What do accounts receivable days indicate?
Accounts receivable days is an important key figure for companies, as it has an influence on the liquidity situation. Here we show you how to calculate, interpret and improve accounts receivable days.
Accounts receivable days: Meaning
Accounts receivable days is also referred to as days sales outstanding (DSO). This key figure indicates how long it takes on average for a company's customers to pay their invoices.
Thus, accounts receivable days play an important role in liquidity management. If it takes a long time for customers to pay their invoices, the company may experience a liquidity bottleneck and get into payment difficulties through no fault of its own. For this reason, companies strive to keep the value of accounts receivable days as low as possible.
Accounts receivable days and payable days: What's the difference?
Besides accounts receivable days, there are also accounts payable days. The latter indicate how long it takes on average for a company to pay its own invoices (e.g. to its suppliers).
Accounts payable days also play an important role in cash management. The longer a company can postpone the payment of an invoice, the less it burdens its liquidity.
Companies therefore aim for the greatest possible value for accounts payable days.
Accounts receivable days: Equation
Accounts receivable days can be calculated with the following formula:
Accounts receivable days = Average accounts receivable / Revenue x 365 days
Average accounts receivable is the average number of accounts receivable during a period of 365 days. This is related to revenue in the same period and multiplied by 365 days.
If you want to look at accounts receivable days for a shorter period of time (e.g. for 30 or 90 days), you simply adjust the formula according to the days:
Accounts receivable days = Average accounts receivable / Revenue x 90 days
It is important that the values for both Average accounts receivable and Revenue are based on 90 days, otherwise the result for Accounts receivable days will be incorrect.
Example for accounts receivable days formula
At the end of its business year, a company wants to look at the accounts receivable days of the last year. It takes the following values from its balance sheet:
- Average accounts receivable: £100,000
- Revenue: £1,000,000
The calculations for the financial year are now as follows: Accounts receivable days = £100,000 / £1,000,000 x 365 = 36.5 days
On average, the company's customers pay their bills within 36.5 days.
Accounts receivable days: Interpretation
You can see from the example in the previous section that with a higher value of average accounts receivable or a smaller value for revenue, the result for accounts receivable days becomes larger. This means that the higher the average receivable amount within a period with constant revenue, the longer the company has to wait for payment.
If the value for accounts receivable days is very high, a company should look at the causes and eliminate them if possible. In this way, it avoids getting into payment difficulties due to delayed receipts.
What is a good value for accounts receivable days?
As we have seen, the smaller the value for accounts receivable days, the better for liquidity. Depending on the industry, however, the key figures for accounts receivable days differ drastically. In e-commerce, the values are between 7 and 30 days. In industrial companies, where longer payment terms are common, the values for accounts receivable days can be 60 days or even more.
If a company wants to find out whether its values are too high or too low, only a comparison with companies from the same industry is recommended. This can then be used to assess how one compares to the competition and whether it is necessary to take measures to reduce the accounts receivable days.
How can accounts receivable days be improved?
The value for accounts receivable days can be shortened in various ways. Depending on what measures the company has already implemented and what the liquidity situation looks like at the moment and in the near future, further steps can be examined.
Shortening of payment deadlines
Long payment periods are beneficial for a company's customers, but detrimental to the company itself. The longer the payment period of an invoice, the longer the customer can take to pay.
For the company, this means that it has to wait longer for its revenues, while it has already gone into pre-financing by providing the service to the customer and must continue to cover its running costs.
So if you shorten the payment periods for invoices (e.g. from 30 to 14 days), you receive payment more quickly or can send a reminder earlier if the customer does not pay his invoice.
Create invoices immediately after the service has been rendered
Once a service has been rendered (e.g. goods delivered to the customer), it is advisable to create an invoice immediately and send it to the customer. Some companies wait until the end of the month to issue their invoices, thereby pushing their revenues further into the future and, in the worst case, getting themselves into payment difficulties.
With modern invoice management software, companies can quickly create an invoice and send it to their customers without having to build in an "invoicing day" at the end of the month.
Agree advance payment with customers
When customers pay for a service in advance, it is most advantageous for a company. It is therefore worthwhile to offer payment in advance. To make this more attractive to customers, you can give them cash discounts or other rebates. Even if this reduces profits somewhat, it avoids creating a cash shortage due to delayed revenues.
If payment in advance is not possible, e.g. for industrial companies that invoice very large order sums, a deposit can be agreed so that the customer pays a certain amount in advance and the rest after the service has been provided.
In project work, it can be useful to define milestones. After these have been reached, an invoice is created for a partial payment. This way, a company has a constant cash flow for longer projects and can keep the accounts receivable days low.
