Question

#1- Hello please advise and provide examples

• The financial ratios a firm can use to measure the time it will take to collect cash from a potential customer on average.
• How the ratios are computed, and explain how each works.
• Why this is important to a business.

Answer 1

Here the assumption is that only an order is received from a potential customer and the sales is not made to the customer. The finished goods are procured from vendor, processed and then sent to the customer. The various delays possible are delays in receiving finished goods from vendor, delay in sending the goods to the customer and delay from the customer in receiving payment.

Delays in delivery by vendor depends upon the lead time agreed with the vendor, average delivery time and the actual time agreed with the vendor for the order.

Inventory holding period = 365 / (COGS for a year / Average Inventory) = this calculates the number of days inventory is kept in stock before sales to the customer.

Collection period = 365 / (Net Credit Sales for a year / Average Accounts Receivable) = this calculates the number of days average debtors take to make payment.

The total of the above three in number of days give the period from the time the vendor is contacted to the time the debtors make payment.