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.

How Credit is Determined

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:

• Internal Credit Policy: Every firm has an internal policy which determines the amount of credit that can be given to the buyers. These policies however only suggest the maximum number of days and such other parameters.

• Creditworthiness of the Buyer: The sales manager is also expected to look at the creditworthiness of the buyer. This can be done by looking at a credit report, if the buyer is rated by a credit rating agency or by finding out general information from other non-competing suppliers.

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.

How Accounts Payable Turnover Ratio Can Help

• What the Buyer is Used to: The idea is to calculate the number of days in which the buyer usually makes a payment to its suppliers. This can be done easily of the firm is publicly listed or publishes its financials.

  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.

• Extend Credit Accordingly: Sales managers usually see if they are in a commanding position while making the sale. They then provide early payment discounts which are slightly lower that the average time the buyer takes to pay. This ensures that the discount is within the reach of the buyer who usually complies making the fastest payment possible.