Creditor days

Creditor days, a similar measure to debtor days. It is the average time that a company takes to pay its creditors. It is:

(trade creditors ÷ annual purchases) × 365

The problem is that the amount of annual purchases is rarely disclosed and does not form part of any of the mandatory financial statements (a value added statement would disclose this but these are rare). This means that it is usually necessary to use a proxy for the amount of annual purchases. The cost of goods sold is often used. This is completely accurate where a company is purely a trading operation, as the cost of goods sold is purely the cost of purchasing. For companies such as manufacturers it is likely to be inaccurate (far too pessimistic).

Where companies do not disclose the cost of goods sold, provided the company has a low gross margin, then sales can be used as a proxy. This still requires all the conditions for using cost of sales as a proxy to be true as well in order to be used as a proxy for purchases and it will always be the less accurate of the two.

Lengthening creditor days may mean that a company is heading for financial problems as it is failing to pay creditors, on the other hand it may mean that a company is simply getting better at getting good credit terms out of its suppliers (improving its working capital management), or that its pattern of purchasing has changed. Looking at other measures of financial health such as gearing, interest cover and cash flow will help investors assess which is more likely.

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