CHAPTER ONE
INTRODUCTION
1.1
Background to the Study
Small and medium enterprises (SMEs) are getting recognized due to their contribution to economy.
The significant role of SMEs has evolved over a time. A shift has been occurred from the view
point of SMEs as a contribution to society and political stability to more on an economic ground.
The development and success of the SMEs help smooth transition of an economy to market base
one. SMEs constitute a large proportion of economic activity and are among the major growth
drivers for any economy in the world (Purnima, Satish, & Vinodh, 2019). The contribution of
SMEs is highly significant in boosting output of a country, generating employment, enhancing the
income and savings, channeling investments and therefore, in leading the nation towards the path
of progress and prosperity.
In Nigeria, SMEs contribute 48% of national GDP, account for 96% of businesses and 84% of
employment, with a total number of about 17.4 million, they account for about 50% of industrial
jobs and nearly 90% of the manufacturing sector, in terms of number of enterprises (PWC, 2019).
However, planning capital structure involves, to a great extent, the consideration of owners’
interest and other groups. It is clear that credit management is a significant management decision
as it greatly influences the owner’s return, his risks as well as the market value of the business. It
is therefore incumbent on the management of a business to develop an appropriate credit
management policy, which is most suitable to the business’s operation (Rafiu, 2009).
Credit creation has proved to be an important function of some business banking sector in
particular since it is the main source of banks’ internally generated revenue; it is considered one
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of the oldest and most sensitive functions of banks. From the commercial perspective, credit
involves giving out resources obtained from depositors held in their customers’ accounts, to
another party at an interest rate higher than what they pay to suppliers of funds with the aim of
maximizing profit. However, modern business cannot be transacted on cash basis alone. Thus,
most business transactions of small scale enterprises are conducted on credit terms. They grant
credit to their customers and also source credit from their suppliers. In each case, repayment is
expected to be made at a stipulated time in accordance with the terms of the business transactions
(Alobari, Naenwi, Zukbee, & Grend, 2018).
The management of credit in small business is a primary concern for managers and owners of these
small businesses as it has a direct impact on the viability of the business. Effective credit
management determines the business cash flow and thereby, the liquidity of the operations. Failure
to effectively manage credit sees small business experiencing late payment to their creditors and a
breakdown in the supply chain which then affect their ability to service their debtors. Credit
management activities encompass both debtors and creditors (Kagoyire & Shukla, 2016). Failure
to ensure terms of credit for debtors to maintain cash flow, which in turn enhances prompt payment
of creditors, is a cause of many small scale business failures.
Thus, credit management needs to ensure proper monitoring of cash flow and other liquidity
related indicators as well as appropriate procedures to carefully evaluate the customer’s capacity
to meet the business’ credit payment terms. Sound credit management is a requirement for a
business’s stability and continuing profitability, while worsening credit quality is the most frequent
cause of poor profitability. A key requirement for efficient credit management is the ability to
intelligently and resourcefully manage customer credit lines. In order to reduce exposure to bad
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debt, over-reserving and bankruptcies, business must have greater insight into customer financial
strength, credit score history and changing payment pattern (Kagoyire & Shukla, 2016).
One of the primary goals of a business management is to maximize profitability as a metric for
measuring financial performance (Anila, 2015). The scientific examination of a company's
financial performance and strength is what is meant by the term "profitability." To put it another
way, profitability refers to the extent to which a company's financial goals have been met. Financial
performance evaluation is a method used to determine how well an institution's policies and
practices are working for customers. It may be used to compare similar banks within the same
industry or to aggregate industries or sectors in order to assess the overall financial health of a
bank over time. The shareholders get rewarded for their investment if the company is making
money. Investment and expansion in the banking sector are encouraged as a result of this (Vincent
& Gemechu, 2013). Return on assets (ROA), Tobins-Q, profit margin (PM), and return on
investment (ROI) are only a few ways to gauge a company's profitability (Ebrahim, Abdullah, &
Hanim, 2014).
Credit management starts with the sale and does not stop until the complete and final payment has
been received. It is as vital as part of the deal as closing the sale. It follows that principles of goods
lending shall be concerned with ensure, so far as possible that the borrower will be able to make
scheduled payments with interest in full and within the required moment in time otherwise, the
profit from interest earned is reduced or even wiped out by the bad debt when the customer
eventually defaults. Credit management is concerned principally with managing debtors and
financing debts. The objectives of credit management can be stated as safe guarding the company’s
investments in debtors and optimizing operational cash flows. Policies and procedures must be
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useful for granting credit to customers, collecting payment and limiting the risk of non-payments
(Wadike, Abuba & Wokoma, 2017). Thus, it is on this background this study examines the
relationship between credit management and profitability of registered SMEs in Kano State.
1.2
Statement of the Research Problem
Proper credit management is essential to ensure the solvency and long term survival of small
enterprises. It will definitely enhance the credit worthiness of small firms and thus, improve the
future financing accessibility. For the above to be achieved, small firms must be pro-active in their
credit management practices hence it will positively affect their growth and development. Most of
the business transactions of small firms are conducted on credit terms. Debtors of small scale firms
are obtained when goods and services are delivered to customers on credit while creditors may
include suppliers that supply raw materials or input to small firms on credit (Charles & Kenneth ,
2013).
Failure to effectively manage credit sees small scale firms experiencing late payment to their
creditors and a break down in the supply chain which then affect their ability to service their
debtors. The desire of small scale firms to achieve higher profit requires expansion of sales.
Modern business cannot be transacted on cash basis alone thus, increase in sales result to increase
in debtors. As a result of poor credit management practices, the small firms often have problems
of late payment and even non-payment of credit from debtors. This in turn inhibits cash flow and
leaves the small firms having their own outstanding debts. This problem often emanates from the
small firms negligence of having a written customer credit policy (Achou & Tengu, 2008).
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The small scale firms also obtain credit from their suppliers who constitute creditors. This is an
arrangement in which the suppliers usually based on established relationship with the small firms
provide them with short-term credit for raw materials or input supplied. In this aspect of payment
too, most of the small scale firms also delay payment to their creditors even when discount are
offered on prompt payment. Thus, such firms forego the opportunity cost of discount offered and
incur more cost on late payment to their creditors.
However, the problems with the SMEs have been attributed to poor credit management (Hongbo,
Xiaojie & Hongbo, 2009; John & Sylvester, 2011; Ikem, Chidi & Titus, 2013 and Bungule, 2016).
As acknowledge by Ogunlade and Oseni (2018) that provision for bad and doubtful debts that rise
steadily, indicate that credit component of the business’ portfolio is poorly managed. Many of
them were writing off huge amounts of debt yearly and also reflected some going concern issues
that related to their management of credit and finance. Also, most of the SMEs have been running
their businesses with a lot of difficulties due lack of knowledge on credit management policy.
Based on the available information it is obvious that results from the study of the impact of credit
management policy on profitability are inconclusive and needs further study with specific
reference to of registered SMEs in Kano. Therefore, this study fills the gap in literature to examines
the relationship between credit management and profitability of registered SMEs in Kano State.
1.3
Objectives of the Study
The aim of this study is to examine the relationship between credit management and profitability
of registered SMEs in Kano State. The specific objectives of the study are to:
I.
examine the impact of debt collection period on profitability of registered SMEs in Kano
State;
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II.
determine the impact of proportion of bad debt to total debt on profitability of registered
SMEs in Kano State; and
III.
ascertain the impact of customer capacity on profitability of registered SMEs in Kano State.
1.4
Statement of Hypotheses
Hypotheses to be tested in this study are stated below in their null forms:
HoI
Debt collection period has no significant impact on profitability of registered SMEs in
Kano State.
HoII
Proportion of bad debt has no significant impact on profitability of registered SMEs in
Kano State.
HoIII
Customer capacity has no significant impact on profitability of registered SMEs in Kano
State.
1.5
Scope of the Study
This research examines the relationship between credit management and profitability of registered
SMEs in Kano State. However, it is complex and energy requiring to cover all the registered SMEs
in Kano State. The registered SMEs with Kano State Chamber of Commerce as at the year 2020
will be selected within Kano Metropolis. The dependent variable is profitability while the
independent variable is credit management. However, the variables will be measure using
quantitative data. The measures will be developed to determine the respondent’s opinion on how
credit management affect their profitability. The respondents had to give a response on a five-point
likert scale (strongly agree, agree, neutral, disagree and strongly disagree).
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1.6
Significance of the Study
Most SMEs have growth and continuity as part of their objective, and such objectives are best
realized by an efficient credit management and evaluation. This has made it possible for them to
gain inherent advantage while minimizing loses involved in their daily operations. This research
project will therefore be of immense advantage or benefit to the management of SMEs, investors
and other business organization using credit policy. This research will also contribute to enhance
efficiency in the following ways:
Management: This study will help management to 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.
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.
Risk Management Association of Nigeria: 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.
Researchers: they will be able to apply this research 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.
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