Effect of debt collection management on financial performance of listed companies at Nairobi Stock Exchange
Kariuki, Antony M
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Debt collection, late payment and non-payment are becoming increasingly of great interest for business especially with the ongoing slow economic growth and credit rationing by banks. Customers may increase the demand for trade credit and supplier firms may need to put more emphasis on credit worthiness and debt collection management. This is because trade credit is an investment for the firm and best practices should be used during screening of customers before issuing of trade credit and during debt collection. This study sought to address the issue of how debt collection management affects the firm's financial performance in Kenya. The study also sought to determine the debt collection management of companies listed at Nairobi Stock Exchange. The research design was a correlation study. This was chosen because a correlation study method involves collection of data in order to determine whether and to what degree a relationship exists between two or more quantifiable variables. The population of interest in this study constituted the 55 companies listed at the NSE as at the period ending 31 st December 2008. This population was chosen so as to study the large companies specifically as available literature on credit collection suggests there is a significant difference in debt collection management between large companies and small and medium firms. The total sample was 35 firms that were selected by simple random sampling method. The study used secondary data for the period 2008-1999, obtained from annual reports, the balance sheet and income statements from the Capital Markets Authority (CMA) library, and also obtained primary data from the sampled firms on debt collection management using a questionnaire administered to credit and debt collection management staff. For the purpose of identifying the important variables influencing the dependent variables we used the multiple regression analysis. Pearson product moment coefficient of correlation (also called the coefficient of correlation) was used to test the degree of linear association between the different pairs of variables (multi-collinearity) under consideration including the dependent variables. The pooled regression type of panel data analysis was used. In panel data (pooled) regression, time-series and cross-sectional observations are combined and estimated. For the purpose of this study, four dependent variables were used in separate regression models using debt collection performance ratios as independent (explanatory) variables, to establish the degree of correlation with debt collection management. These dependent variables are namely, the profitability, liquidity, solvency, and market ratios. They ratios used are namely net profit margin (NPM), quick ratio (QR), debt ratio (DR), price earnings ratio (PE). Two independent (explanatory) variables namely; average collection period (ACP) and bad debt (80) were used in all four regression models to establish the degree of correlation with the financial performance measures of profitability, liquidity, solvency, and market ratios. For this study, the analysis of the questionnaire was done using descriptive and quantitative statistics. Factor analysis was used to reduce to a manageable number the many interrelated variables as measured by Likert-scales on the questionnaire. The questionnaire data analysis results showed the debt collection management practices used by large firms in Kenya are similar in many areas to other large firms in other countries according to existing empirical studies done. The analysis results also show the importance these companies attach to screening customers before giving credit and to debt collection. The ratio of total staff performing credit screening to credit analysis is 4:1, and the ratio of total staff performing credit screening to a debt collection is 1: 1. A multiple regression analysis of the firms' financial data from the balance sheet, income statements and annual reports showed that the average collection period (based only on trade receivables) has a statistically significant positive effect on 3 of 4 dependent variables that measure financial performance namely, net profit margin, debt ratio and quick ratio. The relationship suggests that large Kenyan firms use trade credit to increase their sales revenues, margins, improve solvency and liquidity. There was no significant relation between debt collection management and market performance and also no significant relationship between bad debts and any of the variables tested in the regression models. On the basis of the results it may be concluded that firms should improve and increase their credit screening and debt collection procedures so as to maximize on the potential of granting more trade credit to customers when demand arises, so as to increase their financial performance in the areas of net profit margins, solvency, liquidity and activity.