Why should you count the days until you pay your Suppliers?

The term ‘Accounts Payable’ may not be new to you, but have you  heard the term ‘Accounts Payable Days’?  This is not the number of days that you take to pay each of your suppliers, but the number of days, on average, that you are taking to pay all of your suppliers.

‘Accounts Payable Days’ is the result of a formula calculating the average number of days it is taking you to pay all of your suppliers from the date of invoice until the payment is made.

Accounts Payable Days = Accounts Payable/Direct Costs x Time Period
(e.g.  Accounts Payable  = $50,000
 Direct Costs  = $500,000
 Time Period  = 365 days
 50,000/500,000x365 = 36.5

This example indicates that a business with Direct Costs of $500,000 and Accounts Payables of $50,000 is taking, on average, 36.5 days to pay its suppliers.

The value of knowing this number, as opposed to just looking at the dollar value of amounts owing to suppliers, is that it’s a relative figure.  e.g. using the above example, if the Accounts Payables rise to $100,000 is this good or bad?  It depends on the relative Direct Costs figure.  Just looking at a dollar number makes it difficult to manage.  Whereas tracking the number of days is an easy indicator to manage, both for the business owner and the accountant or bookkeeper.

Importantly, if this is a growing business wanting to fund growth through external debt i.e. borrowings, any lender would look very closely at this number.  It’s a prime indicator of how well the business manages its own money, and therefore how it would manage the lender’s funds.

Many businesses grow rapidly and get very focused on Revenue growth.  This is fine, but focus also needs to be on paying for Direct Costs and using the maximum days available to pay.  If not, cash-flow can quickly get squeezed, which can strangle any hope of continued business growth.  It becomes a vicious circle, as a lender won’t lend the necessary funds until the business demonstrates it has firm control over its cash-flow.

Managing Accounts Payable Days

It really boils down to making sure you use up the maximum days available to pay suppliers.

Here are some tips on managing Accounts Payable

1. Keep a record of purchases you have made with a supplier over a period.  This gives you more power in negotiations for better prices and payment terms.
2. Regularly ask alternative suppliers to tender for your business.
3. Keep a close eye on margins to ensure costs aren’t creeping up
4. Introduce ‘purchase orders’ to reduce discretionary staff spending
5. Check all supplier invoices carefully to ensure they are accurate
6. It’s EASY to pay all invoices on one day – try paying invoices gradually over the month when payments are actually due.

I have heard lots of examples where a business owner thought they didn’t have any bargaining power with suppliers.  When they took the time to ‘shop around’ they got a real shock at how much money they could save, and how much better payment terms they could receive.

Accounts Payables are part of what makes up ‘working capital’ in a business.  The other parts are Accounts Receivables, Stock and Work in Progress. Think of it as your money sitting in your suppliers’ bank accounts.  You need to create a situation where the funds are in your bank account for the maximum time.  I’m not suggesting simply stringing out suppliers beyond agreed terms, but using the terms to your best advantage and maximising them.

Working capital is needed to fund sales.  If sales are growing and you are experiencing a cash squeeze, this is most likely due to poor working capital management.  If you collect slowly from customers, pay suppliers too quickly, keep stock lying around for too long and are slow to invoice work in progress (jobs), this puts pressure on working capital.  Accounts payable adds to this requirement, so if you are not ‘managing’ them, you could be ‘shooting yourself in the foot’ in regards to working capital and successful business growth.

< back