As a small business owner, it's essential to understand your financial performance and analyze key ratios to make informed decisions. One such ratio is the creditor days ratio, which measures the number of days it takes for a company to pay its creditors. In this article, we'll explore what a creditor days ratio is, how to calculate it, and what is deemed appropriate for a small business.
What is Creditor Days Ratio?
Creditor days ratio, also known as accounts payable days, measures how long a company takes to pay its suppliers. This ratio is an important indicator of a company's ability to manage its cash flow and maintain good relationships with suppliers.
How to Calculate Creditor Days Ratio
To calculate creditor days ratio, you need to divide the accounts payable by the cost of sales and multiply the result by the number of days in the period being analyzed. The formula is as follows:
Creditor Days Ratio = (Accounts Payable / Cost of Sales) x Number of Days
For example, if a company has accounts payable of $10,000, cost of sales of $50,000, and is analyzing a 365-day period, the creditor days ratio would be:
Creditor Days Ratio = ($10,000 / $50,000) x 365 = 73 days
This means that on average, the company takes 73 days to pay its suppliers.
What is Appropriate for a Small Business?
The appropriate creditor days ratio for a small business depends on several factors, including the industry, payment terms with suppliers, and the business's cash flow. Generally, a creditor days ratio of 30-60 days is considered appropriate for a small business. However, it's essential to note that this ratio can vary significantly depending on the industry.
For example, a manufacturing business may have a higher creditor days ratio as it may require longer payment terms with suppliers due to the need for raw materials and the time it takes to manufacture products. In contrast, a service-based business may have a lower creditor days ratio as it may have a shorter payment cycle.
It's important for small business owners to monitor their creditor days ratio regularly and compare it to industry benchmarks to identify areas for improvement. A higher creditor days ratio may indicate that the business is struggling to manage its cash flow, while a lower ratio may indicate that the business is missing out on opportunities to negotiate better payment terms with suppliers.
The creditor days ratio is an essential financial ratio for small business owners to monitor. It measures how long a company takes to pay its suppliers and can be used to identify areas for improvement in cash flow management. A creditor days ratio of 30-60 days is generally considered appropriate for small businesses, but this can vary depending on the industry and payment terms with suppliers. At Accounting Supports, we can help you analyze your financial ratios and make informed decisions for your business. Contact us today to learn more.