INTERNATIONAL JOURNAL OF ACADEMICS & RESEARCH (IJARKE)€¦ · receivables management entails managing the firm's inventory and receivables in order to achieve a balance between risk

INTERNATIONAL JOURNALS OF ACADEMICS & RESEARCH ISSN: 2617-4138 IJARKE Business & Management Journal DOI: 10.32898/ibmj.01/1.4article05

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50 IJARKE PEER REVIEWED JOURNAL Vol. 1, Issue 4 May – Jul. 2019

Effects of Debtors Management on the Financial Performance of

Construction Firms in Mombasa County

Monicah Mueni Muthami, Jomo Kenyatta University of Agriculture and Technology, Kenya

Dr. Peter Ng‟ang‟a, Jomo Kenyatta University of Agriculture and Technology, Kenya

1. Introduction

Business enterprises today use trade credit as a prominent strategy in the area of marketing and financial management. Thus,

trade credit is necessary in the growth of the businesses. When a firm sells its products or services and does not receive cash for it,

the firm is said to have granted trade credit to its customers. Trade credit thus creates account receivables which the firm is

expected collect in future (Kungu, Wangu, & Gekara, 2014). Accounts receivables are executed by generating an invoice which is

delivered to the customer, who in turn must pay within and with the agreed terms. The accounts receivables are one of the largest

assets of a business enterprise comprising approximately 15% to 20% of the total assets of a typical construction firm (Dunn,

2017). Investment in receivables takes a big chunk of organization‟s assets. These assets are highly vulnerable to bad debts and

losses. It is therefore necessary to manage accounts receivables appropriately. Trade credit is very important to a firm because it

helps to protect its sales from being eroded by competitors and also attracts potential customers to buy at favourable terms. As

long as there is competition in the industry, selling on credit becomes inevitable. A business will lose its customers to competitors

if it does not extend credit to them.

Management of debt which aims at maintaining an optimal balance between each of the accounts receivables components, that

is, cash, receivables, inventory and payables is a fundamental part of the overall corporate strategy to create value and is an

important source of competitive advantage in businesses (Deloof, 2012). In practice, it has become one of the most important

issues in organizations with many financial executives struggling to identify the basic accounts receivables drivers and the

appropriate level of accounts receivables to hold so as to minimize risk, effectively prepare for uncertainty and improve the

overall performance of their businesses (Lamberson, 2015).

The term debtors are defined as „debt‟ owned to the firm by customers arising from sale of goods or services in the ordinary

course of business” (Pike and Cheng, 2001). The three characteristics of receivables the element of risk, economic value and

futurity explain the basis and the need for efficient management of receivables (Jackling et al., 2004). The element of risk should

be carefully analyzed. Cash sales are totally riskless but not the credit sales, as the same has yet to be received. Accounts

receivables management entails managing the firm's inventory and receivables in order to achieve a balance between risk and

returns and thereby contribute positively to the creation of a firm value. Excessive investment in inventory and receivables

reduces the profit, whereas too little investment increases the risk of not being able to meet commitments as and when they

become due (Harris, 2005).

INTERNATIONAL JOURNALS OF ACADEMICS & RESEARCH (IJARKE Business & Management Journal)

Abstract

Many companies are offering credit to their customers as a way of retaining existing customers or as a strategy to get acquire

new customers. Therefore, there is need to manage effectively this credit hence the purpose of this study was determining the

effects of Debtors‟ Management on financial performance of construction firms in Mombasa in Kenya, with specific interest

in the construction industry. To strengthen the conceptual framework the researcher used theories such as the credit risk

theory, liquidity preference theory, free cash flow theory, factoring theory and the Knight theory of profits. The study adopted

a descriptive research design. The study collected primary data through use of questionnaires with respondents in the

construction industry. The target population was 273 employees of construction firms in Mombasa County. The sample size

selected was 162, comprising the chief executive officers, finance officers and accountants. Data analysis was done using

frequency counts, percentages, means and standard deviation, regression, correlation and the information generated will be

presented in form of graphs, charts and tables. The study concluded that credit policy, liquidity management, debtors‟ turnover

and factoring have a significant effect on financial performance of construction firms in Mombasa County. The study

recommended that construction firms should develop stronger credit policies; that construction firms should diversify their

activities to ensure that they are liquid all the time; that construction firms should reduce the number of days they receive

finances from their debtors and that construction firms should establish other forms of mitigating financial risks.

Key words: Debtors Management, Credit Policy, Liquidity, Factoring, Financial Performance, Construction Firms


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Construction firm‟s sector failure had been the subject of considerable research efforts in a capitalist economy. There was a

substantial amount of both theoretical and empirical comparison of construction firms research relating to debtors‟ credit

management practices and its relationship to the failure of construction firms was due to lack of Information Access for SMEs in

Indonesia (Gunawan, 2012). However, there seemed not to be much research that focuses on sorting out the relationships among

the many measures of credit management practices that had been used by these researchers. The study described an exploratory

investigation of the relationships among a set of items used to measure the debtors‟ management practices of credit in construction

firm‟s on growth in Brazil. Brazil construction authority usually made the highest percentage of businesses in Brazil and it

recently received a great boost after the enactment of the construction firms of year 2013. The sector had hitherto been largely

unregulated especially with regard to financial hurdles, lack of proper business management skills such as accounting, book

keeping and marketing. This was one of the flagship priorities of the Vision 2050 as it was aimed at construction firms.

Construction sector firm‟s failure had been the subject of considerable research efforts in a capitalist economy. There was a

substantial amount of both theoretical and empirical comparison of construction firm sector for research relating to debtors‟ credit

management practices and its relationship to the failure of hire purchase sector for construction firms was due to lack of

Information access for in Indonesia (Gunawan, 2012). However, there seemed not to be much research that focuses on sorting out

the relationships among the many measures of credit management practices that had been used by these researchers. The study

described an exploratory investigation of the relationships among a set of items used to measure the debtors‟ management

practices of credit in construction firms on growth in Kenya. The sector had hitherto been largely unregulated especially with

regard to financial hurdles, lack of proper business management skills such as accounting, book keeping and marketing.

The debtors‟ management practices on growth according to (Pandey, 2012) stated that was a strategy that involved the process

of designing and monitoring the policies that governs how a construction firm extends credit to its customer. The idea behind this

process was to minimize the amount of bad debt that the construction firms would eventually incur due to customers failing to

honor their commitments to repay the total amount of the credit purchases. Typically, the process of debtor management begins

with evaluating potential customers in terms of credit worthiness; identifying a credit limit that carries a level of risk that the

business was willing to assume; and then monitoring how well the customer makes use of that available credit; including making

regular payments within the terms and provisions associated with the credit account. One of the basics of debtor management was

to accurately assess what type of credit line to extend to a given customer. A number of factors go into making this determination,

including the credit rating of the client, current ratio of debt to average income, and the presence of any negative items on the

customer‟s credit reports. With this information in mind, it was possible to have some idea of how much credit the customer could

reasonably be expected to manage and not present a high risk for defaulting on any outstanding balance. Abor et al. (2016) stated

that the construction firm‟s governance for the construction Sector requires proper management in order to avoid bad debts

occurrence to construction firms in South Africa.

In Kenya, investment in accounts receivables may not be a matter of choice but a matter of survival (Kakuru, 2016). Given

that investment in receivables has both benefits and costs; it becomes important to have such a level of investment in receivables

at the same time observing the twin objectives of liquidity and profitability. To remain profitable, businesses must ensure proper

management of their receivables (Ojeka, 2015). The management of receivables is a practical problem; businesses can find their

liquidity under considerable strain if the levels of their account‟s receivables are not properly regulated (Samuels & walkers,

2016). Thus, management of accounts receivables is important, for without it; receivables will build up to excessive levels leading

to declining cash flows. Poor management of receivables will definitely result into bad debts which lowers the business‟

profitability. The growth in economic activities as currently witnessed in Nigeria; in our present democratic government with its

attendant limited financial resources available to the operators of the market has no doubt brought about increase in credit

transaction (Ifurueze, 2013). The impact depends on the skill and prowess with which the companies manage their credit sales.

Beckan and Richard (2014) have seen that most companies after granting credit sales rely on them as assets without providing

adequately for possible. With this situation, the financial statements of such companies obviously will lack true and fair view

because of the fact that the amount of trade debtors cannot be fully realized. In the same vein liquidity problem is not left out

when granting credit sales. This arises from over investment in receivables especially when the debtors are of high-risk class. A

company suffering from liquidity problem implies that the cost of obtaining funds from other sources may be high and a credit

sale beyond the optimal level of credit is dangerous. On the other hand, sales level and profitability are reduced as a result of

organization to meet short term obligation that are due. One of the major reasons that may cause liquidation is illiquidity and

inability to make adequate profit. These are some of the basic ingredient of measuring the “going concern” of an establishment.

For these reasons‟ companies are developing various strategies to improve their liquidity position. Strategies which can be adapted

within the firm to improve liquidity and cash flows concern the management of working capital, areas which are usually neglected

in times of favourable business conditions (Pass & Pike, 2015). Due to the speed in which technology is changing and the

dynamics in business caused by changes in their internal and external environment, the ways in which businesses are conducted

today differ significantly from yester years. Therefore, for a credit policy to be effective it should not be static (Ojeka, 2015).

Credit policy requires to be reviewed periodically to ensure that the organizations operate in line with the competition. This

will ensure further that sales and credit departments are benefiting. While most companies have their own policies, procedures and

guidelines, it is unlikely that any two firms will define them in a similar manner. However, no matter how large or small an


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organization is and regardless of the differences in their operations or product, the effects of credit policies usually bring about

similar consequences. Effects of a credit policy are either good enough to bring growth and profits or bad enough to bring

declination and losses. This similarity is as a result of the aim of every manager which is to collect their receivables efficiently and

effectively, thus maximizing their cash inflows (Ojeka, 2015). This is contrary under competitive business environment were

survival depends on the volume of turnover (sales) which in turn leads to trade debt accumulation. Here debtors cannot be

completely avoided it is therefore the work of the management to initiate policies concerning credit sales so that they will survive

in the business environment they find themselves.

2. Research Problem

Management of debtors is one of the several functional areas of Management, but it is the center to the success of any

construction firms. Inefficient debtor management combined with the uncertainty of the firm‟s credit environment often led

construction firms to serious problems. Careless, undisciplined or unstructured debtor management practices are the main cause of

failure for construction firms in most developing countries (Wekesa, 2018). Regardless of the construction firms led by owner or

hired credit manager, if the financial decisions are wrong, profitability of the business will be adversely affected. Consequently, a

business organization‟s growth could also be affected because of inefficient credit record management. Record management

enables a firm to refer to mistakes and be efficient in future outcomes. Most construction firms had often failed due to lack of

knowledge of efficient debtor management as pointed out by (Teruel & Solan, 2015).

An analysis of groups of construction firms in Kenya shows that total debtor‟s portfolio represents 13% of the balance sheet

size of the firm. The analysis also shows that the average value of debtors is 50% of the total borrowing. Teruel and Solan (2015)

suggested that managers can create value by reducing their firm‟s number of days of accounts receivables. The construction

industry has huge accounts receivables and would have been more profitable if they were to be reduced significantly and the funds

applied towards other cash flow requirements. According to Kwansa and Parsa (2016) quoted in a study by Gu and Gao (2017),

loan default was found to be one of the events unique to bankrupt companies.

Locally, studies that pivoted linearly on the growth from debtor management practices that had been done include: Wanyungu

(2015) who did a research financial management practices of micro and small enterprises in Kenya, a case of Kibera, Musau

(2015) looked deeply at debtors‟ management practices on profitability of public listed energy companies, Ngugi (2015) examined

determinets of debtors management in the hotel industry, Waititu (2015) evaluated effects of debtors‟ management on profitability

of manufacturing firms in Kenya while Oware (2017) examine debtors management practices in the water industry and finally

Wekesa (2018) examined the effects of debtors‟ management practice on growth of Hire Purchase companies in Kenya. None of

these local studies has ever directly focused on debtor management practices in construction firms in Mombasa. It is in this light

that the current study seeks to fill the existing research gap by studying the influence of debtor management practices on

profitability of construction firms in Mombasa County.

3. Study Objectives

3.1 General Objective

The main objective of the study was to investigate the influence of social media monitoring on digital marketing of Small and

Medium Enterprises (SMEs) in Kenya.

3.2 Specific Objectives

The study was guided by the following specific objectives:

i. To examine the effect of credit policy on financial performance of construction firms in Mombasa County.

ii. To determine the effect of liquidity management on financial performance of construction firms in Mombasa County.

iii. To evaluate the effect of debtor‟s turnover on financial performance of construction firms in Mombasa County.

iv. To examine the effect of factoring on financial performance of construction firms in Mombasa County.

4. Review of Literature

4.1 Theoretical Framework

4.1.1 Credit Risk Theory

Although people have been facing credit risk ever since early ages, credit risk has not been widely studied until recent 30

years. Early literature (before 1974) on credit uses traditional actuarial methods of credit risk, whose major difficulty lies in their

complete dependence on historical data. Up to now, there are three quantitative approaches of analyzing credit risk: structural

approach, reduced form appraisal and incomplete information approach (Crosbie et al., 2017). Melton 1974 introduced the credit


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risk theory otherwise called the structural theory which is said the default event derives from a firm‟s asset evolution modeled by

a diffusion process with constant parameters. Such models are commonly defined “structural model “and based on variables

related a specific issuer. An evolution of this category is represented by asset of models where the loss conditional on default is

exogenously specific. In these models, the default can happen throughout all the life of a corporate bond and not only in maturity

(Longstaff and Schwartz 2015). This theory supports the credit risk objective.

4.1.2 Liquidity Preference Theory

Liquidity preference theory was developed by Keynes in the mid-1930s. Keynes explained the detention of money by the

existence of three motives: the transaction-motive, the precautionary-motive and the speculative-motive (Keynes, 1936). Based on

liquidity preference theory, the central bank sets the rate of interest in order to control the price of financial assets through the

demand for money. The higher the rate of interest, the lower the price of assets with given expectations, and the higher is the

demand. Liquidity preference theory suggests that an investor demands higher interest rate, premium on securities with long term

maturities, which carry greater risk, because all other factors being equal, investors prefer cash or other highly liquid holdings.

Liquidity preference is the core of the relationship between pension funds and assets markets.

Precautionary motive of holding cash is for contingencies or unforeseen circumstances arising from course of business. Real

estate investors invest in real estates. The returns earned from rent income are invested in other properties. When interest rates are

high in the economy, realtors invest in affordable housing, whereas when interest rates are low realtors invest in high end

properties. Transaction-motive refers to cash required by firms to meet its day to day needs of its business operations.

Construction firms hold a portion of their funds to meet their financial obligations as and when they fall due. This motive helps

the construction firms to maintain a good cash flow leaving sufficient fund for investment and away from cash misuse (Marney &

Tarbert, 2017).

4.1.3 Free Cash Flow Theory

The Free Cash Flow Theory by Jensen (1986) presuppose that managers mount up cash so as to augment the amount of

resources they can be in command of and to get unrestricted authority over the investment decisions of the firm. Hence, managers

fancy to cling to more cash and soaring amounts of investment in working capital to lessen the investment risk of the firm so as to

reduce the likelihood of insolvency and consign excess import to deterrent motivation of holding cash (Opler et al., 1999).

Amassing of cash and having a bulky collection of liquidity accessible when wanted throughout the working capital cycle

decreases the anxiety on the managers to execute their responsibilities efficiently and permits them to select projects that make

them contented however may not necessarily keep shareholders pleased (Drobetz, Gruninger & Hirschvogl, 2018). Moreover, the

managers are not subject to scrutiny of the capital markets when funding new projects internally because they do not have to get

new funds externally, which could as well be very costly (Ferreira & Vilela, 2018).

There several implications derived from the Free Cash Flow theory. Companies with larger agency problems are inclined to

build up cash and have exceedingly liberal working capital policies to facilitate adequate liquidity even if they do not have

excellent investment prospects. Thus, cash holdings increase mostly in firms with soaring free cash flows produced and well-

established management, which does not face a great deal of demands to pay out the amassed cash holdings to shareholders in

form of dividends (Bates, Kahle & Stulz, 2019). Such firms might in fact be sloppy in collecting its accounts receivables and may

markedly invest in inventories, as the demands are not there to free the cash and heighten exploitation of it. Opler et al., (2019)

points out that business might be holding surplus cash with the intention of shielding themselves from superfluous takeover

endeavors and that these firms may be harder to assess as a result of liquidity. Equally, firms may have high levels of investments

in working capital. It is against this backdrop that the study sought to determine the mediating role of cash holdings on the

relationship between short-term financing decisions and financial performance of construction firms in Mombasa County.

4.1.4 Factoring Theory

Factoring theory was developed by Fasheng and Kouvelis in the mid-1970s. The contractor is capital constrained (i.e., the

supplier‟s initial capital may be insufficient to produce what is needed in support of the retail demand) and in need of short-term

financing, which is provided by a third-party bank (or a factor). For all cases, the bank offers a fairly priced loan for relevant risks.

Failure of the supplier‟s loan repayment leads to bankruptcy (Fasheng & Kouvelis, 2018).

Receivables constitute a significant portion of current assets of a firm. But, for investment in receivables, a firm has to incur

certain costs such as costs of financing receivables and costs of collection from receivables. Further, there is a risk of bad debts

also. It is, therefore, very essential to have a proper control and management of receivables. In fact, maintaining of receivables

poses two types of problems; (i) the problem of raising funds to finance the receivables, and (it) the problems relating to

collection, delays and defaults of the receivables. A small firm‟ may handle the problem of receivables management of its own,

but it may not be possible for a large firm to do so efficiently as it may be exposed to the risk of more and more bad debts. In such

a case, a firm may avail the services of specialized institutions engaged in receivables management, called factoring firms

(Fasheng & Kouvelis, 2018).


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4.1.5 Knight’s Theory of Profits

The Knight's Theory of Profit was proposed by Frank H. Knight, who believed profit as a reward for uncertainty-bearing, not

to risk bearing. Simply, profit is the residual return to the entrepreneur for bearing the uncertainty in business. In this theory he

claims that bearing uncertainty is the least important of the entrepreneurial functions, and that introducing innovation and adapting

to the innovation of others are more important (Brooke, 2018).

Knight had made a reasonable refinement between the hazard and vulnerability. The hazard can be named a measurable and

non-measurable hazard. The measurable dangers are those whose likelihood of event can be foreseen through factual information.

For example, chances because of the flame, burglary, or mishap are measurable and consequently can be guaranteed in return for a

premium. Such measure of premium can be added to the absolute expense of generation (Brooke, 2018). Knight believes that

profit might arise out of the decisions made concerning the state of the market, such as decisions with respect to increasing the

degree of monopoly in the market, decisions regarding holding stocks that might result in the windfall gains, decisions taken to

introduce new product and technique. The major criticism of the knight‟s theory of profit is, the total profit of an entrepreneur

cannot be completely attributed to uncertainty alone. There are several functions that also contribute to the total profit such as

innovation, bargaining, coordination of business activities (Brooke, 2018).

5. Conceptual Framework

Bryman & Bell (2015) defines conceptual framework as a concise description of phenomenon under study accompanied by a

graphical or visual depiction of the major variables of the study. According to Young (2009), conceptual framework is a

diagrammatical representation that shows the relationship between dependent variable and independent variables. A conceptual

framework shows the relationship between independent and dependent variable. In this study, the dependent variable is the

financial performance of construction firms while the independent variables are credit policy, Liquidity management, debtor‟s

turnover and factoring.

Independent Variables Dependent Variable

Figure 1 Conceptual Framework

6. Review of Study Variables

6.1 Credit Policy

Credit Policy can be viewed as written guidelines that set the terms and conditions for supplying goods on credit, customer

qualification criteria, procedure for making collections, and steps to be taken in case of customer delinquency. This term can also

Credit Policy

Credit approval procedures

Customers Credit worthiness

Credit administration practice

Debtors Turnover

Account receivable practice

Turnover Levels

Trade-Off of sales and profits

Factoring

Contracts with creditors

Source of financing

Affordable funds

Liquidity Management

Optimal liquidity Level

Liquidity and performance

Balanced Liquidity

Financial Performance of

Construction Firms

Return on Equity

Return on Assets

Return on Capital Employed


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be referred to as collection policy. It is also the guidelines that spell out how to decide which goods are sold on open account, the

exact payment terms, the limits set on outstanding balances and how to deal with delinquent accounts. Lawrence (2015), the

objective of managing accounts receivable is to collect receivable without losing sales from high-pressure collection techniques.

Accomplishing this objective encompasses; credit selection and standard which involve the application of technique for

determining which customer should receive credit. This process involves evaluating the customer‟s creditworthiness and

comparing it to the firm‟s credit standard, its minimum requirements for extending credit to customers and credit monitoring

which involves the review of the firm‟s account receivable to determine whether customers are paying according to the stated

credit terms. Slow payments are costly to a firm‟s investment in account receivable.

Debtor management means the process of decisions relating to the investment in business debtors. In credit selling, it is certain

that we have to pay the cost of getting money from debtors and to take some risk of loss due to bad debts. To minimize the loss

due to not receiving money from debtors is the main aim of debtor management. Economic conditions and firms credit policies

are the chief influence on the level of a firm‟s account receivable (James, 2015). The trade-off between increase in the market

share through credit sales and the collectability of the account receivable affects firm‟s liquidity and its eventual profitability. A

firm may report large profit and still suffer liquidity problem if bulk of its transactions are in account receivable and collection

policy in not effective. Credit and collection policies encompasses the quality of accounts accepted, the credit period extended, the

cash discount given, certain special terms and the level of collection expenditure. In each case, the credit decision involves a

trade-off between the additional profitability and the cost resulting from a change in any of these elements.

Receivable management begins with the decision of whether or not to grant credit. Where goods are sold on credit, a

monitoring system is important, because without it, receivable will have built up to excessive levels, cash flow (liquidity) will

decline and bad debts will offset the profit on sales. Corrective action is often needed and the only way to know whether the

situation is getting out of hand is to set up and then follow a good receivable control system (Eugene, 2015). Eugene, (2015),

states that optimal credit policy, hence the optimal level of accounts receivable, depends on the firm‟s own unique operating

conditions. A firm with excess capacity and low variable production cost should extend credit more liberally and carry a higher

level of receivable than a firm operating at full capacity on slim profit margin.

6.2 Liquidity Management

Liquidity management is a concept that is receiving serious attention all over the world especially with the current financial

situations and the state of the world economy. The concern of business owners and managers all over the world is to devise a

strategy of managing their day to day operations in order to meet their obligations as they fall due and increase profitability and

shareholder‟s wealth (Owolabi & Ibida, 2015). The importance of liquidity management as it affects corporate profitability in

today‟s business cannot be over emphasis. The crucial part in managing working capital is required maintaining its liquidity in

day-today operation to ensure its smooth running and meets its obligation (Eljelly, 2014).

Liquidity plays a significant role in the successful functioning of a business firm. A firm should ensure that it does not suffer

from lack-of or excess liquidity to meet its short-term compulsions. A study of liquidity is of major importance to both the internal

and the external analysts because of its close relationship with day-to-day operations of a business (Bhunia, 2015). Dilemma in

liquidity management is to achieve desired trade between liquidity and profitability (Raheman & Nasr 2017). Liquidity

requirement of a firm depends on the peculiar nature of the firm and there is no specific rule on determining the optimal level of

liquidity that a firm can maintain in order to ensure positive impact on its profitability.

Akenga (2015) evaluated effects of liquidity on financial performance of firms listed at the NSE. In order to meet their

obligations, firms are expected to hold a certain percentage of their total finance in cash. However, majority of the institutions

especially financial institutions tend to focus only on profit maximization at the expense of liquidity management. It is therefore

the role of financial managers to establish effective mechanisms of meeting a firm‟s obligations and profit maximization. The

objective of the study was to establish the effect of current ratio, cash reserves and debt ratio on financial performance of firms

listed at the Nairobi Securities Exchange (NSE). Causal research design was adopted. Purposive sampling technique was used to

select 30 firms. The data was analyzed using descriptive and inferential statistics It was found that current ratio and cash reserves

have a significant effect on ROA with a p value of less than 0.05. The debt ratio was found to have no significant effect on ROA

as it had a significance level of 0.571.

6.3 Debtors Turnover

The goal of debtor‟s turnover/accounts receivables management is to maximize shareholders‟ wealth. Receivables are large

investments in firm's asset, which are, like capital budgeting projects, measured in terms of their net present values (Emery et al.,

2014). Receivables stimulates sales because it allows customers to assess product quality before paying, but on the other hand,

debtors involve funds, which have an opportunity cost. The three characteristics of receivables - the element of risk, economic

value and futurity explain the basis and the need for efficient management of receivables. According to Berry and Jarvis (2016) a

firm setting up a policy for determining the optimal amount of account receivables has to take in account the following: The trade-

off between the securing of sales and profits and the amount of opportunity cost and administrative costs of the increasing account


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receivables. The level of risk the firm is prepared to take when extending credit to a customer, because this customer could default

when payment is due.

Accounts receivable measures the unpaid claims a firm has over its customers at a given time, usually comes in the form of

operating line of credit and is mainly due within a relatively short time period (up to one year). The volume of accounts receivable

indicates firm's supply of trade credit while accounts payable shows its demand of trade credit. The study of accounts receivable

and accounts payable during periods of financial crisis is an important topic, particularly when the global economy is going

through a credit shock. During global financial crisis, characterized by high liquidity risk faced by the banks, trade credits may

increase, operating as a substitute for credits, or decrease - acting as their complement. Bastos and Pindado (2012), for example,

suggest that credit constraints during a financial crisis cause firms holding high levels of accounts receivable to postpone

payments to suppliers, which act in the same manner with their suppliers. This gives rise to a trade credit contagion in the supply

chain characterized by a cascading effect. The current financial crisis provides economists a unique opportunity to study the role

of alternative financial sources during periods of breakdown of institutional financing.

Accounts receivables are one of the most important parts of credit management. Receivables often represent large investment

in asset and involve significant volume of transactions and decisions. However, there are considerable differences in the level of

receivables in firms around the world. Demirgüç-Kunt and Maksimovic (2015) present evidence that in countries such as France,

Germany, and Italy account receivable exceed a quarter of firms' total assets, while Rajan and Zingales (2015) find that 18% of

the total assets of US firms consists of receivables. Accounts receivable management is a crucial filed of corporate finance

because of its effects on a firm‟s profitability and risk, and consequently on the firm's value.

Lyani, Namusonge and Sakwa (2018) examined relationship between account receivable management practices and growth of

small and medium enterprises in Kakamega County. Accounts receivable management practices and growth of SME. Descriptive

statistics such as mean, standard deviation and homoscedasticity were used to test for normality of data. Ordinary Least Square

method was utilized to establish the cause-effect relationship between variables while hypotheses were tested at5% significance

level. The overall model was statistically significant at F=11.298and p-value (0.000< 0.05). The findings revealed that efficient

Accounts receivable management practices, when adopted by SMEs lead to growth. The study recommended that owners and

managers should be trained and made to understand the various techniques of managing Accounts receivable levels. The findings

would form a basis for government and policy makers in management decision making, to formulate Accounts receivable

management strategies that would help minimize bad and delinquent debt.

Deloof (2015) study used accounts receivable, accounts payable, inventories and the cash conversion cycle as a comprehensive

measure of working capital management and found a significant negative relation between operating income and the number of

days accounts receivable, inventories and accounts payable. Deloof (2015) based on the study findings recommended that

managers can increase corporate profitability by reducing the number of days accounts receivable and inventories turnover. The

credit risk theory state that investors risk of loss, financial or otherwise, arise from a borrower who does not pay his or her dues as

agreed in the contractual terms. Accounts receivable are credit in the provision of goods or services to a person or entity on agreed

terms and conditions where payments are to be made later with or without interest. When the debtor does not pay on due date, the

lender is exposed to credit risk which may in turn lead to default and bad debts (Nyunja, 2014).

6.4 Factoring

Mian (2015) suggested a simple definition of Factoring being company's sale of its account‟s receivables to a financial

institution other than its captive one. Sopranzetti (1999) defined Factoring through the eyes of service providers, the Factors,

being a financial institution that are in the business of buying and managing other firm's accounts receivables whereas through a

typical Factoring contract the Factor bears credit risk and the responsibility to monitor the credit quality of the outstanding

accounts receivable.

Recently, Soufani (2014) and (Deacon & Whale, 2015) linked the two classifications of Factoring (Notification and right of

Factor to Recourse), they argued that "despite its early foundation, Factoring has been ignored as a source of corporate finance

this why some companies may not favor to Factor its receivables to avoid notifying its customer. This is in our hypothesis is tested

whether the Factor is seen by the companies as a sign of strength or weakness. Overcoming this obstacle, the notification and the

negative reputation of the factoring, encouraged a subsequent development of invoice discounting on a non-notification basis,

against ledger of sales, so-called "Non-Notification-Factoring". They explained the mechanism of non-notification Factoring

through making advance only on the security of receivables, as the seller checks his own credit and bears probably credit losses

and thus do his own collection and ledgering then turn on the proceeds in their original form to the lender.

Recourse Factoring is a typical asset-based lending “ABL” where assets are used as a collateral for the loan while title and risk

remains with the seller unlike nonrecourse Factoring whereby assets are sold to the Factor as that title and risk passed to him

(Weisel, Harm & Bradley 2013). Tomusange (2015)examine facting as a financing alternatives for African SMEs. Factoring could

enable African SMEs to gain access to finance, as underwriters mainly place the risk on the receivables as opposed to the firm

itself. Despite its benefits, factoring has not taken root in sub-Saharan Africa. The purpose of this phenomenological study was to


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explore the obstacles and prospects to stimulating awareness, availability, acceptance, and utilization of factoring in Africa. Data

on the lived experiences of 22 executives providing or promoting factoring in 16 African countries were collected through semi

structured interviews; these data were analyzed using the Braun and Clarke thematic approach. Four themes emerged: supply-side

conditions, demand-side conditions, business environment conditions, and facilitating institutions and industries. Results suggest

high factoring prospects, legal and regulatory impediments, low awareness levels, reluctance of banks to avail factoring, high

entry barriers for nonbank factors, a lack of credit insurance, and a lack of an open account trade culture. A framework was

recommended, based on these findings, along with actions for factoring development in Africa. Implications for positive social

change include increased awareness which may boost factoring. Improved financing options may yield improved African SME

competitiveness, which in turn, may result in improved job opportunities, household incomes, quality of life, and more broadly,

Africa‟s economic growth.

6.5 Financial Performance

Profitability is the ability to make profit from all the business activities of an organization, company, firm, or an enterprise. It

measures management efficiency in the use of organizational resources in adding value to the business. Profitability may be

regarded as a relative term measurable in terms of profit and its relationship with other elements that can directly influence the

profit. Corporate profitability is a measure of the amount by which a company's revenues exceeds its relevant expenses. It is an

evaluation of management's ability to create earnings from revenue-generating bases within an organization (Ifurueze, 2013).

Thus, Management is interested in measuring the operating performance in terms of profitability. Hence, a low profit margin

would suggest ineffective management and investors would be hesitant to invest in the firm. Profitability is the ability to make

returns from all the business activities of an organization, company, firm, or an enterprise and the concern of every firm lies with

its profitability. Profitability shows how efficiently the management can make profit by using all the resources available in the

market (Nwaechina 2013). Profitability is also considered as the rate of return on investment and a widely used financial measure

of performance. Hence, if there will be an unjustifiable over investment in current assets then this would negatively affect the rate

of return on investment. The primary goal of credit management is to control current financial resources of a firm in such a way

that a balance is reached between profitability of the firm and risk associated with that profitability (Ifurueze 2013). The greater

the risk associated with a business the more profitable it is adjudged and vice-versa. Profitability is determined by the capital

structure, size, growth, market discipline, risk and reputation of a firm. Corporate profitability is measured using ratio analysis.

Profitability in relation to sales includes ratios such as gross profit margin (GPM), net profit margin (NPM), operating expense

ratio (OER), and so on.

However, profitability in relation to investment, which to a greater extent justifies the efficiency and performance of a firm,

includes ratios such as return on investment (ROI), return on equity (ROE), earnings per share (EPS), dividend per share (DPS),

dividend pay-out ratio (DPR), dividend yield (DY) and earnings yield (EY), price-earnings ratio (P/E), market value to book value

ratio (MV/BV), and Tobin‟s Q (T-Q). Profitability and management efficiency are usually taken to be positively associated such

that poor current profitability may threaten current management efficiency and poor management efficiency may threaten

profitability. It is related to the goal of shareholders‟ wealth maximization, and investment in current assets is made only if an

acceptable return is obtained. Therefore, the management of investment in current assets is an aspect of corporate finance and it

has the capacity of influencing how profitable a firm is (Ifurueze, 2013).

7. Research Methodology

7.1 Research Design

Marczyk, DeMatteo & Festinger (2018) defines research design as the strategy that will be in use to integrate the different

components of the study in a coherent and logical manner that ensures the statement of the problem is addressed effectively. It

further provides the roadmap of collection, measurement and analysis of data. This study will adopt a cross sectional survey and

mixed methods research design. Tashakori and Teddlie (2019), argue that in cross sectional research design, data is collected at

once perhaps over a period of days, weeks or months in order to answer research questions.

This cross sectional research design is preferred because of its ability to combine quantitative and qualitative methods and it is

deemed to be the most effective to significantly contribute to the depth and specificity of the study (Creswell, 2018). Mixed

methods research design will be used in the study since some dataset may be inadequate in answering the research questions, an

explanation of initial results will be required, generalizability of quantitative findings will be desired or broader and deeper

understanding of a research problem will be necessary (Hadi, David, Closs, & Briggs, 2017).

7.2 Target Population

This study targeted 91 constructions firms registered by National Construction Authority operating in Mombasa County. The

study targeted finance officers, accountants, chief executive officers making it to 273. Zikmund, Babin, Carr and Griffin, (2017)

defined a population in research as any group of institutions, people or objects that have at least one characteristic in common.


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Sekaran (2015) further explains that a target population in experimental research refers to the total number of all possible

individuals relating to a topic which could, if funds were available, be included in a study.

Table 1 Target Population

Group Target Population

Chief Executive Officers 91

Finance Officers 91

Accountants 91

TOTAL 273

7.3 Sampling Technique

The study adopted Stratified random Sampling technique with total sample size drawn from each stratum (sub-sector) and

elements selected from each stratum using simple random sampling. A stratified sampling technique will be used because target

population is classified in stratums. As Bryman and Bell (2015) explains, stratified random sampling is used to reduce extent of

variability of heterogeneity of the study population with respect to the characteristics that have a strong correlation with what one

tries to ascertain. The study therefore will adopt this method since construction firms have various sub-sectors with varied

characteristics that would be useful to study to achieve greater accuracy.

7.4 Sample Size

Sample size determination is the act of choosing the number of observations or replicates to include in a statistical sample. The

sample size is an important feature of any empirical study in which the goal is to make inferences about a population from a

sample (Bryman and Bell, 2015). The total sample size for this study will be obtained using the formulae developed by Cooper

and Schinder, (2013) together with (Kothari, & Garg, 2018). The sample size was 162.

n = N / 1 + N (α) ²

Where:

n= the sample size,

N= the sample frame (population)

α= the margin of error (0.05%).

n = 273 / [1+ 273 (0.05)2 ]

= 162

Table 2 Sample Size

Group Sample Size

Chief Executive Officer 54

Finance Officer 54

Accountants 54

TOTAL 162

7.5 Data Analysis

Kothari and Garg (2018) argue that data collected has to be processed, analyzed and presented in accordance with the outlines

laid down for the purpose at the time of developing the research plan. Data analysis involves the transformation of data into

meaningful information for decision making. It involved editing, error correction, rectification of omission and finally putting

together or consolidating information gathered. The collected data was analyzed quantitatively and qualitatively. Descriptive and

inferential statistics will be done using SPSS version 22 and specifically multiple regression model will be applied. Set of data

was described using percentage, mean standard deviation and coefficient of variation and presented using tables, charts and

graphs. Fraenkel and Wallen, (2014) argue that regression is the working out of a statistical relationship between one or more

variables. The researcher used a multiple regression analysis to show the influence of the independent variables on the dependent

variables.

The multiple regression equation is as follows;

Y=α + β1X1 + β2X2 + β3X3 + β4X4 + ε

Where,


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Y = Represents the dependent variable, Profitability of Construction Firms

α= Constant

β1, β2, β3 and β4 = Partial regression coefficient

X1 = Credit Policy, X2= Liquidity, X3= Debtors Turnover and X4 = Factoring

ε = error term or stochastic term.

8. Data Analysis and Results

8.1. Descriptive Statistics

8.1.1 Credit Policy

The first objective was to examine the effect of credit policy on the financial performance of construction firms in Mombasa

County. The statement that capacity of a debtor is evaluated before credit is approved had a mean score of 3.33 and a standard

deviation of 1.554. The statement that conditions and terms of the debtors is evaluated before offering credit had mean score of

3.18 and a standard deviation of 1.537. The statement that collateral of the debtor is evaluated before offering credit had a mean

score of 3.13 and standard deviation of 1.683. The statement that capability of the debtor is evaluated before offering credit had a

mean score of 3.24 and standard deviation 1.615. This result are in agreement with (Ifurueze, 2013) as shown in Table 3.

Table 3 Credit Policy

N Mean

Std.

Deviation

Capacity of a debtor is evaluated before credit approval 115 3.33 1.554

Conditions and terms of the debtor is evaluated before

offering credit. 115 3.18 1.537

Collateral of the debtor is evaluated before offering credit. 115 3.13 1.683

Capability of the debtor is evaluated before offering credit 115 3.24 1.615

Valid N (listwise) 115

8.1.2 Liquidity Management

The second objective was to evaluate the effect of liquidity management on financial performance of construction firms in

Mombasa County. The statement that action on defaulters was set in place by the credit department had a mean score of 2.93 and

a standard deviation of 1.582. The statement that recovered amount in a period had been increasing according to the credit

department had a mean score of 3.51 and a standard deviation of 1.435. The statement that liquidity of the construction firms has

been increasing in the last three years had a mean score of 3.37 and a standard deviation of 1.641. The statement that payments to

suppliers are normally made on cash basis had a mean score of 3.67 and a standard deviation of 1.599. These results agree with

(Akenga, 2015) as shown in Table 4.

Table 4 Liquidity Management

N Mean

Std.

Deviation

Action on defaulters was set in place by the credit

department. 115 2.93 1.582

Recovered amount in a period had been increasing

according to the credit department 115 3.51 1.435

Liquidity of the business had been increasing in the last

three years 115 3.37 1.641

Payments to suppliers are normally made on cash basis. 115 3.67 1.599


8.1.3 Debtor’s Turnover

The third objective was to determine the effect of debtor‟s turnover on financial performance of construction firms in

Mombasa County. The statement that available debt collection policy has assisted towards effective debt management had a mean

score of 3.52 and a standard deviation of 1.416. The statement that construction firms sets and follows debt collection policy and

terms had a mean score of 3.00 and a standard deviation of 1.595. The statement that the organization implements these terms and

policies in case of failure to repay the loan had a mean score of 3.27 and a standard deviation of 1.385. The statement that

favourable credit terms stimulates sales had a mean score of 3.49 and a standard deviation of 1.471. These results agree with

(Lyani, Namusonge, & Sakwa, 2018) as shown in Table 5.


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Table 5 Debtor’s Turnover

N Mean

Std.

Deviation

Available debt collection policy has assisted towards

effective debt management 115 3.52 1.416

Construction firms sets and follows debt collection policy

and terms 115 3.00 1.595

The organization implements these terms and policies in

case of failure to pay the loan 115 3.27 1.385

Favourable credit terms stimulates sales 115 3.49 1.471


8.1.4 Factoring

The fourth objective was to examine the influence of factoring on financial performance of construction firms in Mombasa

County. The statement that contracts helps construction firms to buy materials at low prices had a mean score of 3.26 and a

standard deviation of 1.493. The statement that invoice discounting helps construction firms obtain building materials at a lower

price had a mean score of 3.40 and a standard deviation of 1.456. The statement in disagreement that factoring helps construction

firms reduce purchasing risks had a mean score of 2.75 and a standard deviation of 1.290. These results agree with (Tomusange,

2015) as shown in Table 6.

Table 6 Factoring

N Mean

Std.

Deviation

Contracts helps construction firms to buy materials at low

prices 115 3.26 1.493

Invoice discounting helps construction firms obtain

building materials at a lower price. 115 3.40 1.456

Factoring helps construction firms reduce purchasing risks 115 2.75 1.290


8.1.5 Financial Performance

Business growth has been as a result of proper financial management practices undertaken by the firm had a mean score of

3.69 and a standard deviation of 1.624. The statement that there had been an improvement in debtors‟ collection by using credit

collection policies had a mean score of 3.10 and a standard deviation of 1.441. The statement that the business growth depends on

sales returns in terms of price of the product, sales in the period, number of customers in a period and credit collection policy in

place had a mean score of 3.69 and a standard deviation of 1.541. The statement that managerial competences had been applied

well, it played a positive role on the business growth had a mean score of 3.37 and a standard deviation 1.570. as shown in Table

7. These results agree with (Makori, Jagongo, & Simiyu, 2017).

Table 7 Financial Performance

N Mean

Std.

Deviation

Business growth has been as a result of proper financial

management practices undertaken by the firm. 115 3.69 1.624

There had been an improvement in debtors‟ collection by using

credit collection policies. 115 3.10 1.441

The business growth depends on sales returns in terms of price of

the product, sales in the period, number of customers in a period and

credit collection policy in place.

115 3.69 1.541

Managerial competences had been applied well, it played a

positive role on the business growth 115 3.37 1.570


8.2 Inferential Statistics

8.2.1 Correlation Analysis


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To establish the relationship between the independent variables and the dependent variable the study conducted correlation

analysis which involved coefficient of correlation and coefficient of determination.

Pearson Bivariate correlation coefficient was used to compute the correlation between the dependent variable (Financial

Performance) and the independent variables (Credit policy, Liquidity management, Debtor‟s Turnover and Factoring). According

to Sekaran, (2015), this relationship is assumed to be linear and the correlation coefficient ranges from -1.0 (perfect negative

correlation) to +1.0 (perfect positive relationship). The correlation coefficient was calculated to determine the strength of the

relationship between dependent and independent variables (Kothari & Gang, 2014).

Total 8 Pearson Correlations

Financial

Performance

Credit

Policy Liquidity

Debtors

Turnover Factoring

Financial

Performance

1

115

Credit

Policy

.517**

1

.000

115 115

Liquidity .177 .433**

1

.000 .000

115 115 115

Debtors

Turnover

.421**

.261**

.419**

1

.000 .005 .000

115 115 115 115

Factoring .113 .272**

.560**

.486**

1

.000 .003 .000 .000

115 115 115 115 115

**. Correlation is significant at the 0.01 level (2-tailed).

In trying to show the relationship between the study variables and their findings, the study used the Karl Pearson‟s coefficient

of correlation (r). This is as shown in Table 8 above. According to the findings, it was clear that there was a positive correlation

between the independent variables, credit policy, liquidity management, debtor‟s turnover and factoring and the dependent

variable financial performance. The analysis indicates the coefficient of correlation, r equal to 0.517, 0.177, 0.421 and 0.113 for

credit policy, liquidity management, debtor‟s turnover and factoring respectively. This indicates positive relationship between the

independent variable namely credit policy, liquidity management, debtor‟s turnover and factoring and the dependent variable

financial performance.

8.2.2 Coefficient of Determination (R2)

To assess the research model, a confirmatory factors analysis was conducted. The four factors were then subjected to linear

regression analysis in order to measure the success of the model and predict causal relationship between independent variables

(Credit policy, liquidity management, debtor‟s management and factoring), and the dependent variable (Financial Performance).

Table 9 Model Summary

Model R R Square Adjusted R Square

Std. Error of the

Estimate

1 .771a .595 .580 2.30880

a. Predictors: (Constant), Factoring, Credit Policy, Liquidity, Debtors Turnover

The model explains 59.5% of the variance (R Square = 0.595) on Financial Performance. Clearly, there are factors other than

the four proposed in this model which can be used to predict financial sustainability. However, this is still a good model as

Bryman and Bell, (2018) pointed out that as much as lower value R square 0.10-0.20 is acceptable in social science research. This

means that 59.5% of the relationship is explained by the identified four factors namely credit policy, liquidity management,

debtor‟s turnover and factoring. The rest 40.5% is explained by other factors in the financial performance not studied in this

research. In summary the four factors studied namely, credit policy, liquidity management, debtor‟s turnover and factoring also

explains 59.5% of the relationship while the rest 40.5% variation is explained by other factors which are not related to the four

variables.

8.2.3 Analysis of Variance (ANOVA)


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The study used ANOVA to establish the significance of the regression model. In testing the significance level, the statistical

significance was considered significant if the p-value was less or equal to 0.05. The significance of the regression model was as

per Table 10 below with P-value of 0.00 which is less than 0.05. This indicates that the regression model is statistically significant

in predicting factors of financial performance. Basing the confidence level at 95% the analysis indicates high reliability of the

results obtained. The overall Anova results indicates that the model was significant at F = 18.672, p = 0.000

Table 10 ANOVA

Model Sum of Squares df

Mean

Square F Sig.

1 Regression 398.128 4 99.532 18.672 .000b

Residual 586.359 110 5.331

Total 984.487 114

a. Dependent Variable: Financial Performance

b. Predictors: (Constant), Factoring, Credit Policy, Liquidity, Debtors Turnover

8.2.4 Regression Coefficients

The researcher conducted a multiple regression analysis as shown in Table 4.15 so as to determine the relationship between

financial performance of construction firms in Mombasa County and the four variables investigated in this study.

The regression equation below established that taking all factors into account (Financial Performance of Construction firms in

Mombasa County) constant at zero financial performance of construction firms in Mombasa County will be 12.742. The findings

presented also showed that taking all other independent variables at zero, a unit increase in credit policy would lead to a 0.318

increase in the scores of financial performance of construction firms in Mombasa County; a unit increase in liquidity management

would lead to a 0.233 increase in the scores of financial performance of construction firms in Mombasa County; a unit increase in

debtor‟s turnover would lead to a 0.308 increase the scores of financial performance of construction firms in Mombasa County

and a unit increase in factoring would lead to 0.216 increase the scores of financial performance of construction firms in Mombasa

County (Mac-Bhaird & Lucey, 2011).

Table 11 Regression Coefficients

Model

Unstandardized

Coefficients

Standardize

d Coefficients

t Sig. B Std. Error Beta

1 (Constant) 12.742 1.439 8.854 .000

Credit Policy .318 .089 .360 3.562 .001

Liquidity .233 .089 .278 2.621 .000

Debtors

Turnover .308 .094 .347 3.264 .001

Factoring .216 .107 .198 2.016 .004

a. Dependent Variable: Financial Performance

The regression equation was:

Y = 12.742 + 0.318X1 + 0.233X2 + 0.308X3 + 0.216X4

Where;

Y = the dependent variable (Financial Performance)

X1 = Credit Policy, X2 = Liquidity Management, X3 = Debtor‟s Turnover and X4 = Factoring

This therefore implies that all the four variables have a positive relationship with financial performance of construction firms

in Kenya with credit policy contributing most to the dependent variable and factoring contributing lowest to the dependent

variable. From the table we can see that the predictor variables of credit policy, liquidity management, debtor‟s turnover and

factoring got variable coefficients statistically significant since their p-values are less than the common alpha level of 0.05.

From the table we can see that the predictor variables of credit policy, liquidity management, debtor‟s turnover and factoring

got variable coefficients statistically significant since their p-values are less than the common alpha level of 0.05.

9. Conclusions and Recommendations

9.1Conclusions

The study results led to the following conclusions:


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9.1.1 Credit Policy

From the research findings, the study concluded credit policy studied have significant effect on financial performance of

construction firms in Mombasa as indicated by the strong coefficient of correlation and a p-value which is less than 0.05. The

overall effect of the analyzed factors was very high as indicated by the coefficient of determination. The overall P-value of 0.00

which is less than 0.05 (5%) is an indication of relevance of the studied variables, significant at the calculated 95% level of

significance. This implies that the studied independent variables namely credit policy, have significant effect on financial

performance of construction firms in Mombasa County.

9.1.2 Liquidity Management

From the research findings, the study concluded liquidity management studied have significant effect on financial performance

of construction firms in Mombasa as indicated by the strong coefficient of correlation and a p-value which is less than 0.05. The



significance. This implies that the studied independent variables namely liquidity management, have significant effect on financial


9.1.3 Debtors’ Turnover

From the research findings, the study concluded debtors‟ turnover studied have significant effect on financial performance of




significance. This implies that the studied independent variables namely debtors‟ turnover, have significant effect on financial


9.1.4 Factoring

From the research findings, the study concluded factoring studied have significant effect on financial performance of




significance. This implies that the studied independent variables namely factoring, have significant effect on financial


9.2 Recommendations

The study recommended as follows:

i. That construction firms should develop stronger credit policies;

ii. That construction firms should diversify their activities to ensure that they are liquid all the time;

iii. That construction firms should reduce the number of days they receive finances from their debtors.

iv. That construction firms should establish other forms of mitigating financial risks.

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INTERNATIONAL JOURNAL OF ACADEMICS & RESEARCH (IJARKE)€¦ · receivables management entails managing the firm's inventory and receivables in order to achieve a balance between risk