Everyone knows that the longer it takes your customers to pay you, the worse your cash position will become.
However, just because your debtors are high at the end of the month, doesn’t necessarily mean your debtors are taking longer to pay!
For example, if your annual sales are £2.4m with debtors at £800k, all this tells you is that you are owed £800k!
From these figures it is impossible to ascertain if this is good or bad news. It does show that on average your debtors are taking four months to pay you. However, that may not be very useful information because your debtors may be high because you’ve just had the best monthly sales performance of the year. Therefore, it is imperative to know the level of your debtors in the light of the actual sales you have made in recent months.
The best way to measure this is to calculate how many days of your actual sales are equal to the total of your debtors at the end of each month. This is known as the Days Sales Outstanding. Simply, if the DSO is growing then your debtors are taking longer to pay and vice versa.
When businesses have a large number of debtors, not all of whom are paying slowly, it is helpful to analyse only those who are taking over say, three months to pay. An aged debtor listing can help establish the real position and enable those responsible for collection to become more focussed on the task in hand.
In one recent experience, the aged debtor listing eventually revealed that virtually all the slow payers had been offered extended terms by the sales team in return for new orders. Armed with this new information, not only did the MD rule that in future extended credit could only be authorised by him, but the sales team bonus structure was changed to be based on sales made less debts owed. After all a sale isn’t a sale until it’s been paid!
In the next tip, I’ll be showing you how to get the best from your bank manager.
For a free analysis of cash movements in your business, please email me at firstname.lastname@example.org and let me help you take the first step to understanding your accounts.
Blog post written by Gordon Welsby of www.welsbyassociates.co.uk