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It is a myth that financial ratios are to be used only by investors and analysts in deriving a fair valuation for the firm.
In reality, financial ratios are used by a wide variety of people for a wide variety of reasons. A common usage is by the sales department. Usually sales departments in large companies are converted to cash. Managers, therefore have to determine the optimum quantum of credit that must be given to the buyers to receive the fastest possible payment.
The following article will explain a common practice amongst sales managers to achieve a faster repayment from the buyers.
The sales managers have a fair degree of discretion in determining the credit to be given to the buyers. They however have to work within limits set by the organization. The parameter of these limits is usually determined by the following:
Based on a number of factors, the sales manager can give credit to the buyer. However, smart sales managers use ratios to their advantage and this is how.
The sales department can calculate the accounts payable turnover ratio from the buyers financial statements. This is the time that the buyer takes on an average to make payments to its suppliers. The sales manager can now design payment terms to induce the buyer to pay up at the earliest.
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