Understanding how quickly a business pays its suppliers and receives money from its customers is vital to maintaining a strong cash position and avoiding liquidity problems.
What Are Payables and Receivables?
Payables (Trade Creditors)
Payables refer to the amounts a business owes to its suppliers for goods and services received but not yet paid for. These are also known as trade creditors or accounts payable. Businesses often buy raw materials, stock, or services on credit, meaning they are given a set period (e.g. 30, 60, or 90 days) to make payment.
This arrangement provides businesses with time to generate revenue from the goods or services before having to make the payment, helping them manage cash flow more effectively. For many businesses, especially those with high upfront costs or inventory needs, access to trade credit is essential.
Example:
A clothing retailer places a £10,000 order with a supplier who offers 60-day payment terms. This amount becomes a payable, and the retailer has 60 days to pay the invoice, during which time it can sell the stock and generate revenue.
Receivables (Trade Debtors)
Receivables represent the money owed to a business by its customers for goods or services already delivered. These are often called trade debtors or accounts receivable. When a business provides goods or services on credit, it issues an invoice with a payment deadline (e.g. 30 days). The amount remains a receivable until the customer pays.
Providing credit to customers can help boost sales, but it also introduces the risk of delayed payments and bad debts if customers do not pay on time or at all.
Example:
A web design agency completes a £5,000 project for a client and invoices them on 30-day terms. Until the payment is made, that £5,000 is recorded as a receivable.
Importance of Managing Payables and Receivables
Ensuring Liquidity
Liquidity is the ability of a business to meet its short-term financial obligations. A business may have strong profits, but if it lacks liquid cash to pay suppliers, staff, or bills on time, it can quickly face serious financial difficulties.
Managing payables and receivables is key to maintaining liquidity:
If receivables are collected promptly, cash enters the business and can be used to fund operations.
If payables are timed strategically, cash stays in the business longer before going out.
A well-managed balance ensures there is always enough cash on hand to cover day-to-day expenses.
Aligning Payment and Collection Cycles
Businesses must carefully time when money comes in (receivables) and when money goes out (payables). If customers delay payments but suppliers require fast payment, the business may encounter a cash flow gap.
Ideal scenario:
Payables days are equal to or longer than receivables days.
The business receives money before it has to pay it out.
Poor scenario:
Receivables days exceed payables days.
The business pays for goods before collecting revenue from customers, leading to potential shortfalls.
Cash Flow Risks: Timing Mismatches
Delayed Receivables
When customers do not pay on time, the business faces:
Reduced cash inflow, affecting its ability to meet immediate obligations.
Increased likelihood of needing external finance, such as overdrafts or short-term loans, which add interest costs.
A potential strain on supplier relationships if the business cannot pay its own bills.
Delayed receivables are especially risky for smaller firms with limited cash reserves. Businesses with long credit terms may find a significant proportion of their working capital locked up in unpaid invoices.
Example:
A consultancy provides £25,000 worth of services on 90-day terms. If the client delays payment by an additional 30 days, the consultancy must survive four months without receiving the cash.
Early Payables
If a business pays its suppliers earlier than necessary:
It reduces the available cash for other needs.
The business may miss opportunities for investment or growth due to a lack of working capital.
It might need to delay payments to others, such as HMRC or landlords, damaging its reputation.
Early payment should only be considered if discounts are offered or the business has excess liquidity.
Example:
A business pays a supplier within 10 days despite having 45-day credit terms. That cash could have been held longer or used elsewhere, possibly avoiding an overdraft.
Key Calculations for Receivables and Payables
Understanding how long it takes to collect or pay money helps assess the efficiency of a business’s cash flow cycle. The following ratios are used to measure timing.
Receivables Days
This calculates the average number of days it takes to collect payments from customers.
Formula:
Receivables Days = (Receivables ÷ Revenue) × 365
Example:
Receivables = £40,000
Revenue = £320,000
Receivables Days = (40,000 ÷ 320,000) × 365 = 45.6 days
This means customers take just over 45 days on average to pay.
Payables Days
This calculates the average number of days the business takes to pay its suppliers.
Formula:
Payables Days = (Payables ÷ Cost of Sales) × 365
Example:
Payables = £60,000
Cost of Sales = £360,000
Payables Days = (60,000 ÷ 360,000) × 365 = 60.8 days
The business pays suppliers after around 61 days, which is a positive sign for cash flow if receivables are collected faster.
Analysing the Gap
The difference between receivables days and payables days is crucial. A positive gap (receivables days < payables days) means the business receives cash before it pays others, strengthening liquidity.
Strategies to Improve Receivables Management
Strengthening Credit Control
Effective credit control ensures timely collection of payments:
Conduct credit checks on new customers to assess their payment reliability.
Set clear payment terms, typically 30 days or fewer where possible.
Send invoices promptly after the delivery of goods/services.
Monitor aged debtors reports to track outstanding receivables.
Send reminders before and after due dates.
Apply penalties for late payments or offer early payment discounts to incentivise customers.
Example:
A business introduces a 1.5% discount for payment within 7 days. This can significantly improve cash inflow if widely adopted by customers.
Using Factoring
Businesses struggling with late payments may use factoring, where a third party buys the receivables at a discount and collects the money from the customer.
Pros:
Immediate cash inflow
Reduced administrative burden
Cons:
Lower overall income due to fees
Potential impact on customer relationships
Strategies to Manage Payables Effectively
Extending Supplier Terms
Negotiating longer payment terms with suppliers can reduce pressure on cash reserves:
Ask for 30, 60, or 90-day terms depending on industry norms.
Build a reputation for reliability to gain more favourable credit terms.
Avoid making early payments unless discounts are substantial.
Example:
A business negotiating an extension from 30 to 60 days gains an additional 30-day cushion, potentially freeing up thousands in working capital.
Payment Scheduling
Even when long credit terms exist, some businesses pay suppliers too early. Payment systems should be configured to:
Pay just before the due date, not before.
Batch payments to manage cash flows more predictably.
Avoid missed payments, which can damage supplier trust and credit ratings.
Real-World Scenarios
Scenario A: Retail Business with Long Receivables
A wholesale supplier sells £100,000 of stock to retail clients on 60-day terms but pays its own suppliers in 30 days.
Receivables Days = 60
Payables Days = 30
Result: 30-day cash flow gap
Solution: Reduce credit terms to 30 days or renegotiate supplier terms.
Scenario B: Manufacturing Firm with Early Payments
A manufacturer insists on paying suppliers within 15 days to preserve goodwill, while clients pay within 45 days.
30-day cash shortfall
Result: Uses overdraft and pays interest
Solution: Shift supplier payments closer to due date or use invoice financing.
Scenario C: Service Firm with Strong Credit Control
A digital agency:
Requires 50% deposit and 50% on delivery
Pays suppliers after 45 days
Chases all unpaid invoices after 7 days
This business maintains positive cash flow, avoids borrowing, and reinvests its cash into business development.
Summary of Key Terms and Applications
Payables: Amounts owed to suppliers; aim to delay payment without penalty.
Receivables: Amounts owed by customers; aim to accelerate collection.
Receivables Days: Measure of how long customers take to pay.
Payables Days: Measure of how long the business takes to pay suppliers.
Liquidity: Ability to meet short-term obligations.
Credit Control: Systems in place to ensure customers pay on time.
Timing Gap: The difference between receivables and payables periods; positive gaps benefit cash flow.
Best practice: Collect cash before paying it out.
By carefully managing both receivables and payables, businesses can strengthen their cash position, reduce reliance on external funding, and better navigate periods of uncertainty. This makes the understanding of timing in cash flows essential for financial planning and operational success.
FAQ
Many businesses offer credit terms to remain competitive and boost sales, particularly in industries where credit is standard practice. Customers may prefer or expect flexible payment options, and refusing to offer credit could result in lost business. Offering credit can also build customer loyalty and improve long-term relationships. However, firms must balance this benefit with strict credit control processes to minimise the risk of delayed payments, bad debts, and damage to cash flow.
Different industries have varying norms for payment cycles. For instance, construction firms often experience long receivables periods due to staged payments or retention clauses, while supermarkets may pay suppliers quickly due to high volume, fast-moving stock. Tech companies with subscription models might receive payments upfront, improving cash flow. Understanding industry standards is essential, as deviating significantly may harm supplier or customer relationships. Businesses must align their cash flow planning with these typical timing expectations.
Modern accounting software automates invoicing, tracks overdue payments, and sends reminders, helping businesses manage receivables more efficiently. It can also schedule payables based on due dates, ensuring suppliers are paid on time but not prematurely. Dashboards highlight cash flow gaps and help forecast future inflows and outflows. Using cloud-based systems improves accuracy, reduces administrative delays, and provides real-time visibility into financial performance, all of which are critical for managing liquidity effectively.
This decision depends on the trade-off between the cost of the discount and the benefit of retaining cash. If a supplier offers a discount for early payment (e.g. 2% within 10 days), the business must assess whether that saving outweighs the benefit of using the cash elsewhere or keeping it for liquidity. If the cash is not urgently needed and the discount improves profit margins, paying early may be justified. However, if liquidity is tight, holding cash is usually safer.
Seasonal businesses, such as tourism or retail, often experience uneven cash inflows and must carefully manage payables and receivables to avoid running out of cash during off-peak months. They may negotiate longer payment terms with suppliers during low-revenue periods or build up cash reserves during peak seasons. Forecasting tools are essential, as are flexible credit arrangements with banks. Some may also offer limited-time early payment discounts to customers to accelerate receivables during quieter months.
Practice Questions
Analyse the impact on a business of having longer receivables days than payables days. (6 marks)
When receivables days exceed payables days, the business receives payments from customers after it has already paid its suppliers. This creates a cash flow gap, increasing the risk of liquidity problems. The business may struggle to meet short-term obligations like wages or rent and might rely on overdrafts or short-term loans, raising financial costs. In extreme cases, supplier relationships could be damaged if payments are delayed. Maintaining longer receivables days can also tie up working capital, limiting opportunities for reinvestment and growth. To avoid these issues, businesses should align their payment terms and strengthen credit control.
Explain two ways a business could improve its receivables management to maintain liquidity. (6 marks)
One way to improve receivables management is by offering early payment discounts, encouraging customers to pay invoices sooner and improving cash inflow. For example, a 2% discount for payment within 10 days can significantly reduce the time money is owed. A second way is to implement a clear credit control system, including credit checks, prompt invoicing, and regular reminders. This helps ensure payments are received within agreed terms, reducing the chance of late payments and bad debts. Together, these methods support steady cash flow and help the business avoid relying on short-term finance.
