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MAKERERE UNIVERSITY
CREDIT MANAGEMENT AND PROFITABILITY OF COMMERCIAL BANKS:
CASESTUDY: FINCA UGANDA.
BY
WAHINYA GEORGE NGARUIYA
07/K/4158/EXT
SUPERVISOR
EBBIRU DAVID
A RESEARCH REPORT SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIERMENT FOR AWARD OF THE BACHELOR OF COMMERCE DEGREE OF
MAKERERE UNIVERSITY
JULY 2011
1
DECLARATION
I WAHINYA GEORGE NGARUIYA, solemnly declare that this research report is my original work and has never been presented before to any institution for any award
Signature……………………..
Student WAHINYA GEORGE NGARUIYA
Date………………………….
2
APPROVAL
This research report has been submitted under my supervision as a university lecturer.
Signature……………………………………..
Supervisor: EBIRU DAVID
Date…………………………………………..
3
DEDICATION
To my parents Mr. and Mrs. Charles Wahinya Ngotho, Mr. Isaiah Ngotho, Mr. Dickson Ngotho and all my brothers, cousins and friends.
4
ACKNOWLEDGEMENT
A number of people have made relentless contributions, academically, financially and morally, without whose support, guidance and self sacrifice the research would not have been successful.
Firstly, I wish to thank my supervisor Mr. Ebiru David for his professional guidance accorded to me throughout the research period. I owe much of this report to his guidance.
Management and staff of Finca Uganda who availed me with all the data and information for this research report.
I owe special thanks to the my parents, brothers Bedan Ngotho, Isaiah Githara and cousins and all not mentioned here may the almighty God bless you mightily.
Finally, I also owe special thanks to all my friends especially Nelson, Kibet, Mwenda, Dickson, Vincent, who we have shared various materials, moments, and experience in this academic struggle, May the Almighty God reward you all.
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TABLE OF CONTENTS
Declaration...........................................................................................................................................i
Approval..............................................................................................................................................ii
Dedication...........................................................................................................................................iii
Acknowledgement..............................................................................................................................iv
List Of Tables.....................................................................................................................................viii
List Of Figures......................................................................................................................................ix
Acronyms.............................................................................................................................................x
Abstract..............................................................................................................................................xi
CHAPTER ONE: BACK GROUND OF THE STUDY
1.0Introduction....................................................................................................................................1
1.2 Statement of the problem..............................................................................................................2
1.3Purpose of the study.......................................................................................................................3
1.4Objectives of the study....................................................................................................................3
1.5Research questions.........................................................................................................................3
1.6Scope of the study...........................................................................................................................4
1.7Significance of the study..................................................................................................................4
CHAPTER TWO: LITERATURE REVIEW
2.0: Introduction..................................................................................................................................5
2.1: Credit management.......................................................................................................................5
2.2: Sound Credit Management Principles............................................................................................5
2.3: Credit management variables........................................................................................................6
2.4: Credit standards............................................................................................................................6
2.5: Credit terms..................................................................................................................................8
6
2.6: Collection policy..........................................................................................................................10
2.7: Importance of credit management..............................................................................................12
2.8: Profitability.................................................................................................................................13
2.9: Sources of profitability information.............................................................................................13
2.10: How to calculate profitability.....................................................................................................14
2.11: Types of profits and calculations................................................................................................14
2.12: Relationship between credit management and profitability.......................................................15
CHAPTER THREE :METHODOLOGY
3.0 Introduction.................................................................................................................................16
3.1 Research design............................................................................................................................16
3.2 Population of study......................................................................................................................16
3.3 Sampling design...........................................................................................................................16
3.6: Methods of data collection..........................................................................................................17
3.7: Data processing and analysis.......................................................................................................17
3.8 Limitations...................................................................................................................................17
FOUR:DATA ANALYSIS, DISCUSSION OF RESULTS AND PRESENTATION OF FINDINGS
4.1Introduction..................................................................................................................................18
4.2 Actual response rate.................................................................................................................18
4.3: Findings on personal data of the respondents..............................................................................19
4.4: Findings on the credit management policy...................................................................................20
4.5: Findings on profitability of finca Uganda......................................................................................25
4.6: Findings on the relationship between credit management policy and profitability of Finca Uganda...........................................................................................................................................................27
CHAPTER FIVE:SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS.
5.0: Introduction................................................................................................................................31
5.1: Summary of findings....................................................................................................................31
7
5.1.1: To establish the credit management policy of Finca UG, the following were revealed:..............31
5.1.2: To establish the causes of low profitability the following conclusions, were made....................31
5.1.3: To establish relationship between credit management and profitability...................................31
5.2: conclusion:..................................................................................................................................31
5.3: Recommendations;......................................................................................................................32
5.4: Areas for further research;..........................................................................................................32
REFERENCES;......................................................................................................................................33
APPENDICES
Questionnaire…………………………………………………………………….……..Appendix I
Introduction letter…………………………………………………..………………….Appendix II
8
LIST OF TABLES
Table 1: showing loan advances and payments...........................................................................................2
Table 2: showing officers and management executives.............................................................................16
Table 3: showing the response rate............................................................................................................18
Table 4: Responses of personal data of the respondents............................................................................19
Table 5: Response of respondents on the nature of credit management.....................................................20
Table 6: Responses on the objectives of credit management policy in Finca Uganda................................21
Table 7: Responses on the rampant costs of credit to Finca Uganda..........................................................22
Table 8: Responses on whether Finca has a formal credit management policy..........................................23
Table 9: Responses on whether finca has a formal credit management department...................................24
Table 10: Responses on causes of low profitability in Finca Uganda........................................................25
Table 11: Responses on the sources of profits to the bank.........................................................................26
Table 12: Responses on the extent effects of credit management policy on profitability...........................27
Table 13: Responses on the extent of relationship between credit management policy and profitability...28
Table 14: Responses on management effort to improve on credit management in order to increase profits...................................................................................................................................................................29
9
LIST OF FIGURES
Figure 1: showing the response rate...........................................................................................................18
Figure 2: Response on nature of credit management.................................................................................21
Figure 3: Response on objectives of credit management policy in Finca Uganda.....................................22
Figure 4: Response on rampant costs of credit to Finca Uganda................................................................23
Figure 5: Response on whether Finca has a formal credit management policy..........................................24
Figure 6: Response on whether Finca has a formal credit management department..................................25
Figure 7: Response on causes of low profitability in Finca Uganda..........................................................26
Figure 8: Responses on the sources of profits in Finca Uganda.................................................................27
Figure 9: Responses on the extent effects of credit management policy on profitability...........................28
Figure 10: responses on extent of relationship between credit management policy and profitability........29
Figure 11: Responses on management efforts to improve on credit management to increase profits........30
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ACRONYMS
CMP Credit management policy.
COC Costs of credit.
UG Uganda.
MGT Management.
FCP Formal credit management policy.
FCD Formal credit management department.
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ABSTRACT
The principal aim of this study was to evaluate the effectiveness of credit management policy and profitability, a case study of Finca Uganda, and to come up with issues which need attention and redress to address the causes of low profitability in the bank.
The study had the following objectives;
i. Examine the credit policy of Finca Uganda.ii. Assess causes of low profitability in Finca Uganda.
iii. Establish the relationship between credit management policy and profitability in Finca Uganda.
In pursuance of the above aim, the study was based on information gathered from a sample of staff of Finca Uganda, research design was descriptive, purposive sampling was used to select the respondents.
Findings indicate that, the bank has a formal credit management policy, which is an average of leniency and stringent, collection costs make a large portion of the bank’s cost of credit, the bank has a formal credit management department.
On profitability, loans were the largest sources of profits to the bank, poor client appraisal was the major cause of low profitability, credit management greatly affects profitability, and there exists a strong relationship between credit management policy and profitability.
Recommendations:
On recommendations from the findings of the researcher Finca Uganda should undertake reforms on supervision of the clients by closely supervising them from the day the loan is given to them till all loan arrears are paid, the bank should also undertake a strong client appraisal policy so as to reduce losses brought about by poor client appraisal, the bank should also look for more channels to increase on profitability and also cushion it if one of the major sources of profits is affected by changes in macro environment of the economy.
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CHAPTER ONE
BACK GROUND OF THE STUDY
1.0 Introduction
This chapter covers the background of the study, statement of the problem, purpose of the study,
research objectives, research question, scope of the study, and significance of the study.
1.1 Background of the study
The practice of banking has become increasingly sophisticated in recent years. Decades ago,
bankers requiring their sources of funds required much less attention than users.
On the users’ side, a large proportion of funds were placed directly or indirectly on government
paper and the remainder lent on over draft on the basis of general appraisal of the credit
worthiness of customers (Crocket Andrew2000)
Commercial banks are essentially leaders in credit /borrowed funds. They bring together surplus
units and credit spending units by taking deposits at low interest rates. The objective here is to
maximize profits. The interest earned is supposed to cover the cost of the funds as well as
operational expenses so that the bank remains with a profit (Obone 1993)
Commercial banks are usually required to keep a certain portion of their deposits as reserves.
This enables the bank to meet day to day requirements of their customers and funds on excess of
reserves may be lent out to customers/borrowers. Banks also have a choice of investing the
excess reserves in marketable securities which normally earn less interest than lending but have a
lower level of risk than lending (Tayebwa, 1992)
This therefore requires banks to balance profitability ands liquidity in such a way that an
optimum level is found. Besides, decisions as to whether to lend or invest in marketable
securities have to be made. To achieve this, banks put in a credit policy to provide a frame work
with in which such decisions can be made.
Credit, forms the core of banking business, consequently it accounts for a very high percentage
of the bank’s revenue. Because of the nature of this function, credit needs to be properly
13
managed. According to FINCA Uganda Ltd, credit advances constitutes the largest assets of the
bank.
Bank lending, if not properly assessed involves risks that the borrower will not be able or willing
to honor his/her obligations. (Reder and Just, 1980). With banks earning only after they have lent
and with more than 60% of the assets in FINCA Uganda being lent out as loans, if not efficiently
allocated will cause losses not only to FINCA Uganda but also the whole economy of the
country.
Indeed the biggest problem of FINCA Uganda is credit management as it mainly lends to poor
unemployed people who have no properties to attach to it if the loans are not paid.
Due to FINCA Uganda lending to low income earners and people who have not lost fixed
incomes, it has always missed on its collection targets on the advances it gives out as loans as
shown in the table below.
Year Total
outstanding
loans
Paid on time Paid on
action
Total paid Total
paid%
Target
2003
2004
2005
2006
2007
4,071,912,000
4,800,000,000
5,100,000,000
5,400.000,000
5,650,000,000
2,809,619,288
3,400,000,000
3,550,000,000
4,100,000,000
4,300,000,000
601,633,000
785,000,000
850,000,000
920,000,000
970,000,000
3,411,252,288
4,185,000,000
4,400,000,000
5,020,000,000
5,270,000,000
83%
87%
86%
92%
93%
90%
90%
90%
95%
95%
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1.2 Statement of the problem
Despite the existence of a credit management system in FINCA Uganda, it continues to
experience low profitability due to lending to mainly poor people who do not have collateral,
poor project evaluation short loan projects which do not guarantee maximum profits.
In the year 2003, out of shillings 4,071912000 loan due for collection it recovered 3,411252288
representing 83% against a target of 90%.
In year 2004, out of shillings 4, 800, 000,000 loan due it recovered 4,185,000,000 representing
87% against a target of 90%.
In year 2005, out of shillings 5,100,000,000 loans due it recovered 4,400,000,000 representing
86% against a target of 90%
In year 2006, out of shillings 54,000,000,000 loans due It recovered 5,020,000,000 representing
92% against a target of 95%
In year 2007, out of shillings 5,650,000,000 loans due it made a recovery of 5,270,000,000
representing 93% against a target of 95%
The study therefore is intended to establish how FINCA’s credit management has affected its
profits.
1.3 Purpose of the study
The purpose of the study was to evaluate the relationship between credit management and
profitability.
1.4 Objectives of the study
The study is guided by the following objectives;
(i) To examine the credit policy of FINCA
(ii) To assess causes of low profitability of FINCA
(iii) To establish the relationship between credit management and profitability
15
1.5 Research questions
(i) What are the credit management policies of FINCA Uganda?
(ii) What are the causes of low profitability of FINCA Uganda?
(iv) What are the difference between credit management and profitability?
1.6 Scope of the study
FINCA Uganda has 22 branches in Uganda, study was carried out at FINCA headquarters, it
covered credit management policy and profitability of the bank. Study is to consider the subject
for the period of five years 2003-2008.
1.7 Significance of the study
The study shows importance of credit management in financial institutions, demonstrates how
theoretical concepts of credit management are applied practically.
Study assists FINCA to improve on its credit management policy so as to be able to increase on
profitability.
Study is also useful to other researchers who are interested in carrying out study on credit
management and profitability.
16
CHAPTER TWO
LITERATURE REVIEW
2.0: INTRODUCTION
This chapter provides a critical review of the issues that have been studied theoretically and
empirically in the existing literature on credit management from banking books and finance text
books.
2.1: CREDIT MANAGEMENT
In any organization, financial planning is an integral part of cooperate planning. All cooperate
strategic plans enunciate a profit objective and financial policy is designed mainly to achieve
profit as an objective growth and liquidity stability (Brockington 1987).
Among the financial policies of an organization is management of its debtors.
Credit management involves the correction, compilation, storage, analysis, retrieval of
information regarding trading on credit (Hapren et al 1993). Effective credit management
requires that clear guidelines and procedures are laid down for granting credits to individuals and
collecting individual accounts.
2.2: Sound Credit Management Principles
(Franks, Broyle and Carleton 1996) have argued that there is need to develop cost effective
measures for identifying credit customers, monitoring the status or customer Accounts and
revenue collection procedures from customers with overdue bills. (Gitman 1992) identifies three
important aspects of sound accounts receivable management. These are credit standards or
analysis, credit terms and collection policies.
The three aspects have been articulated by (Beiley and Myers 1981) to have the following focal
points which also form the evaluation yard stick of credit management function of enterprises)
- Setting credit terms
- Choice of instrument to use as evidence for indebtedness.
- Establishment of credit analysis method.
- Establish the credit limit.
- Establishing credit monitoring and procedures and efforts.
17
2.3: Credit management variables
(Pandey, 1993and Weston and Copeland 1986) highlighted the need to establish an effective
policy in consideration of decision variables which influence the level of receivables and these
include;
- Credit standards
- Credit terms
- Collection efforts
2.4: Credit standards
Credit standards provide guidelines for determining whether to extend credit and how much
credit to extend (Mannaseh, 1997)
(Pondey and Van-Horne, 1995) define credit standards as criteria to decide the types of who
qualify for the credit extension. Credit standards influence the quality of the firms, customers
that is in terms of line taken by clients to repay credit obligations and the default rate in terms of
bad debts and losses.
To estimate the probability or default the credit manager should consider the various
characteristics of the client. These include the 5Cs as capacity character, condition, capital and
collateral (Babigamba H, 1995)
Both (Pandey, 1995 and Tapenski, 1997) agree on the 5Cs as important variables to consider in
establishing the probability of default. They further agree that the 5Cs are important in
evaluating credit risk, the 5Cs include;
Character
This refers to integrity of the customer, for instance, his/her willingness to honor his/her
indebtedness and in time (Pandey, 1995). The character of the borrower can be established and
judged by using the past records and personal interview. The lender has to establish whether the
borrower seems open and straight forward in his plans. The financial manager should judge
whether the customers will make honest efforts to honor credit obligations.
18
Capacity
This refers to a subjective judgment of the ability of the customer and it is gauged by examining
the projected cash flows of the prospective client.
(Halpen et al1983).
(Pandey, 1995) refers to capacity as customer’s ability to pay, it can be judged by assessing the
customers capital assets which he may offer as security.
According to (Kakuru, 2008), the financial manager should consider the following sources when
analyzing capacity;
Financial statements- This requires the customers to present, past, present and projected financial
statements.
Previous experiment with the firm- This involves assessing the customers regularly in setting his
credit obligations using previous dealings with the client.
Banking and trade references- Cross checking the dealing or the customers with their bankers.
Conditions
Refers to the prevailing economic and other conditions which may affect the customers’ ability
to pay for instance adverse economic conditions, bad weather, and insecurity.
(Collier et al 1993) refers to condition as the impact of general economic trends on the firm to
special developments in certain areas of the economy that may affect the customers’ ability to
meet his obligations.
Capital
Capital refers to amount borrower’s investment and his liquidity and solvency that is debt
liquidity position. It is measured by the general conditions of a firm as indicated by analysis of
its financial statements, special emphasis is given to the risk minimum current rations and the
time interest earned ratio (Rouse 1993)
According to (Halpen, 1983) capital is measured by general financial position of the firm as
indicated by a financial ration analysis with special emphasis on tangible net worth of the
enterprises.19
Collateral
Collateral is a security which the client offers in the event of his failure. (Rouse, 1993), argues
that lenders should consider security important because it is an alternative repayment incase the
customer fails to pay.
According to (Levitsky and Panga 1997) In theory recourse to collateral or other assets provides
an element of security to a lending firm that even in the event of default it will not incur serious
losses.
A good indicator of a long run variability of a borrowing firm according to (Shahidir, Khander,
and Osman 1995) is the analysis of its net worth, accumulation of assets and savings.
Information on 5Cs is obtained from the firm’s previous experience with the customer
supplemented by a well developed system of information gathering groups.
2.5: Credit terms
According to (Pandey 1993), credit terms are the stipulations under which affirm decides to offer
credits to customers.
Credit terms typically express the amount of cash discount and the date of its expiration. After a
firm has evaluated the credit applicant using set credit standards and the decision to extend credit
is made, it has to decide on the duration of the credit, the interest rate and the credit instrument to
be used.
Credit period
Credit period is the length of time during which credit is extended to customers (Lewellen and
Johnson, 1972). A credit period may be governed by industry norms. But depending on its
objective, the firm can lengthen the credit period on the other hand and may tighten the credit
period if the customers are defaulting too frequently and bad debt losses are building up.
(Pandey 1995) argues that lengthening credit period stimulates sales but there is a cist to typing
up funds in receivables.
20
Determining the optimal credit period involves locating that period where marginal profits on
increased sales are exactly offset by costs of carrying the higher amounts of account receivables.
(Gutman, 19820 also argues that the credit period the firm offers could affect its profitability
through the three under mentioned ways.
- Increase in credit period leads to increase in interest income which may have a positive
effect on the profits of the firm.
- Increase in credit period leads to increase in bad debts looses which has a negative effect
on profitability.
- Increase in the average collection period leads to an increase of funds invested in account
receivables which has a negative effect on profitability and liquidity.
- To this effect, there must be an established stable and optimal credit period in order to
ensure certainty of funds flow as well as profitability.
Cash discount
Cash discounts are cash incentives given for receipt of payments before or within the normal
credit period. A cash discount is a reduction in payment offered to customer to induce them to
pay credit obligations with in a specific period of time which will normally be less than the
normal credit period(FORGY, 1993)
According to (MC Laney 1991), the firm should consider the costs and advantages of allowing
discounts, if the firm establishes a particular policy of allowing discounts, care should be taken
to ensure that customers are allowed to deduct discounts only when they have in fact paid with in
the specified period.
There are costs involved in giving up some percentage of invoice amount which is associated
with the three under mentioned benefits (Van Horne, 1989)
(a) Cash is received sooner, reducing the need to borrow which allows more internally
generated cash flows.
21
(b) It may be possible to reduce bad debts since customers are induced to pay early and less
the amount previously contested.
(c) Sales may increase since in effect a discount is a price reduction.
(Hill and Reiner; 1979) recommend the guidelines below in determining an optimal cash
discount rate.
(a) Credit terms must be varied as the firm’s opportunity changes since cash discounts
offered depend on the company’s cost of funds.
(b) The timing of cash flows is critical in cash discount decision since the company cash
discount shifts tend to shift some payments forward while non-discount taking
customers are affected either positively or negatively.
(c) Cash discounts must be matched with customer demand sensitivity to price changes.
(d) Bad debt losses affect the maximum justifiable discount level, if bad debt loss is high,
then higher discounts may be given provided that discounts help reduce the loss.
2.6: Collection policy
According to (Pandey, 1995), collection policy is the procedure the firm follows to obtain
payment based on stated credit terms and how company deals with overdue accounts. One
technique to improve the collection of accounts receivables is to charge interest on over due
accounts receivables is to charge interest on overdue accounts at a rate that is at least equivalent
to that which the buy4er would have to pay to obtain goods on credit.
(Van Horne 1995) recommends collection policy because all customers do not pay the firm’s
bills on time. Some customers are slow payers while some are non payers. The collection effort
according to (Pandey 1995) should aim at accelerating collections from slow payers and
reducing bad debt losses.
(Forgy 1993). Recommends the use of collection procedures in a clear cut sequence. First with a
demand letter framed in a polite language as a reminder then progressively strong worded letters,
then a firm’s representative could personally visit the debtor. If these efforts fail, the firm may
proceed to institute legal actions after assessing the financial position of the debtor.
22
(Porter, 1992) argues that the firm ought to be cautions with its collection procedure/ policy. A
tight collection policy may offend and send away customers while a lenient one would increase
receivables, bad debt losses and reduce profits.
(MC Laney 1991), goes on to say that at some stage it often becomes more costly to pursue
reluctant pays that their debt is worth the firm should decide what its policy on writing off bad
debts should be, once having been established the policy should be followed except in unusually
circumstances. It is important that writing of a debt only occurs when all the steps identified in
the policy have been followed.
Procedures to follow in implementing collection efforts;
(collier, Cooke and Glynn, 1993) suggest that the supplying firm should try to establish some
“ear to the ground routines” so that for signs that particular established credit customer is
experiencing liquidity problems can be picked up quickly and some action taken. Such routines
might include regularly monitoring the customer’s financial accounts. Another approach would
be to look out for customers who are taking larger than they usually do to pay their debts, this
may indicate a weakening liquidity position from incurring those costs.
(Brealey and Myers, 1998) further suggests that in order to collect slow paying account, the firm
should follow collection procedures in a clear cut sequence; for example when the normal credit
period granted to a customer is over and he has not made the payment, a polite letter reminding
the customer that the account is over due should be sent, if the receivables still remain un
collected, letters that are progressively strong worded are sent. This may be followed by a
telephone, the firm’s representative personal visit. If payment is not made after all the above
have been followed then the firm can proceed for legal action.
According to (Johnson 1995), the firm should examine the financial condition of the customer, if
the customer is very weak, legal action against him may help to cause his bankruptcy. This will
mark the chances of getting any payment.
The firm has to be very cautious in taking steps bin order to collect from slow paying customers
because some customers may feel offended and shift to competitors.
23
Yoonje and Joonkyung Kim, 1995) go on to say that the benefits of the flexibility of credit
policies should not be taken for granted. Especially poor information on behalf of creditors may
turn their potential effectiveness into a large hazard.
2.7: Importance of credit management.
Lending is a practical subject which requires its practitioners to have either a theoretical
knowledge or techniques and to be “street wise” in them. The theoretical knowledge can be
learned from books but becoming street wise is usually the trust of better experience (Nicholas
Rouse 1994)
The successful bank is a successful lender. While banks can engage in a large number of the
financial activities and render a wide range of services to customers, direct lending is the primary
function not only in lending the central service provided by banks but also their most profitable
type of business which gives them the best available rate of return. Credit management plays a
critical role in risk management and the overall creation of value of a lending institution. This is
because the majority of banks earning assets are inform of loans.
Lending involves some danger of credit risk, which is the uncertainty about loan payment. The
primary danger in granting credit is the chance that the borrower will not repay the loan on
timely basis there by destroying value (Sinkey 1998)
(Edminster 1997) for this reason, bank creditors must be extended with great care thus credit
management and other unusual protective measures must be taken by banks to assure them
selves that they are not assuming excessive risks.
(Rouse 1993) says that bankers need to approach lending propositions with healthy skeptism.
Banks do not have to do business with customers they feel uncomfortable with.
(Sawyer 1996) since the purpose of lending is to earn interest and to Make a profit, it follows
that these principles of good lending should be concerned with ensuring as far it is possible to do
so that the borrower will be able to make the scheduled repayment in full with in the required
period of time.
24
2.8: Profitability
Profitability is an indicator of firm’s capacity to carry risk and to increase its capital. Profit is an
indicator of an organization’s competitive position in markets and its quality management. It
allows the organization to maintain certain a certain risk profile and provide a cushion against
short-term problems. It’s unfortunate that the word short term is looked at as a term of abuse
since some firm always wants to maximize profits at the cost of employees, customers and
society. Except such in frequent cases it is in fact that sufficient profits must be earned to certain
the operations of the business to be able to obtain funds from investors for expansion and growth
and to contribute towards the social overheads for welfare of the society (Drucker P.F 1968).
There are two profitability ratios, profitability in relation to sales and profitability in relation to
investment.
2.9: Sources of profitability information
The source document of profitability is the income statement which is the main source of
profitability information. It is a key source of information on organizations earnings and their
quality and quantity, as well as a variety of organization’s portfolio and the targets of its
expenditure. The analyst will be able to interpret the firm’s profitability more meaningful if he
evaluates both the ratios growth margin and net margin jointly.
2.10: How to calculate profitability
Profitability is very hard to determine and calculate because the factors that influence have a
great impact on the firm in question. However, in order to calculate profits we need to ascertain
the following.
Turnover; This is the gross turn over of the business from sales or services over a given period.
Turn over takes no account of profit or expenses; it’s simply a record of money coming into the
business.
Over heads; These represent expenses which are a general charge to business. There are
essential or fixed things which a business has to meet regardless of any trading activity which
include rent, heating, lighting, insurance, security and systems. These are expenses incurred in
the actual incurred in the actual running of the business. Examples here include payment of
wages and salaries of employees, insurance and security.
25
2.11: Types of profits and calculations
(Drucker P.F 1968) recognized that no business can run without making profits through with
consequences the following types were identified;
Gross profit.
This is profit which a business makes before recognizing any expenses.
Net profit
This is the excess of sales turn over to relevant expenses there business deducts expenses like
wages, insurance and lighting from growth profit.
Money profit
The cash difference between the cost price and selling price of an item is money profit.
Percentage profit
The expression of profits as a percentage of the cost of sales, gives rise to mark up and margin.
Mark up is a profit expressed as a percentage of the cost of sales which a margin is profit
expressed as a percentage of sales.
2.12: Relationship between credit management and profitability.
In conclusion there fore, the literature review has indicated that every business to operate there
must be profit making (Vera Hughes and Wellern, 1989).
For any business to increase profits, it must improve on its turn over and reduce on it’s operating
costs.
For a firm to be able to increase on sales volume, it should offer credit to its customers. However
offering credit exposes the business to the risk of bad debts and losses. This can be reduced by
establishing a good optimum credit management policy. The investment in account receivable
depends on the volume of credit sales and the collection period there fore the investment in
receivables may be expressed in terms of costs instead of sales value. The percentage of credit
sales is influenced by the nature of business and industry norms.
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CHAPTER THREE
METHODOLOGY
3.0 Introduction
In this chapter, the researcher presents the background against which data was collected and
analyzed which include; research design, population of study, data collection methods,
processing and analysis.
3.1 Research design
The researcher used descriptive research so as to better understand the variables under study.
3.2 Population of study
The staff covered staff of credit department of FINCA Uganda. They were chosen because they
were able to give relevant data to answer the research objectives and questions.
3.3 Sampling design
For the purpose of this study, the researcher used purposive sampling for the staff so as to get
responses necessary to the study.
3.4: A sample size of 40 was selected. These include loan officers and management executives.
Respondents Number
FINCA’S management executive 19
FINCA’S loan officers 21
TOTAL 40
3.5: Sources of data
Data was collected from both primary and secondary sources.
3.5.1: Primary Source
This source was used to yield first hand information. This was exploited through the use of
questionnaires designed by the researcher.
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3.5.2: Secondary sources
This source involved obtaining information that was collected by other researchers but in line
with this particular study. This involved use of text books, departmental reports and news papers.
3.6: Methods of data collection
The researcher used questionnaires. The data was collected from respondents by use of self
administered questions.
3.7: Data processing and analysis
This came after data collection. It involved transformation of data into information. The data
collected was edited, coded and finally analyzed.
Editing was done to improve on completeness and accuracy, data analysis was carried out using
tables, percentages and frequencies.
3.8 Limitations
The researcher had the following hindrances during his research.
(i) Funding; securing funds to finance the research exercise.
(ii) Time frame; The researcher faced a problem of limited time for the whole exercise.
(iii) Obtaining adequate information about the research topic especially concerning the
primary data
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CHAPTER FOUR
DATA ANALYSIS, DISCUSSION OF RESULTS AND PRESENTATION OF FINDINGS
4.1 INTRODUCTION
This chapter examines the data collected in a way of questionnaire and presents the findings, in order to establish the impact of credit management on profitability.
4.2 Actual response rate
Out of 40 questionnaires that were distributed to staff of Finca Uganda, only 35 questionnaires were filled, making a response rate of 87.5% and non-response rate of 12.5%.
Table 1: showing the response rate
Actual response rate 40
Response 35 87.5
Non-response 5 12.5
Total 100
Source: primary data
From the table above it’s evident that 87.5% response rate is a good response where one can depend to draw conclusions and make recommendations. Only 12.5% is a non-response which can be ignored.
Chart 1: showing the response rate.
From the chart above it’s evident that 87.5% response rate is a good response where one can depend to draw conclusions and make recommendations. Only 12.5% is a non-response which can be ignored.
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4.3: FINDINGS ON PERSONAL DATA OF THE RESPONDENTS.
TABLE 2: Responses of personal data of the respondents.
Marital status 35
single 8 22.86
married 23 65.71
divorced 4 11.43
total 100.00
Age 35
20-29 12 34.29
30-39 8 22.86
40-49 12 34.29
50-59 3 8.57
60> 0 0.00
total 100.00
Sex 35
male 25 71.43
female 10 28.57
total 100.00
Position held 35
Credit officer 11 31.43
Evaluation officer 14 40.00
Marketing officer 10 28.57
others 0
total 100.00
Education Level 35
Certificate 7 20.00
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Diploma 7 20.00
Degree 15 42.86
Masters 6 17.14
total 100.00
Source: primary data.
On the personal data of the respondents, 71.43% were male and 28.57% were female.
On marital status 22.86 were single, 65.71% were married, and 11.43% were divorced.
On the age of the respondents, 34.29% of the respondents were in the age bracket of 20-29 years, 22.86% of the respondents were in the age bracket of 30-39 years, 34.29% of the respondents were in the age bracket of 40-49 years, 8.57% of the respondents were in the age bracket of 50-59 years.
On the position held in Finca Uganda, 31.43% of the respondents were credit officers, 40% of the respondents were evaluation officers, and 28.57% of the respondents were marketing officers. On the education level of the respondents, 20% of the respondents were certificate holders, 20% of the respondents were diploma holders, 42.86% of the respondents were degree holders, 17.14% of the respondents were master’s holders.
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4.4: FINDINGS ON THE CREDIT MANAGEMENT POLICY.
TABLE3: Response of respondents on the nature of credit management.
Nature of credit management policy 35
lenient 9 25.71
stringent 10 28.57
Both of the above 4 11.43
Average of both 12 34.29
total 100.00
Source: primary data.
On the nature of credit management policy, 25.71% cited that Finca Uganda has a lenient credit management policy, 28.57% cited that the credit management policy is stringent, 11.43% cited that the credit management policy is both lenient and stringent, 34.29% cited that credit management policy is an average of lenient and stringent policy. This therefore implies that the credit management is an average lenient which can lead to low profitability due to its leniency.
Chart 2: Response on nature of credit management
On the nature of credit management policy, 25.71% cited that Finca Uganda has a lenient credit management policy, 28.57% cited that the credit management policy is stringent, 11.43% cited that the credit management policy is both lenient and stringent, 34.29% cited that credit management policy is an average of lenient and stringent policy. This therefore implies that the credit management is an average lenient which can lead to low profitability due to its leniency.
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TABLE 4: Responses on the objectives of credit management policy in Finca Uganda.
objectives of CMP in FINCA UG 35
Maximize sales 8 22.86
Minimize investment in receivables 7 20.00
Both (a) and (b) 20 57.14
Total 100.00
Source: primary data.
On the objectives of credit management policy in Finca Uganda, 22.86% of the respondents cited that maximizing sales is the main objective, 20% of the respondents cited minimization of investment in receivables, 57.14% of the respondents cited both maximizing sales and minimizing investment in receivables as the objectives of credit management policy of Finca Uganda. This therefore implies that the objectives of credit management policy is maximizing sales and minimizing investment in receivables.
Chart 3: Response on objectives of credit management policy in Finca Uganda.
On the objectives of credit management policy in Finca Uganda, 22.86% of the respondents cited that maximizing sales is the main objective, 20% of the respondents cited minimization of investment in receivables, 57.14% of the respondents cited both maximizing sales and minimizing investment in receivables as the objectives of credit management policy of Finca Uganda. This therefore implies that the objectives of credit management policy is maximizing sales and minimizing investment in receivables.
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TABLE 5: Responses on the rampant costs of credit to Finca Uganda.
Rampant coc to FINCA UG 35
Collection costs 18 51.43
Bad debts losses 7 20.00
Administration costs 7 20.00
Opportunity costs 3 8.57
Total 100.00
Source: primary data
On the rampant costs of credit to Finca Uganda, 51.43% of the respondents cited collection costs as the rampant cost of credit, 20% of the respondents cited that bad debt losses as the rampant cost of credit, 20% of the respondents cited administration costs as the rampant cost of credit, 8.57% cited opportunity costs as the most rampant cost of credit for Finca Uganda. Hence from the above analysis collection costs account for the largest cost of credit for Finca Uganda.
Chart 4: Response on rampant costs of credit to Finca Uganda.
On the rampant costs of credit to Finca Uganda, 51.43% of the respondents cited collection costs as the rampant cost of credit, 20% of the respondents cited that bad debt losses as the rampant cost of credit, 20% of the respondents cited administration costs as the rampant cost of credit, 8.57% cited opportunity costs as the most rampant cost of credit for Finca Uganda. Hence from the above analysis collection costs account for the largest cost of credit for Finca Uganda.
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TABLE 4: Responses on whether Finca has a formal credit management policy.
FINCA UG HAS A FCP 35
Strongly agree 14 40.00
Agree 16 45.71
Not certain 3 8.57
strongly disagree 0
disagree 2 5.71
Total 100
Source: primary data.
On whether Finca has a formal credit policy, 40% of the respondents strongly agreed that Finca has a formal credit management policy, 45.71% of the respondents agreed that Finca has a formal credit management policy, 8.57% of the respondents were not certain that Finca has a formal credit management policy, 5.71% of the respondents disagreed that Finca has a formal credit management policy. Hence from the above analysis most of the respondents agree that Finca Uganda has a formal credit management policy.
Chart 5: Response on whether Finca has a formal credit management policy.
On whether Finca has a formal credit policy, 40% of the respondents strongly agreed that Finca has a formal credit management policy, 45.71% of the respondents agreed that Finca has a formal credit management policy, 8.57% of the respondents were not certain that Finca has a formal credit management policy, 5.71% of the respondents disagreed that Finca has a formal credit management policy. Hence from the above analysis most of the respondents agree that Finca Uganda has a formal credit management policy.
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TABLE 5: Responses on whether finca has a formal credit management department.
FINCA HAS A FCD 35
Yes 28 80
no 7 20
total 9 100.00
Source: primary data.
On whether Finca Uganda has a formal credit management department, 80% of the respondents agreed with the statement, while 20% of the respondents disagreed with the statement that Finca Uganda has a formal credit management department, this means that the bank has a formal credit management department.
Chart 6: Response on whether Finca has a formal credit management department.
On whether Finca Uganda has a formal credit management department, 80% of the respondents agreed with the statement, while 20% of the respondents disagreed with the statement that Finca Uganda has a formal credit management department, this means that the bank has a formal credit management department.
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4.5: Findings on profitability of finca Uganda.
TABLE 6: Responses on causes of low profitability in Finca Uganda.
Cause of low profitability in Finca Ug 35
Low earnings ratio 9 25.71
poor client appraisal 20 57.14
High operational costs 6 17.14
Total 100.00
Source: primary data.
On causes of low profitability of Finca Uganda out of the 35 respondents polled 9 indicated that low earnings ratio causes low profitability representing a 25.71%, 20 of the respondents cited poor client appraisal representing a 57.14% of the total respondents , 6 of the respondents cited high operational costs representing a 17.14% of the total respondents. Hence the major cause of low profitability is poor client appraisal.
Chart 7: Response on causes of low profitability in Finca Uganda.
On causes of low profitability of Finca Uganda out of the 35 respondents polled 9 indicated that low earnings ratio causes low profitability representing a 25.71%, 20 of the respondents cited poor client appraisal representing a 57.14% of the total respondents , 6 of the respondents cited high operational costs representing a 17.14% of the total respondents. Hence the major cause of low profitability is poor client appraisal.
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TABLE 7: Responses on the sources of profits to the bank.
SOURCES OFPROFITS IN FINCA UG 35
Loans 22 62.86
Savings/ investment facility 8 22.86
Utility clearance facilities 5 14.29
total 100
Source: primary data.
On the sources of profits in Finca Uganda, 62.86% of the respondents cited loans as the major source of profits, 22.86% of the respondents cited savings/investment facility as the major source of profits, 14.29% of the respondents cited utility clearance fees as the major source of profits. Hence loans are the major sources of profits to Finca Uganda.
Chart 8: Responses on the sources of profits in Finca Uganda.
On the sources of profits in Finca Uganda, 62.86% of the respondents cited loans as the major source of profits, 22.86% of the respondents cited savings/investment facility as the major source of profits, 14.29% of the respondents cited utility clearance fees as the major source of profits. Hence loans are the major sources of profits to Finca Uganda.
4.6: Findings on the relationship between credit management policy and profitability of Finca Uganda.
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TABLE 8: Responses on the extent effects of credit management policy on profitability.
Extent effects of CMP on profitability
35
Strongly agree 10 28.57
Agree 15 42.86
Not certain 8 22.86
Disagree 2 5.71
Total 100.00
Source: primary data.
On the extent effects of credit management policy on profitability, 28.57% of the respondents strongly agreed that credit management policy affects profits, 42.86%of the respondents agreed that credit management policy affects profitability, 22.86% of the respondents were not certain if credit management policy affects profitability, 5.71% of the respondents disagreed that credit management policy affects profitability. Hence from the above analysis majority of the respondents agree that credit management policy greatly affects profitability of Finca Uganda.
Chart 9: Responses on the extent effects of credit management policy on profitability.
On the extent effects of credit management policy on profitability, 28.57% of the respondents strongly agreed that credit management policy affects profits, 42.86%of the respondents agreed that credit management policy affects profitability, 22.86% of the respondents were not certain if credit management policy affects profitability, 5.71% of the respondents disagreed that credit management policy affects profitability. Hence from the above analysis majority of the respondents agree that credit management policy greatly affects profitability of Finca Uganda.
TABLE 9: Responses on the extent of relationship between credit management policy and profitability.
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Extent of relationship between credit mgt policy and profitability
35
strong relationship 19 54.29
weak relationship 6 17.14
average relationship 8 22.86
not certain 2 5.71
Total 100.00
Source: primary data.
On the extent of the relationship between credit management and profitability, 54.29%of he respondents indicated existence of a strong relationship, 17.14% of the respondents indicated existence of a weak relationship, 22.86% of the respondents indicated existence of an average relationship, 5.71% of the respondents indicated that they were not certain if any relationship existed. Hence from the above analysis the extent of the relationship between credit management policy is a strong relationship as profitability depends on credit management policy.
Chart 10: responses on extent of relationship between credit management policy and profitability.
On the extent of the relationship between credit management and profitability, 54.29%of he respondents indicated existence of a strong relationship, 17.14% of the respondents indicated existence of a weak relationship, 22.86% of the respondents indicated existence of an average relationship, 5.71% of the respondents indicated that they were not certain if any relationship existed. Hence from the above analysis the extent of the relationship between credit management policy is a strong relationship as profitability depends on credit management polic
TABLE 10: Responses on management effort to improve on credit management in order to increase profits.
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Mgt efforts to improve on credit Mgt in order to increase profits
35
Establish stringent credit policy 21 60.00
Establish a credit management panel 8 22.86
Establish new loan limits 6 17.14
total 100.00
Source: primary data.
On management efforts to improve on credit management in order to improve on profitability, 60% of the respondents favored establishment of a stringent credit policy, 22.86% favored establishment of a credit management panel, 17.14% favored establishment of new loan limits. Hence from the above analysis most of the respondents stated that management should establish a stringent credit policy in order to increase profits of Finca Uganda.
Chart 11: Responses on management efforts to improve on credit management to increase profits.
On management efforts to improve on credit management in order to improve on profitability, 60% of the respondents favored establishment of a stringent credit policy, 22.86% favored establishment of a credit management panel, 17.14% favored establishment of new loan limits. Hence from the above analysis most of the respondents stated that management should establish a stringent credit policy in order to increase profits of Finca Uganda.
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CHAPTER FIVE
SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS.
5.0: INTRODUCTION
In this chapter the researcher presents the summary of findings, conclusion and recommendations in line with the results achieved after carrying out the research.
5.1: Summary of findings.
5.1.1: To establish the credit management policy or Finca UG, the following were revealed:
The credit policy of Finca UG was found to be lenient, this causes cases of nonpayment of existing loans hence affecting profits .The main objective or credit policy is mainly centered to the sales maximization and the most common cost or credit policy of Finca is bad debts losses and existence of formal credit management policy was also revealed
5.1.2: To establish the causes of low profitability the following conclusions, were made
On the profitability aspects, the bank experiences low loan turn over due to poor client together with high interest rates charged by the bank to its clients, also the existence of a poor bank client relationship and also credit management policy was found to be weak
5.1.3: To establish relationship between credit management and profitability
The examination of the affect of credit management revealed that there were great effects on profitability emanating from credit management policy of Finca UG, on the basic of this the strong relationship was concluded.
5.2: conclusion:
From the findings credit management policy of Finca Uganda plays a major role on the profitability of the bank much emphasis should be placed on this variable for all stakeholders who include investors who provide capital for the bank and they require a return on their investment.
The client appraisal policy of Finca Uganda which mainly contributes to selection of the clients is the bench mark which is set by the bank to ensure payment of the loans advanced to them by the bank is not at a level which ensures prompt payment of the loans and a good return on the bank’s profitability.
The bank’s reliance on one source of profits which is loans usually leads the bank to have a low loan earnings ratio as not all the loans due are paid in time while a portion of the loan is not paid at all making it’s revenues to be unreliable and unpredictable.
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The bank’s cost of credit which carries a big percentage of the costs is collection costs should be minimized by having an extensive coverage especially when visiting it’s clients on the ground.
5.3: Recommendations;
On recommendation, the bank should carry out the following in order to maximize profit; it should put much emphasis on its risk management policy.
The bank should put close supervision on its clients to reduce chances or payments that affect its profits, the bank should revise its credit terms.
The bank should improve on client appraisal to avoid giving credit to customers whom may not be able to repay back the loan in time.
They should emphasize on credit management as it creates more channels for the bank to gain profits from the loans it offers to its customers the credit management policy should be stringent so as to be easier to collect the loans it gives out to its customers.
The bank should emphasize on proper appraisal mechanism that will lead to reduced instances of bad debt losses hence increasing the bank’s profitability and increased returns to the shareholders of the bank.
5.4: Areas for further research;
Due to the limited time and funds, the researcher was not in position to cover effectively and appropriately in the areas of interest in the study and therefore there is need for more research on:
i. Credits risk management and efficiency of management of micro finance institutions.
ii. Loan management and profitability of micro finance institution.
iii. Factors affecting loan repayment in micro finance institutions
iv. Client relationship and repayment of loans in commercial banks.
v. Role of client appraisal and loan repayment in commercial banks.
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REFERENCES;
Edminster Robert (2006). Financial institutions, makers and management. McGraw-hill London series in finance.
Kakuru Julius (2000) Financial Decisions and the business. Mubs First edition.
Nsereko. J. (2003) credit management in commercial banks vol. 1 no. 1.
Okwech J. (2002) financial integration and development in sub-Saharan Africa. A study on informal finance in Ghana” Overseas development institute Ghana.
Halpen p; J.F. Weston & Eugene f. Brigham (2009) Managerial finance 2nd Edition. Dryben press.
James c. Horne (2005) financial management and policy 16th Edition New Jersey.
Pandey I.M (2004) financial management vikas publishing house PVT India.
Obone A.E (2003) “Monetary Theory Banking and Public Finance 4th ed. The Marium Press Uganda.
Robinson I.R (2001) “The management of Bank Funds” New York Mc Graw Hill.
Mc lancy (1991) Business finance for decision makers Pitman publishing.
Gitman L.J (1998) Principles of managerial finance 3rd ed New York. Harper & Row, publishers. Inc.
Boggess (2003) screen-test your credit risk Harvard Business review.
Soloman, E. and Pringle, J.J, (1997) An Introduction to financial management, Prentice- Hall of India.
Van Horne (2005) J.C. Financial management and policy, Prentice- Hall of India.
Winter (1997) financial management.
Finca Uganda limited 2003-2007 Financial statements.
J.V. Weide and S.E. Maire (2001)
Ramamoorthy, V.E. (1999) Credit management Madras institute for financial management and research.
APPENDICES
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QUESTIONNAIRE
Dear respondents
This questionnaire is intended to facilitate the study on “credit management and profitability of
commercial banks. The case study of FINCA Uganda” The study is for academic purposes and is
carried out as partial requirement of the “award of a Bachelor of commerce degree of Makerere
University” you are kindly requested to fill the gaps and spaces below with appropriate answers.
The information obtained will be treated strictly confidential will be used for academic purposes
only.
Thank you so much for your valuable time.
Yours sincerely
WAHINYA GEORGE
Date of interview ……………………………………
SECTION A. BACKGROUND INFORMATION
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In this section tick in the box provided
a). Sex
a). Male
b). Female
2. Age of respondent
a). 20-29
b). 30-39
c). 40-49
d). 50-59
e). 60 and above
3. Marital status
a). Married
b). Single
c). Divorced
d). Others (specify)
4. Position held
a). Credit officer
b). Evaluation officer
c). Marketing officer
d). Any other (specify)………………………………
5. State your highest level of education.
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a). Certificate
b). Diploma
c). Degree
d). Masters
e). Any other (specify)…………………………..
SECTION B: CREDIT MANAGEMENT POLICY
1. What is the nature of credit management policy in FINCA Uganda?
a). Lenient
b). Stringent
c). Both of the above
d). Average of both
2. What are the objectives of credit management policy in FINCA Uganda?
a). Maximize sales
b). Minimize investment in receivables
c). Both (a) and (b)
d) Others specify……………………………………………………..
3. What is the most rampart cost of credit to FINCA Uganda?
a). Collection costs
b). Bad debts losses
c). Administration costs
d). Opportunity costs
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4. To what extent is the statement that FINCA Uganda has formal credit policy?
(a) Strongly agree
(b) Agree
(c) Not certain
(d) Strongly disagree
(e) Disagree
5. Does FINCA Uganda have a functioning credit department?
(a) Yes
(b) No
(c) Not sure
SECTION C: PROFITABILITY OF FINCA UGANDA
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1. What do you think is the cause of low profitability of FINCA Uganda?
a). Low earnings ratio
b). Poor client appraisal
c). High operational costs
d). Any other (specify)……………………………………………………………….
2. What are the major sources of profits for FINCA Uganda?
a). Loans
b). Savings/ investment facility
c). Utility clearance facilities
d). Others specify……………………………………………………………………………..
3. From the major source of profit chosen above which generates a large percentage of earnings?
a). Loans
b). Savings
c). Utility clearance facilities
d). Others specify…………………………………….
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SECTION D: RELATIONSHIP BETWEEN CREDIT MANAGEMENT POLICY AND
PROFITABILITY OF FINCA UGANDA?
1. To what extent do you agree that credit management policy affects profitability?
a). Strongly agree
b). Agreed
c). Not certain
d). Disagree
2. What do you think is the extent of relationship between management policy and profitability?
a). Strong relationship
b). Weak relationship
c). Average relationship
d). Not certain
3. What has management done to improve on credit management in order to increase profits?
a). Establish stringent credit policy
b). Establish a credit management panel
c). Establish new loan limits
d). Not certain
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