In this fourth instalment of our working capital series we discuss the impact debtors has on the working capital cycle.
Debtors and their impact
Debtors are, simply put, the amounts owed to you by your customers. Debtors are critical to achieving a positive working capital cycle, collect all you are owed in a timely manner and everything else should fall into place within the cycle.
An entity can have both a negative and a positive working capital cycle and debtors is a major factor in this:
- A positive working capital cycle is when current assets (cash and debtors) exceed current liabilities.
- A negative working capital cycle is when current liabilities exceed current assets.
The faster you can convert your debtors into cash the better it is for your business. A long-term negative cash flow can indicate issues and suggest that a company is having to borrow or extend credit lines to meet their own obligations.
A key indicator of how good or indeed bad debtors are affecting your working capital cycle is something known as debtor days, which is the number of days it takes the company to convert its credit sales into cash. In a formula it looks like this:
Debtor days = (Debtors receivable / Annual total sales) x 365 days
The lower this number the more efficient and therefore liquid your company will be. The higher the number indicates the contrary.
How can you improve your working capital cycle through managing your customers?
There are some key points you should consider when trying to manage your customers which should contribute to a healthier working capital cycle. Don’t forget what we are trying to achieve through a positive working capital cycle; your money in your account for as long as possible (potentially earning interest).
These key points are:
Educating your customers
Customers may become used to certain payment terms despite what your practices are, you should therefore ensure that things are on your terms as much as possible.
Discounts for prompt payment
Sometimes a small discount for prompt payment can go a long way to encouraging a customer to make that transfer, always consider how much the discount is and whether it remains profitable.
Have the right people in charge of your sales ledger
This may seem obvious but more often than not is overlooked and it is critical as it can have various adverse effects:
The effect of this may not seem too key but put in context, if you invoice incorrectly, you then spend time credit noting and re-invoicing. This uses up man hours and could sometimes take a few days to first notice and then correct. The whole of this time the customer will still not have paid and then the payment terms cycle restarts.
Knowing your customers
Do you have a customer that is notoriously slow at paying? Are they paying you regularly but still their line of credit increases? Another overlooked aspect, spotting these signs early is imperative as ultimately if this happens it indicates a customer is in trouble and you could end up having to write off the debt in its entirety.
In having the right people in charge who review these processes regularly and keep an eye on such things can help your business. Don’t underestimate the value of someone who understands the sales and collections process. At the end of the day the money is better utilised in your bank account as opposed to your customers and streamlining that process shouldn’t be overlooked.
What can Invicta do for you?
Invicta uses a widely recognised cloud-based accounting software which has a built-in automated invoicing and reminder feature. This means that not only can you send invoices direct from the software but you can also set a reminder which will be sent at a date in the future predetermined by you, freeing up your time to focus on your business.
Call Invicta Accounting on 01624 672358 or emails us at email@example.com for more information, and be sure to refer to our final upcoming article in the working capital series.