EBITDA definition in theory and practice – when to pay special attention
16. August 2023.ADVANCES – How to treat them in financial statements analysis
2. October 2023.The standard textbook formula:
Payables days = 365 * Trade payables / COGS
(You might also see average trade payables, but for the sake of simplicity let’s leave this element out)
So, what is wrong with the formula above?
#1 – Issue with trade payables
Getting the trade payables figure from financial statements is pretty much easy.
But what happens when the company does not receive invoices for the costs already included in COGS?
Companies book this part under the “accrued expenses” account in the balance sheet.
This means we should probably include this element too in the calculation of trade payables.
Why?
Well, we don’t know what it the reason why the company has not booked some invoices. Perhaps they close their books really fast and do not leave enough time to book everything. Or perhaps the suppliers are slow with sending invoices.
The fact is that we don’t know, and because of this uncertainty, I tend to include this figure in the calculation.
(Pro tip: trade payables can sometimes include payables towards suppliers for Capex which distorts the calculation, so make sure to exclude this if you have info…)
#2 – Issue with COGS
Including only COGS in the formula can be misleading.
Many companies do not have high COGS but may have high SG&A (don’t forget to exclude labour costs from SG&A!).
If we look deeper into the SG&A specification, we will likely find the costs like rent, marketing, advisory, maintenance…which all have trade payables attached to them!
So, excluding this part of the SG&A from the formula can change the conclusion dramatically.
I would advise to include at least a portion of the SG&A into the formula, depending on the level of information you have at hand.
(Pro tip: COGS also includes a portion of costs like labour, depreciation and amortization…which don’t have anything with trade payables, and this creates another issue)
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If you are an insider (controller / FP&A / CFO…), you will probably have all the necessary information to be more precise in calculating payables days.
If you are an outsider (banker, investor…), you will rely on externally available info like annual accounts etc. and the level of detail will be limited, so take this into account.
Whichever formula we use, we will never get the 100% right figure. Still, with meaningful adjustments we can improve our understanding of the business.
And understanding the true payables days of your customers impacts their credit ratings and credit limits – i.e., your cash flow.
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CreditAnalyst(.eu) Credit Risk Management | Debt Advisory | Financial Planning
