CREDIT MANAGEMENT AND FINANCIAL PERFORMANCE OF MANUFACTURING FIRMS IN RIVERS STATE

CREDIT MANAGEMENT AND FINANCIAL PERFORMANCE OF MANUFACTURING FIRMS IN RIVERS STATE

The study aims to examine the relationship that exists between credit management and financial performance of manufacturing firms in Rivers State.

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CHAPTER ONE

INTRODUCTION

• Background to the study

Credit management is one of the most important activities in any company and cannot be overlooked by any economic enterprise engaged in credit irrespective of its business nature. It is the process to ensure that customers will pay for the products delivered or the services rendered. According to John and Sollenberg (2017) credit management as procedure adopted by an organization to ensure that they maintain an optimal level of credit and its effective management.

It is an aspect of financial management involving credit analysis, credit rating, credit classification, and credit reporting. Frank (2016) views credit management as simply how an entity manages its credit sales. It is a prerequisite for any entity dealing with credit transactions since it is impossible to have a zero credit or default risk.

The higher the amount of accounts receivables and their age, the higher the finance costs incurred to maintain them. If these receivables are not collectible on time and urgent cash needs arise, a firm may result in borrowing and the opportunity cost is the interest expense paid.

Myers and Brealey (2017) opined that credit management greatly influences the success or failure of commercial banks and other financial institutions. This is because the failure of deposit banks is influenced to a large extent by the quality of credit decisions and thus the quality of the risky assets. He further notes that credit management provides a leading indicator of the quality of the deposit banks’ credit portfolio. A key requirement for effective credit management is the ability to intelligently and efficiently manage customer credit lines. To minimize exposure to bad debt, over-reserving, and bankruptcies, companies must have greater insight into customer financial strength, credit score history and changing payment patterns.

Credit management starts with the sale and does not stop until the full and final payment has been received. It is as important as part of the deal as closing the sale. A sale is technically not a sale until the money has been collected. It follows that principles of goods lending shall be concerned with ensuring, so far as possible that the borrower will be able to make scheduled payments with interest in full and within the required period otherwise, the profit from an interest earned is reduced or even wiped out by the bad debt when the customer eventually defaults. Credit management is concerned primarily with managing debtors and financing debts. The objectives of credit management can be stated as safeguarding the companies’‟ investments in debtors and optimizing operational cash flows. Policies and procedures must be applied for granting credit to customers, collecting payment and limiting the risk of non-payments.

According to the business dictionary, financial performance involves measuring the results of a firm’s policies and operations in monetary terms. These results are reflected in the firm’s return on investment, return on assets and value-added.

Stoner (2003) as cited in Turyahebya (2018), defines financial performance as the ability to operate efficiently, profitably, survive, grow and react to environmental opportunities and threats. In agreement with this, Sollenberg and Anderson (2015) assert that performance is measured by how efficient the enterprise is in the use of resources in achieving its objectives.

Credit management is the method by which you collect and control the payments from your customers. It is an aspect of financial management involving credit analysis, credit rating, credit classification, and credit reporting.

Proper credit management will lower the capital that is locked with the debtors and also reduces the possibility of getting into bad debts. According to Edwards (2014), unless a seller has built into his selling price additional costs for late payment, or is successful in recovering those costs by way of interest charged, then any overdue account will affect his profit. In some competitive markets, companies can be tempted by the prospects of increased business if additional credit is given, but unless it can be certain that additional profits from increased sales will outweigh the increased costs of credit, or said costs can be recovered through higher prices, then the practice is fraught with danger.

Most companies can readily see losses incurred by bad debts, customers going into liquidation, receivership or bankruptcy. The writing-off of bad debt losses visibly reduces the Profit and Loss Account. The interest cost of late payment is less visible and can go unnoticed as a cost effect. It is infrequently measured separately because it is mixed in with the total bank charges for all activities. The total bank interest is also reduced by the borrowing cost saved by paying bills late. Credit managers can measure this interest cost separately for debtors, and the results can be seen by many as startling because the cost of waiting for payment beyond terms is usually ten times the cost of bad debt losses.

Effective management of accounts receivables involves designing and documenting a credit policy. Many entities face liquidity and inadequate working capital problems due to lax credit standards and inappropriate credit policies. According to Neale (2016), a sound credit policy is a blueprint for how the company communicates with and treats its most valuable asset, the customers. Scheufler (2014) proposes that a credit policy creates a common set of goals for the organization and recognizes the credit and collection department as an important contributor to the organization’s strategies.

If the credit policy is correctly formulated, carried out and well understood at all levels of the financial institution, it allows management to maintain proper standards of the bank loans to avoid unnecessary risks and correctly assess the opportunities for business development.

• Research Problem

Sound credit management is a prerequisite for any manufacturing company’s stability and continuous profitability while deteriorating credit quality is the most frequent cause of poor organization performance and condition. According to Gitman (2017), the probability of bad debts increases as credit standards are relaxed. Firms must, therefore, ensure that the management of receivables is efficient and effective Such delays on collecting cash from debtors as they fall due has serious financial problems, increased bad debts and affects customer relations. If payment is made late, then profitability is eroded and if payment is not made at all, then a total loss is incurred. On that basis, it is simply good business to put credit management at the front end‟ by managing it strategically.

Credit is one of the many factors that can be used by a firm to influence demand for its products. According to Horne (2016), firms can only benefit from credit if the profitability generated from increased sales exceeds the added costs of receivables. Myers and Brealey (2017) define credit as a process whereby possession of goods or services is allowed without spot payment upon a contractual agreement for later payment.

Timely identification of potential credit default is important as high default rates lead to decreased cash flows, lower liquidity levels, and financial distress. In contrast, lower credit exposure means an optimal debtor‟ level with reduced chances of bad debts and therefore financial health. According to Scheufler (2014), in today’s business environment credit risk management and improvement of cash flows are very challenging.

Most research works that have been done were addressing bank performance and credit risk management.  The poor level of trade credit management is reflected in the credit and profitability position of the firm. It is on this note this research set to study Credit management and financial performance of manufacturing firms in Rivers State.

• Aim and Objectives of the study

The study aims to examine the relationship that exists between credit management and financial performance of manufacturing firms in Rivers State. The specific objectives of the research are;

1. determine the extent to which credit policy can affect the return on assets of manufacturing companies in Rivers State.
2. evaluate the relationship between credit policy and return on equity of manufacturing companies in Rivers State.
3. investigate the relationship between Credit granting policy and return on assets of manufacturing companies in Rivers state
4. ascertain the relationship between Credit granting policy and return on equity of manufacturing companies in Rivers State.

• Research question

1. What is the relationship between credit policy and return on assets of manufacturing companies in Rivers State?
2. What is the relationship between credit policy and return on equity of manufacturing companies in Rivers State?
3. What is the relationship between Credit granting policy and return on assets of manufacturing companies in Rivers State?
4. What is the relationship between Credit granting policy and return on equity of manufacturing companies in Rivers State?

• Research hypotheses

Ho₁: There is no significant relationship between Credit policy and return on assets of manufacturing companies in Rivers State.

Ho₂: There is no relationship between credit policy and return on equity of manufacturing companies in Rivers state

Ho₃: There is no significant relationship between credit-granting policy and return on assets in manufacturing companies in Rivers State.

Ho₄: There is no relationship between Credit granting policy and return on equity of manufacturing companies in Rivers state

• Significance of the Study

This research will be of importance to the following persons in the respective fields;

Scholars/researchers, policymakers, business managers

Scholars/Researchers: The results of this study will be valuable to researchers and scholars, as it would form a basis for further research. Scholars would use this study as a basis for discussions on credit management and financial performance. It will provide scholars with empirical studies that they will use in their studies. The study will also add to the body of knowledge in the finance discipline by bridging gaps in credit management research in general.

Policymakers: It also expected that it will aid policymakers in their effort to revamp the sector.

Business managers: It shall be of great relevance to the organizations under study as well as other financial institutions. The nonfinancial business firms, whether manufacturing or service-oriented shall also benefit from the research findings. This is because the result of the study shall enable the business managers especially financial to appraise its credit policies and to review its operations critically for a more result-oriented approach in dealing with its credit facilities.

• Scope of the Study

1.7.1 Unit scope: This study focuses on credit management and financial performance of manufacturing firms in Rivers state

1.7.2 Content scope: The independent variable for the research is credit management which is proxied credit policy (credit limit), credit-granting policy (credit sales), while the dependent variable is financial performance proxied by return on assets and return on equity

1.7.3 Geographical scope: The research work is done in Rivers state.

• Operational Definition of Terms

Credit management: A function performed within a company to improve and control credit policies that will lead to increased revenues and lower risk including increasing collections, reducing credit costs, extending more credit to creditworthy customers, and developing competitive credit terms.

Credit policy: A firm’s credit policy is the set of principles based on which it determines who it will lend money to or gives credit (the ability to pay for goods or services at a later date).

Credit granting policy: is a procedure of final decision whether to grant credit to the prospective customer or not.

Financial performance: Comprises the actual output or results of an organization as measured against its intended outputs (or goals and objectives).

Return on equity (ROE): is a measure of financial performance calculated by dividing net income by shareholders’ equity

Return on assets (ROA): Is a measure of financial performance calculated by net income by total assets

• Organization of the study

The study is systematically organized into five chapters as follows:

Chapter one: provides the introductory aspect of the study, which is divided into the background of the study, statement of the problem, purpose of the study, and research questions. Others are Research hypotheses, significance of the study, definition of terms, scope of the study, limitation of the study and the organization of the study.

Chapter two: deals with the review of related literature on the subject matter.

Chapter three: describes the research methodology. Here the emphasis is made on the research design, population, sampling procedure, and sample size determination, data collection methods, operational measures of the variables, instrumentation, and data analysis technique, test of validity and reliability.

Chapter four: deals with the presentation and analysis of data, and

Chapter five presents the discussion of findings, conclusions, recommendations, and suggestions for further studies.