Credit terms are terms that are formulated by companies to determine various variables that are used to offer credit to customer on purchase of goods and services (Lee, & Lee, 2006). Credit terms usually address the percentages of discounts that the customer should be offered upon purchase certain quantities of a product. These terms also express the number of days that are allowable before the payment of the products is made by customers. Credit terms also specify penalties that the customer will be liable to pay in case of delayed payments. A company needs consider various factors when formulating credit terms to its customers. The company should consider its cash flow position and industry which it operates. The company should also determine analyse credit terms that its supplier is offering (Lee, & Lee, 2006).
Reasons for offering credit terms to customer
Companies offer customer with credit services on a varied number of reason. There are two major reasons why companies are more than willing to grant customers goods on credit term. Marketing reasons is the most important reason why companies do this (Lee, & Lee, 2006). Companies are conscious that customer customers are more willing to buy on credit terms than on cash terms. Furthermore, the company managers are aware that competitors use credit terms to lure customer to buy more of their products. Therefore, company finance and marketing managers works hand in hand to determine the most attractive credit terms that the company can offer to its customer. The rationale of offering company goods and services to customer on credit terms is the general understanding that not all customers have the capacity to buy good by cash payments (Lee, & Lee, 2006). Additionally, selling goods on credit to customers induces more customers to buy more of the produce. By doing so, it enables company increase volumes of products sold. The ultimate result of credit facilities to the customer is that companies are able to achieve their marketing goals (Vishwanath, 2006).
The second reason for offering credits to customers is to consolidate it market share. Offering goods and serves companies greater benefit by establishing customer loyalty. Constant credit offers to customers is a common strategy use by companies especially in manufacturing industry to consolidate customer base over a long period of time. Credit sales have a direct link to increase in company profits in the long run (Lee, & Lee, 2006). The growth in company revenues when compared to other competitors results in the company acquiring substantive competitive advantage in the market place. Credit terms also help the company to expand vertically. The revenues generated can be used to gain strategic access to vital raw materials from supplier. This situation is common where there are few suppliers of raw material and a large number of manufacturing firms competing for one common resource. The revenues generated can be used to acquire large volumes of raw material (Lee, & Lee, 2006).
Importance of cash
From the study carried out, it not generally accepted that cash is not important in financial management of companies. Cash is neither profit nor loss to a company. Cash takes two forms. Cash can either be in cash in flow or in assets. Cash flow only earns when it is in use and it has no economic value when left idle. When cash is in flow it contributes greatly to a business enterprise (Bhattacharyya, 2004). Idle cash, on the other hand, does not contribute to any earning for the business.
Business assets like machines and equipment are very vital to the overalls profitability of a company but cannot be totally be compared to the role played by cash in overall business profitability (Bhattacharyya, 2004). Companies cannot afford to let such fixed assets remain idle for long since it negatively affect the revenues. Without cash companies cannot afford to pay its suppliers and salaries of it workers. Cash is similar to fixed assets in that if left idle may have a negative impact on company revenues. When a company buys a new machine the machine must be used or else the company is going to incur a fixed cost and depreciation. Similarly, cash, if left idle has an impact on company profitability. Basing on the above arguments cash can be seen as is a lifeline of most companies and therefore, cannot be ignored. According to Bhattacharyya (2004, p.257), “growth of business depends upon cashability of profits, not profits per se as reflected in the income statement”. From this argument, cash should not be disregarded in by companies during financial management planning. Companies should realise the importance of cash in the overall in the operation of business enterprises.
It is important for companies to consider offering goods and services and to customers on credit. Credit not only contributes to increases in volumes of sales of the company but also play a major role in enabling the company acquires competitive advantage in the marketplace. Therefore, company managers should develop proper credit terms so as to attract more customers.
As discussed above, companies should not neglect cash during financial management and planning. The role played by cash in the profitability of the company cannot just be swept under the table by managers in financial management. Managers should therefore, recognize the role of cash as a crucial component in financial management.
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