Average period of credit received ratio is calculated in weeks, or months, to ascertain how long does the company take to pay off its trade creditors. It is a fallacy to assume that a company that is successful in having a long credit received period is efficient.
Like every thing else in the world, credit has a price. If a company takes too long to settle its trade payables, it will not be allowed any cash discount, its suppliers will build-in a factor for delayed payments in their prices, it may experience real difficulty in getting required materials in days of low supply when the suppliers will tend to service only the better pay masters, etc. Again, having a reputation of being a late payer, in itself causes a lot of difficulties in the market place. Hence, having an average credit received period that is consistent with the industry average is in the best interest of the company.
Average period of credit received is calculated as follows if the answer is sought in months:
- Creditors: $500,000
- Net purchases: $3,660,000
Calculate average period of credit received.
Average period of credit received = (Creditors/Purchases)×12
= 1.64 month
On average the company takes 1.64 months to pay off its creditors.