As Tata group has a good reputation and the bank would believe that the Tata group company would honour its commitment and pay the money after 60 days. Therefore, it agrees to pay ₹98 to the company against the security of ₹100 that the company is expected to receive from Tata Group Company after 60 days. The company get ₹98 today from the bank and the bank receives ₹100 directly from the Tata group company after 60 days.

Low value of trade receivables days suggests that business is able to convert its credit sales into cash pretty swiftly, which is a sign of efficient trade receivables management. It means that the credit control department of the business has done a good job in screening of customers resulting in bookkeeping outsource sales being made to quality customers who pay their dues well in time. This also means that there are fewer long outstanding receivables balances, which is a good thing for the business. If the business is not able to collect its receivables efficiently, it would be suffering the opportunity cost.

What is days sales outstanding (DSO)?

For example, companies operating within the oil and gas industry are likely to have a much higher accounts receivable days ratio than a business in the technology space. Offer a small discount to customers that pay with cash or within their credit period to bring down A/R days. It may not work for every customer, but you can motivate businesses with healthy cash flow that still delay payments till the last day without any reason to pay earlier. You can impose late payment charges to payment terms to make the process effective and prevent customers from defaulting on their due date. It can be considered a guide for the credit management and sales teams on issues relating to credit lines, risk exposure, payment waive-offs, etc. Business leaders looking to create or update the credit policy document can use a customizable template that outlines the broad sections that go into an effective credit policy document.

An investor would appreciate that excipient is a low value-adding part of the drug and the pharmaceutical companies have a large number of supplier willing to sell them excipient. These pharmaceutical companies are usually large organizations and have a higher negotiating power over suppliers of excipients like Vikram Thermo (India) Ltd. Let us see some of the typical situations with examples of real-life companies that faced higher receivable days.

Receivable days: A negotiation war:

Moreover, a customer may knowingly delay payments to the company as he/she knows that the company would have to keep supplying it in order to stay in the business. The more liquid the business is, the higher the cash flows and returns will be. Management is also interested in the company’s days sales in inventory to determine how fast inventory moves, which is important when taking storage and maintenance expenses of holding inventory into account. The DSI figure represents the average number of days that a company’s inventory assets are realized into sales within the year.

Be sure and subtract any returns or adjustments, and if you don’t track cash sales automatically, you’ll have to subtract those as well. Smaller businesses may find it more useful to calculate DSO quarterly, although businesses that frequently sell on credit should do a DSO calculation monthly. Similarly, if the number of days in which payment is recollected is long, this is an indication of very lenient payment terms and could create problems for the business. However, as mentioned previously, what is considered to be a long or a short period varies from one industry to another. With modern invoice management software, companies can quickly create an invoice and send it to their customers without having to build in an “invoicing day” at the end of the month.

Example of Calculating Days’ Sales in Accounts Receivable

On the other hand, DSO decreasing means the company is becoming more efficient at cash collection and thus has more free cash flows (FCFs). If payment in advance is not possible, e.g. for industrial companies that invoice very large order sums, a deposit can be agreed so that the customer pays a certain amount in advance and the rest after the service has been provided. The calculation indicates that the company requires 60.8 days to collect a typical invoice. While analysing Nile Ltd, an investor notices that the company used to have its receivable days in the range of days; however, in FY2016 and FY2017, the receivable days suddenly declined to 16 days and 14 days respectively. Let us see the example of a company that has used bill discounting to lower its receivable days. An investor notices such a situation in the case of Quick Heal Technologies Ltd that relies on distributors to sell its products.

As discussed above, whenever the customer believes that it can push the suppliers for a longer credit period, then it will delay the receivables. In addition, whenever there is any dispute between the customer and the supplier e.g. quality of the product, the achievement of the milestones in the projects etc., then the receivables would be delayed. An investor may appreciate that there can be many genuine situations where a company may not get payments from its customers and in turn may report higher receivable days. In such situations, an investor would note that the profit after tax (PAT) of the company would not translate into CFO. At times, companies would have to rely on debt to meet the gap i.e. they would have to take loans to meet their day to day expenses.