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Debt Control and Debt Collection Period

If you lend someone some money, what conditions would you attach to it? First, hopefully, you would set the time they had to pay it back. Secondly you may decide to attach further conditions like paying interest or perhaps even a penalty clause if they failed to pay up on time (though stick here to financial penalties rather than physical ones that may be illegal!). The same is true of any business. If they sell goods and offer a period of credit then they have to ensure that all the debts are paid and that they are paid on time. This is known as debt / credit control.

Debt control is an important part of business activity because although a debt is an asset, it is not as liquid an asset as cash in the bank. Employees would not be very happy to hear that they will be paid when your debtors pay up, they would rather have cash now, as would your creditors! Firms therefore have to ensure they collect their debts as efficiently as possible within the terms they have set for the debt. These terms would usually be something like 30 days credit.

As outsiders the only way we can consider how efficient the firm's debt control has been is to use a ratio. This ratio is known as the debt collection period.

DEBT COLLECTION PERIOD =
(in days)		 Trade debtors
Sales Revenue		 x 365

The figure measures (in number of days) how long on average it has taken the firm to collect its debts. The higher the figure the longer it has taken. However, we do have to interpret the figure carefully. The normal period for collecting debts will differ between industries. For example, a figure of 10 days may sound very impressive, but if this was the figure for a chain of supermarkets it would be worryingly high. This is because most goods in supermarkets should be paid for as you go through the till. Therefore no debt is incurred and retail firms will tend to have very few debtors and a low debt collection period. Firms who do a lot of business on credit though will have much higher debt collection periods.


Source:
http://www.bized.co.uk
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