What it means
Creditors are the mirror image of debtors: where a debtor owes you money, a creditor is owed money by you. Every purchase on credit, every unpaid utility bill, every loan drawdown and every accrued but unpaid tax creates a creditor balance until it is settled.
Collectively they represent claims on the business that have to be met out of future cash. Accounts split creditors by timing and by rank.
Current creditors fall due within twelve months and sit in current liabilities; long-term creditors, such as the portion of a loan repayable beyond a year, sit separately. Rank matters in a distress scenario, where secured creditors are paid from the assets they hold security over, then preferential creditors such as certain employee claims and taxes, then unsecured creditors, typically trade suppliers, last.
Trade creditors are also a source of finance, and usually the cheapest one available. Buying on 30-day terms means a supplier is funding your stock for a month at no interest, which is why creditor days is watched as closely as debtor days.
The working capital cycle is essentially the gap between paying creditors and collecting from debtors. Stretching creditors is tempting and often counterproductive.
Paying late preserves cash in the short term, but it damages supplier relationships, forfeits early settlement discounts, can trigger credit limit reductions or prepayment demands, and shows up in the credit reports that your own customers may be reading. The cash gained is real but rarely free.
Directors also have duties towards creditors that intensify as solvency deteriorates. Once a company is at risk of being unable to pay its debts, the interests of creditors take priority over those of shareholders, and continuing to trade while incurring new obligations that cannot be met carries real personal consequences in most jurisdictions.
In practice
Real-world examples.
Example
A restaurant group negotiates a move from 14-day to 45-day terms with its two largest food suppliers in exchange for consolidating spend. The change releases roughly a month of purchasing costs into working capital without any borrowing at all.
Example
A construction subcontractor is placed on prepayment terms by its builders merchant after two months of late payment. The prepayment requirement removes $90,000 of free supplier finance overnight and forces the business to draw on its overdraft instead.
Example
A manufacturer reviewing its creditor ledger finds it is paying a specialist component supplier in 12 days while its own customers pay in 55. Renegotiating to 40-day terms with that supplier closes a meaningful part of a working capital gap it had been funding with a facility.
Formula
Calculation
Creditor days = (trade creditors / cost of sales) x 365. This shows the average number of days the business takes to pay its suppliers, and it is the direct counterpart of debtor days.
A wholesaler has trade creditors of $480,000 at the year end and cost of sales for the year of $3,650,000. Daily cost of sales is $3,650,000 / 365 = $10,000, so creditor days is $480,000 / $10,000 = 48 days.
If the business decided to move to an average of 60 days, trade creditors would rise to 60 x $10,000 = $600,000, releasing $600,000 - $480,000 = $120,000 of cash into the business on a one-off basis. That $120,000 is genuine, but it comes at a cost: if suppliers offer 2% for settlement within 10 days on $3,650,000 of purchases, the discounts forgone are worth $3,650,000 x 2% = $73,000 every year, which makes stretching an expensive way to raise $120,000 once.Case study
Seen in the real world.
Ashcombe Joinery is a fictional cabinet maker presented here as an illustrative example. Facing a cash squeeze after a delayed contract, its management decided to stretch payments to suppliers from 40 days to 75 days across the board, which released about $185,000 of cash over one quarter.
The cash arrived, but so did the consequences. In this illustrative account, two timber suppliers moved Ashcombe to prepayment, a third withdrew its 2.5% settlement discount, and the delays showed up in the trade payment data on Ashcombe's own credit report, which one of its larger customers checked before renewing a supply agreement.
The fictional finance director eventually reversed course, restoring 45-day terms with the two most critical suppliers while negotiating genuinely longer terms with three non-critical ones in exchange for volume commitments. The illustrative conclusion was that creditor stretch works as a negotiated arrangement and fails as a unilateral one.
Watch out
Common mistakes.
- Using creditor and debtor interchangeably. A creditor is owed money by the business, while a debtor owes money to it, and confusing the two reverses the entire working capital picture.
- Treating supplier finance as free without checking discounts. Forgoing a 2% early settlement discount to gain twenty extra days is an expensive form of borrowing on an annualised basis.
- Assuming all creditors rank equally in an insolvency. Secured and preferential creditors are paid ahead of unsecured trade suppliers, who often recover only a fraction of what they are owed.
Questions
People also ask.
What is the difference between a creditor and accounts payable?
Accounts payable, or trade creditors, is the subset of creditors made up of suppliers, while creditors overall also include lenders, tax authorities, landlords and others.
Are creditors always a bad thing on a balance sheet?
No, trade creditors are an interest-free source of working capital, and a business with unusually low creditor days may simply be paying faster than it needs to.
What are creditor days used for?
They show how long a business takes to pay suppliers on average, and comparing them with debtor days reveals whether the business is funding its customers or being funded by its suppliers.
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