Creditor Payment Period Formula

Creditor Payment Period Formula

Creditor payment period formula has been shown below. Creditor payment period calculation has been explained with an example;

Creditor payment Period =   Average Creditor x 365                                               Cost of Sales

Creditor Payment Period Formula Example

Cost of Sales of Company    =700,000

Creditor or Average Creditor= 90,000

Calculate Creditor payment period

Solution

Creditor payment Period =   Average Creditor x365  

                                           Cost of Sales

=(90,000/700,000) x 365

=46.92 Days (Average Payment period)

It means that at average company takes 47 days to pay its creditor or company.

Significance of Creditor Payment Period

Creditor payment period is important calculation, because longer period means that company is enjoying free credit for long period. It is important to note those creditors are free source of funding (funding without cost).

Ideal Creditor Payment Period

Ideal creditor payment period means is difficult to establish. Collection period normally depends on the market practice and therefore company has little choice for selection of that period. Creditor payment period vary industry to industry. Thump rule is longer payment is better.

 Disadvantages of Longer Creditor payment period

Longer payment period is normally preferred by the companies due to free financing, however, delayed payment may have number of disadvantages. Delayed payment shows that company week financial position, creditor confidence also shakes with delayed payment, and Goodwill of the company is also at stake with delayed payments.

Advantages of Shorter Creditor Payment Period

Shorter payment period is not preferred by the companies for the reason already explained above (creditor is source of free financing). However , Shorter payment period has number of advantages i.e. shorter creditor payment period improves the confidence of the supplier , continuity or stability of supplies is guaranteed, more credit options are available, and goodwill of the company is on the higher side.

One of the main advantages of shorter creditor payment period is availing the discount available on the early payment.