No. 17 dealt with measuring and managing debtor days. This week’s challenge is controlling creditor days. Why? Instead of measuring what your business is owed, this ratio measures what it owes to others.
The ratio is straightforward:
Creditors x 365
Cost of Sales
Interpretation is less so. Again it can be used internally to compare changes between different accounting periods, looking for reasons for any changes. If creditor days are steadily increasing, for example, this will indicate that your cash balance is misleading, since it does not reflect payments due. There may be a reason such as the structure of incoming payments on a particular contract. If the reason is that there is no longer enough income to cover the expenditure, it is time to worry, and take action.
Again the bank or your accountant may have a feel for the usual ratio for your kind of business. If you are outside normal limits, you should consider taking action. This includes being a good payer – if you pay much quicker than the industry norm, you soak up cash.
The aim of using these measures is to gain a deeper understanding of how your business works, and of any changes that are taking place.