Average period of credit received is calculated in weeks (or months) in order to determine how long a company takes to pay off its trade creditors.
It is incorrect to assume that a company that is successful in having a long credit received period is efficient.
Like everything else in the world, credit comes at a price. If a company takes too long to settle its trade payables, it will suffer from various negative impacts. For example:
- The company won’t be allowed any cash discounts
- The company’s suppliers will build in a factor for delayed payments in their prices
- The company may find it difficult to procure materials during periods of low supply, particularly if suppliers favor companies with better payment histories
Having a reputation for being a late payer causes countless difficulties. Hence, it is in the best interest of the company to ensure that its average credit received period is consistent with the industry average.
Average period of credit received is calculated as follows (for an answer in months):
Consider the following information:
- Creditors: $500,000
- Net purchases: $3,660,000
Required: Calculate the average period of credit received.
Average period of credit received = (Creditors/Purchases)×12
= 1.64 month
As this solution shows, the company takes 1.64 months on average to pay off its creditors.