Account payables deferral periods or creditors’ payment period is an important aspect in calculating the net operating cycle. The truth is, the figure is deducted from the gross operating cycle to arrive at the aforementioned. In this article, I will explain this in detail.
Definition of Account Payables Deferral Period
Account payables (or creditors) deferral period (CDP) is the length of time a business can defer payments from suppliers and creditors. We can define it as the period it takes to delay the payment of debts to creditors.
The time frame. This is the number of days, weeks, or years it takes for the firm to pay up debts owed to creditors. The longer the period, the better for the business. Why? If payment is deferred, the company can use the cash to finance its activities. Organizations used this technique to finance their business if the benefit outweighs the cost.
What do I mean? Most times, creditors or suppliers give discounts to encourage the company to pay on time. If the benefits of such a discount outweigh the cost, then the organization should pay the debt on time. Such a discount can be recognized as other income to the entity. However, if after careful analysis, the firm’s management believes that it won’t be of benefit to them to accept the cash discount, then it can defer payment for a longer period than usual. And use the fund to finance other more profitable activities.
Account payables deferral period is an important aspect in calculating the net operating cycle (NOC). The value is deducted from the gross operating cycle (GOC) to arrive at NOC. Therefore, NOC equals GOC minus CDP. Also, NOC can be referred to as cash conversion cycle if depreciation and other notional expenses are not included in the computation of Net operating cycle.
How to Calculate Account Payables Deferral Period (CDP)
It is not difficult to calculate the creditor’s deferral period (CDP). First, you need to remember the formula. Which is the Average Account Payables (AAP) ÷ Credit Purchases × 365 days/52weeks/12months
Where the AAP is (opening + closing Account Payable) ÷ 2. Where there are no credit purchases, the total purchases can be used.
Example of Account Payable Deferral Period
Assuming FBC firm has the following financial data for Account Payables and purchases. Opening Account Payables 500,000 Naira, closing Account Payables 620,000 Naira, and credit purchases 1,300,000 Naira. Then, the Average Account Payables (AAP) = (500,000 + 620,000) ÷ 2. This gives 1,120,000 ÷ 2. The AAP is 560,000. So, the Account Payable Deferral Period is 560,000 ÷ 1,300,000 × 365 days. This gives 157.23 days.
The implication of Account Payables Deferral Period
When CDP is longer, the company benefits. It means that the company can use present cash resources to meet working capital financing and other obligations with such money before paying creditors. In this example, the company pays creditors in 150 days. This will imply that it takes three months for the company to pay its debt obligations. Therefore, the cash can be used by the company to finance working capital or operating cost.
However, there is a but! If the creditors are offering discounts then it might be best to pay up the debts. On the other hand, if the company believes that it will be more profitable to use the money to finance its operations for as long as possible before paying the debt it will lose the discount income that it will have earned.
Creditors’ deferral period CDP is the number of days it takes to pay creditors. A longer period is good for a business. Why? It allows the company more time to pay creditors. And use such funds to finance operating costs.