figures in any “analyse” or “evaluate” question — that is where the marks live.
Link the numbers back to the case: a firm selling to supermarkets often has no choice about long debtor days.
Improving both ratios also improves working capital and liquidity, so mention that connection.
Common mix-up
Swapping the two denominators. Debtors go with revenue, creditors go with cost of sales.
Assuming a high figure is always good. High is good for creditor days, bad for debtor days.
Forgetting the 365. Without it the answer is a fraction of a year, not days.
Saying long creditor days are always clever. They can also mean the firm has no cash and is simply not paying.
Confusing debtors with creditors. Debtors owe you; you owe creditors.
Treating insolvency and bankruptcy as the same word. One is a financial state, the other is a legal outcome.
Up next: Cash, Profit and Working Capital — why a profitable business can still run out of money.
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