Debt Payment period Part 3

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It measures an average period for which the credit purchases remain unpaid or the average credit period actually availed.

Debt Payment period =

Significance:

  • It indicates the ability of the firm to pay its trade creditors/suppliers.

  • A high ratio indicates the shorter payment period.

  • A low ratio indicates a longer payment period.

Example: Calculate creditors turnover ratio and debt payment period from the following information

Cash purchases Rs.1,00,000 Total purchases Rs.4,07,000

Opening sundry creditors Rs.25,000 Closing sundry creditors Rs.50,000

Closing bill payables Rs.25,000 Opening bill payables Rs.20,000

Purchase returns Rs.7,0001

Solution:

Creditors Turnover Ratio =

Net purchases = Total purchases – Purchase returns

= Rs 407000 – Rs 7000 = Rs 400000

Net credit purchases = Net purchases – cash purchases

= Rs 4,00,000 – Rs 1,00,000

= Rs 3,00,000

Average Creditors =

=

= 60,000

Creditors Turnover Ratio = = 5 times

Debt Payment period = = 73 days

Working Capital Turnover Ratio: It is the ratio between cost of sales and net working capital.

Working capital Turnover Ratio =

Working Capital = Current assets – Current liabilities

Average Working Capital =

Note: If the figure of cost of sales is not given, then the figure of sales can be used. On the other hand if opening working capital is not discussed then working capital at the year-end will be used.

Significance:

  • It indicates the speed at which the working capital is utilised for business operations.

  • It measures a company's efficiency and the health of its short-term finances.

  • A higher ratio indicates efficient utilisation of working capital

  • A low ratio indicates the working capital is not properly utilised.

  • Most analysts consider the ideal working capital ratio to be between 1.2 and 2.

Example:

Find out working capital turnover ratio for the year 2006.

Cash Rs.10,000

Bills receivable Rs.5,000

Sundry debtors Rs.25,000

Stock Rs.20,000

Sundry creditors Rs.30,000

Cost of sales Rs.1,50,000

Solution:

Working capital Turnover Ratio =

Working Capital = Current assets – Current liabilities

Current Assets =

Current Liabilities = Rs.30,000

Net Working Capital = 60000 – 30000 = Rs.30,000

Cost of Sales = Rs.1,50,000

Working capital Turnover Ratio = = 5 times

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