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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.
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