THE IMPACT OF CREDIT MANAGEMENT ON THE PROFITABILITY OF MANUFACTURING FIRM
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Abstract
Liquidity and its management determines to a great extent the growth and profitability of a firm. This is because either inadequate liquidity or excess liquidity may be injurious to the smooth operations of the organization. This seeming controversy has attracted a lot of interest in the subject of liquidity management. The intent of the study was to determine whether credit management mechanism: credit policy, liquidity management and debtors’ turnover have effect on profitability of manufacturing firm measured by return on assets (ROA).
CHAPTER ONE
INTRODUCTION
1.1 Background of the study
Business enterprises today use trade credit as a prominent strategy in the area of marketing and financial management. Thus, trade credit is necessary in the growth of the businesses. When a firm sells its products or services and does not receive cash for it, the firm is said to have granted trade credit to its customers. Trade credit thus creates accounts receivables which the firm is expected to collect in future (Kungu, Wanjau, Waititu&Gekara, 2014). Accounts receivables are executed by generating an invoice which is delivered to the customer, who in turn must pay within and with the agreed terms. The accounts receivables are one of the largest assets of a business enterprise comprising approximately 15% to 20% of the total assets of a typical manufacturing firm (Dunn, 2009). Investment in receivables takes a big chunk of organization’s assets. These assets are highly vulnerable to bad debts and losses. It is therefore necessary to manage accounts receivables appropriately. Trade credit is very important to a firm because it helps to protect its sales from being eroded by competitors and also attracts potential customers to buy at favourable terms. As long as there is competition in the industry, selling on credit becomes inevitable. A business will lose its c ustomers to competitors if it does not extend credit to them. Thus, investment in accounts receivables may not be a matter of choice but a matter of survival (Kakuru, 2001). Given that investment in receivables has both benefits and costs; it becomes important to have such a level of investment in receivables at the same time observing the twin objectives of liquidity and profitability. To remain profitable, businesses must ensure proper management of their receivables (Foulks, 2005). The management of receivables is a practical problem, businesses can find their liquidity under considerable strain if the levels of their accounts receivables are not properly regulat2ed (Samuels & walkers, 1993). Thus management of accounts receivables is important, for without it; receivables will build up to excessive levels leading to declining cash flows. Poor management of receivables will definitely result into bad debts which lowers the business‟ profitability. The growth in economic activities as currently witnessed in Nigeria; in our present democratic government with its attendant limited financial resources available to the operators of the market has no doubt brought about increase in credit transaction (Ifurueze, 2013). The impact depends on the skill and prowess with which the companies manage their credit sales. Beckan and Richard (1984) have seen that most companies after granting credit sales rely on them as assets without providing adequately for possible. With this situation, the financial statements of such compa.nies obviously will lack true and fair view because of the fact that the amount of trade debtors cannot be fully realized. In the same vein liquidity problem is not left out when granting credit sales. This arises from over investment in receivables especially when the debtors are of high risk class. Working capital management is among the four cardinal decision areas of financial management, for which every commercially oriented organisation has to make (Pandey, 2005). Interestingly, working capital components of a firm’s financial management deals with the liquidity aspect of a firm and hence fundamental for the effective and efficient operations as well as the sustainability of its going concern status (Enyi, 2006). It is worth mentioning from the outset that working capital and liquidity are use in this paper to mean one and the same thing and relates to the management of current assets and currents liabilities of an enterprise. This synonymy is based on the observation that working capital ratios are the most common measures of liquidity (Lam1berg, & Valming, 2009). Liquidity management as it were, determine to a large extent the quantity of profit that result as well as the value of shareholders wealth (Ben-Caleb, 2008). This is because, a firm in order to survive must remain liquid as failure to meet its obligation in due time results in bad credit rating by the short term creditors, reduction in the value of goodwill in the market and may ultimately leads to liquidation (Bhavet, 2011). Hence, a good and firm financial management policy seeks to maintain adequate liquidity in order to meet its short-term maturing obligations without impairing profitability. Unfortunately, the principal focus of most organizations is profitability maximization while the need for efficient management of liquid assets is ignored. This approach is justified by the belief that profitability and liquidity are conflicting goals. Hence, a firm can only pursue one at the expense of the other, in consonance with the theory of liquidity and profitability trade-off. On the contrary, Padachi (2006) advised that a firm is required to maintain a balance between liquidity and profitability while conducting its daily operations. This is because both inadequate liquidity and surplus liquidity directly affect profitability (Ogundipe, Idowu and Ogundipe, 2012). For instance, when the “necessary” level of liquid assets is exceeded, their surpluses when the market risk remains stable, become a source of ineffective utilization of resources which has an adverse effect on profitability. An insufficient working capital on the other hand, result in a liquidity crisis which is life threatening and can force a company into bankruptcy, often with little notice; this also affect the returns of the firm (Spinella, 2007).
STATEMENT OF THE PROBLEM
Credit Policy can be viewed as written guidelines that set the terms and conditions for supplying goods on credit, customer qualification criteria, procedure for making collections, and steps to be taken in case of customer delinquency. This term can also be refers to as collection policy. It’s also the guidelines that spell out how to decide which customers are sold on open account, the exact payment terms, the limits set on outstanding balances and how to deal with supply of raw materials. This is because raw materials is one of the most important aspect of production in manufacturing sector. It is in view of this that the researcher intend to investigate the impact of credit management on the profitability of manufacturing firms.
1.3 OBJECTIVE OF THE STUDY
The main objective of this study is to ascertain the impact of credit management on the profitability of manufacturing firm. But for the successful completion of the study, the researcher intends to achieve the following objective;
- To ascertain the impact of credit management in the profitability of an organization
- To ascertain the relationship between credit management and liquidity
- To ascertain the effect of credit management on the profitability of the an organization
- To ascertain the role of the accountant in credit management of an organization
1.4 RESEARCH HYPOTHESES
To aid the completion of the study, the following research hypotheses were formulated by the researcher;
H0: credit management has no impact on the profitability of the organization
H1: credit management has a significant impact on the profitability of the organization
H0: there is no significant relationship between credit management and liquidity in an organization
H2: there is a significant relationship between credit management and liquidity in an organization
1.5 SIGNIFICANCE OF THE STUDY
Most manufacturing companies have growth and continuity as part of their objective, and such objectives are best realized by an efficient credit management and stock evaluation. This has made it possible for them to gain inherent advantage while minimizing loses involved in their daily operations. It is expected that at the end of the study the findings will be of great benefit; to the management of manufacturing companies, investors and other business organization using credit policy. Hence, the theories and concept contained therein can be infused into their management system. To Management: This study will help them forecast the future behaviour and performance of credit behaviour. It will also assist them in identifying approaches, pursuing available opportunities and reducing the probability of high value losses in the market as regards to liquidity risk. A general study of the factors influencing credit management will not only give management a grasp of the underlying nature of the its credit policy but also enable them to access the current state of the economy and formulate expectations about its future course. To investors: it would assist existing shareholders and potential investors to make appropriate judgments as regards their investments and performance of the companies in which they are stakeholders. To financial risk management Authority: This group might find the results helpful in avoiding any unexpected market catastrophe, controlling market strategies, improving the credit policy, and assessing the degree to which the policy and practice need to be reformed. Also to future researchers: as they will be able to apply this findings to carry out further studies in the same area or related area by serving as a theoretical base for the research to be carried out.
1.6 SCOPE AND LIMITATION OF THE STUDY
The study is on the impact of credit management on the profitability of manufacturing firm, it is entirely cantered on identifying effect of credit management on profitability of manufacturing firms. The researcher encountered some constraint in the course of the study which include:
Time factor: The time allocated to the researcher during the period of the study was limited coupled with lectures and exams.
Financial constraint: the finance at the disposal of the researcher during the course of the study wasn’t sufficient enough to run the expenses of the research work.
1.7 DEFINITION OF TERMS
Credit management: Credit management is the process of granting credit, the terms it’s granted on and recovering this credit when it’s due. This is the function within a bank or company to control credit policies that will improve revenues and reduce financial risks.
Firm profitability: Firm profits are computed as the ratio of profit level to the value of total assets. The level of profit is defined as the difference between sales revenue and total operating expenses. Total. Costs include labour, material and opportunity costs of capital.
Liquidity Management: In finance, liquidity management takes one of two forms based on the definition of liquidity. One type of liquidity refers to the ability to trade an asset, such as a stock or bond, at its current price. The other definition of liquidity applies to large organizations, such as financial institutions.
Debtors’ Turnover: The receivables turnover ratio is an activity ratio measuring how efficiently a firm uses its assets. Receivables turnover ratio can be calculated by dividing the net value of credit sales during a given period by the average accounts receivable during the same period.
Manufacturing firm: Manufacturing is the production of merchandise for use or sale using labour and machines, tools, chemical and biological processing, or formulation. The term may refer to a range of human activity, from handicraft to high tech, but is most commonly applied to industrial production, in which raw materials are transformed into finished goods on a large scale. Such finished goods may be sold to other manufacturers for the production of other, more complex products, such as aircraft, household appliances, furniture, sports equipment or automobiles, or sold to wholesalers, who in turn sell them to retailers, who then sell them to end users and consumers.
1.8 ORGANIZATION OF THE STUDY
This research work is organized in five chapters, for easy understanding, as follows Chapter one is concern with the introduction, which consist of the (overview, of the study), statement of problem, objectives of the study, research question, significance or the study, research methodology, definition of terms and historical background of the study. Chapter two highlight the theoretical framework on which the study its based, thus the review of related literature. Chapter three deals on the research design and methodology adopted in the study. Chapter four concentrate on the data collection and analysis and presentation of finding. Chapter five gives summary, conclusion, and recommendations made of the study.
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