THE IMPACT OF TRADE CREDIT MANAGEMENT ON FIRM’S PERFORMANCE

Description

THIS RESEARCH WORK IS ON  THE IMPACT OF TRADE CREDIT MANAGEMENT ON FIRM’S PERFORMANCE

ABSTRACT

An efficient credit management system reduces the amount of capital tired up with debtors and minimizes bad debts. Good credit management system is vital to business cash flow and success and ensures effective business operation.

The study investigated the impact of financial management of trade credit on firm’s performance; using Guinness Ghana brewery limited (GGBL) as case study. The choice of the topic was influenced by the impact of short term financial management of trade credit on profitability of companies.

Secondary data was used for the study. It noted that, average collection period of 39.6 days was maintained by GGBL over the period. Average payment period was also 96.2 days, which was encouraging.  This means that, supplies made to GGBL on credit were utilized to turn over sales cycle three times before payments were eventually made to suppliers. The performance in terms of profitability evidenced by ROE (Return On Equity), was 36% and OPM (Operating Profit Margin) was 12.4%. This goes to highlight the importance the impact of efficient credit management have on profitability of firms.

The study further observed that ACP and APP were positively related to profit margin (OPM), but negatively related to return on equity. The study was observed to be consistent with other studies conducted by Poutziouris, Michaelas and Soufani (2005)

The recommendations made include;

• Policy makers should have the interest in promoting efficient management of working capital to facilitate performance management.
• Top management of every firm should manage their trade credits prudently in order to remain profitable and competitive.

CHAPTER ONE

INTRODUCTION

1.1       BACKGROUND OF THE STUDY

An efficient credit management system reduces the amount of capital tied up with debtors and minimizes bad debts Finlay (2009). Peter D. (2005) conceived that there is a positive correlation between credit management and profitability. According to Dina A. (2007), good credit management is vital to business cash flow and ensures business operations. Good credit management involves optimizing cash flow to ensure stability and provide maximum potential for growth. Credit arises when a firm sells its products or services on credit and does not receive cash immediately. It is an essential marketing tool, acting as a bridge for the movement of goods through production and distribution stages to customers. A firm grants trade credit to protect its sales from the competitors and to attract the potential customers to buy its products at favorable terms. Trade credit creates receivable or book debts which the firm is expected to collect in the near future. The book debts or receivable arising out of credit has three characteristics:’ first, it involves an element of risk which should be carefully analysed. Cash sales are totally riskless, but not the credit sales as the cash payment are yet to be received. Second it is based on economic value. To the buyer, the economic value in goods or services passes immediately at the time of sale, while the seller expects an equivalent value to be received later on. Third, it implies futurity. The cash payment for goods or services received by the buyer will be made by him in a future period. The customers from whom receivable or book debts have to be collected in the future are called trade debtors or simply as debtors and represent the firm’s claim or asset.(Ramamoorth,1976,p.183)

Receivable constitutes a substantial portion of current assets of several firms. For example in India, trade debtors, after inventories, are the major components of current assets. They form about one-third of current assets in India. Granting credit and creating debtors amount to the blocking of the firms funds,(Ramamoorthy,1976.)

It is perceived that the following factors might have contributed to high failure of business having bad debt sitting in their account statements;

• Either no documentation or poorly constructed documentation specifying the terms and conditions of trade in the organization’s credit policy.
• Inability to seek legal advice before finalizing the documentation to ensure it has internal consistency and covers all the key issues.
• Inability to clearly specifying what will be supplied, when the work will be done, and when and how payment is to be made.
• Failure to obtain a written acceptance of the agreement along with written approval of any variations to the original agreement
• Poor timing of invoicing and insufficient details to resolve invoice queries or disputes quickly.
• Poor maintenance of debtors’ records to identify any due or over due debts and how much is owed and who owes (Ramamurthy, 1976.)

Philip K. (2010) cited four basic things businesses must strive for effective credit management:

• Know who your customers are before you start trading with them.
• Agree payment terms before supplying,
•  Do not be afraid to ask for payment when it is due.·Invoice promptly after you have sent the goods; and

The importance of practicing good credit management cannot be over emphasized. According to Michael (1997), good credit management is an essential component and a fundamental part of the modern commercial strategy. Michael (1997) consented that extending credit to customers is an aid to selling and all staff should be involved. Michael blended sensible control of credit management and customer satisfaction with profitability. According to Steve (1997) of Association of Credit Professionals (ACP) good credit management is all about customer satisfaction and profit. Steve, (1997) agreed with Michael’s assertion. Michael contended that satisfied customers are more likely to pay promptly than buyers who feel they are not getting a good deal.

Indeed if revenue is the energy that powers company, credit management is the engine that keeps it flowing. The credit management engine acts as a powerhouse, driving revenue and motivation to every part of the company. As credit management engine becomes more refined and efficient, so the company becomes more productive and profitable. Good credit management should be a proactive task, starting even before the sales begin. Effective credit management will protect and prosper the business with regards to profitability however; the opposite is true if ineffective credit management is practiced. Credit indeed impacts all areas of life and efficient credit management minimizes delinquency and bad debt losses.

It is against this background that the researchers want to ascertain the impact of credit management on profitability using GGBL as a case study.

1.2.      PROBLEM STATEMENT

A lot of studies have been conducted to establish the impact of short term debt management policies on profitability. Dina, A. (2007) argued that, it appears that customers who pay promptly are not the problem but those who cannot pay or would not pay. Invariable unpaid debts will affect profitability. If repayments are not made regularly as a result of poor controlling, monitoring and collection of debts, then the ability to make profit is severely affected.  It is believed that inefficient credit management generates irregular incomes which hinder the organization’s effectiveness and efficiency.

Further study conducted by Michael,(1997) concluded that, about 38% of businesses that extend credit to clients are unlikely to sustain in the market. Michael asserted that it is possible to be profitable on paper but lack the cash to continue operating the business. The European Commission in 2008 reported that, 33% of EU businesses regard late payment as a survivalthreatening issue.  The report stated that late payments hinder the functioning of the single market and cross-border trade.

However, extending credit has become an aspect of everyday business activity to be able to increase sale. Since it contributes significant revenue to businesses especially as the world recovers from the financial shocks of recent years and exposures of company balance sheet

The above have demonstrated the contributions made so far by theses researchers in contributing to the existing literature in this context. Irrespective of this doubt still remains as to whether the findings can be applied in the Ghanaian situations, where the business environment is very fragile. In addition, there is inadequate research on trade credit management in Ghana.

Furtherance to this, the significance of the relationship between the two variables still remains to be empirically concluded. Hence this study was initiated to contribute to the existing literature using data from the Ghanaian business environment. It is hoped that the findings of this study will have enormous policy implications to the private sector given the fact that the private sector has been earmarked to be the engine of growth.

1.3       RESEARCH OBJECTIVE

The objective of this study is to identify any relationship between short term financial management of trade credit on profitability of GGBL. .Specifically; we are going to look at the

Average Collection Period (ACP), Average Payment Period (APP) and their relationship with

Return On Equity (ROE) and Operating Profit Margin (OPM)

1.4       RESEARCH QUESTIONS

Do short term debt or trade credit management policies or decisions matter in firms’ performance in Ghana? Is there any relationship between trade credit management and performance? To what extent does effective trade credit financial management affect profitability?

1.5       RESEARCH HYPOTHESIS

To answer the above questions the following hypothesis are designed based on the test of the null hypothesis:

HoA:     There is no significant relationship between short term debt or credit and profitability as measured by Return on Equity (ROE) and operating profit margin (OPM).

H1B:     There is a significant relationship between short term debt or credit and profitability as measured by Return on Equity (ROE) and operating profit margin (OPM).

HOi:     There is no significant change in firm’s profitability as a result of increase or decrease in short term debt and credit.

HOii:    There is a significant change in firm’s profitability as a result of increase or decrease in short term debt and credit.

1.6       SCOPE OF THE STUDY

The study covered a period of 2004 – 2012 works of GGBL.

1.7       SIGNIFICANCE OF THE STUDY

For the academic world, this study has shed some light on the short term debt policies. The significance of this study has further enhanced considering the fact that research into the relationship between short term debt and profitability in Ghana is only at its infantile stage. For practitioners, this study is relevant and of much interest to financial controllers, managers, directors particularly those working in the brewery sector to get to know about the trend of debt management policies of their competitors. The study is also relevant to the government of Ghana. Policy makers in Ghana recently developed Medium-Term National Private Sector Development Strategy, and articulated government’s commitment to facilitating private sector-led growth. It is expected that the findings of this study will have important policy implications.

1.8       LIMITATIONS OF THE STUDY

The limitations of the study are;

• Financial constrains
• Time constrain.

1.9       ORGANIZATION OF THE STUDY

The study is organized as follows:

Chapter One covers the background, statement of the problem, purpose of the study, research question, significance of the study, limitations, and organization of the study.

Chapter two; Review of related literature on; Theoretical basis of the study, Working capital management, Management of trade credit, Financing current assets, Empirical studies on working capital management and its effects on performance.

Chapter three covers research methodology used for this study. The chapter includes the sources of the data, description of the variables; research questions with respective hypotheses .The analysis of the data and the tools that were used to perform the statistical analysis. Chapter four; includes data analysis, presentation of results and discussion of the findings of the study.

The last chapter that is chapter five; consists of the summary of findings, recommendations and conclusion.