EM3083 | Examining Accounts: Business Ratios: Debtors to Sales

In a well-run business you would expect to see close control over debtors: both quick payment of money outstanding and few debts written off. A useful indicator is to look at the average collection period, which can be obtained with the following formula:

Number of days debts outstanding = Closing Debtors / Annual Credit Sales X 365

This formula tells you the number of days debts outstanding at the year end. Over the counter cash sales would normally be included but as they do not create debtors, their inclusion means the average Collection Period is understated.

You use this average collection period with care. Average collection periods vary greatly between trades, and may vary between businesses in the same trade. The size of individual sales may be such that the business has to offer instalment payment facilities. Some clue may be obtained by looking at the terms which the business under review obtains from its own suppliers.

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