Ratio Analysis: What is the significance of variations in Efficiency Ratios?
Debtor days increasing could be due to the business changing its policy on the periodof credit offered to customers. This may be to gain new customers, or increase sales fromexisting customers. The consequence of doing this will increase the amount of fundingrequired for working capital. A reduction in debtor days may be as a result of poorcontrol in the past and a tightening of procedures. This would be unlikely to lead to anincrease in sales and more likely end up in a reduction.
If a company decides to offer better credit terms to customers, it may try and obtainbetter terms themselves from suppliers to offset the cash flow disadvantage. This may bedone through agreement or by simply deciding to pay suppliers late. The latter methodcarries the risk of being refused supplies in future. Non-payment to suppliers can be thequickest way to obtain immediate cash injection to a business.
Interaction between debtors and creditors days is linked. Changes in one can affect theother. The one scenario that is unlikely to happen is when the number of debtors daysincreases and the number of creditor days falls. This has cash flow implications. Theposition that all traders would like to achieve is one where the working capital cycle isnegative and payment is received from customers before suppliers require payment.