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 period of credit offered to customers. This may be to gain new customers, or increase sales from existing customers. The consequence of doing this will increase the amount of funding required for working capital. A reduction in debtor days may be as a result of poor control in the past and a tightening of procedures. This would be unlikely to lead to an increase 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 obtain better terms themselves from suppliers to offset the cash flow disadvantage. This may be done through agreement or by simply deciding to pay suppliers late. The latter method carries the risk of being refused supplies in future. Non-payment to suppliers can be the quickest way to obtain immediate cash injection to a business.
Interaction between debtors and creditors days is linked. Changes in one can affect the other. The one scenario that is unlikely to happen is when the number of debtors days increases and the number of creditor days falls. This has cash flow implications. The position that all traders would like to achieve is one where the working capital cycle is negative and payment is received from customers before suppliers require payment.