Abstract

Credit management is one of the most important activities in any company and cannot be overlooked by any economic enterprise engaged in credit irrespective of its business nature. As with any financial institution, the biggest risk in microfinance is lending money and not getting it back. The study sought to determine how credit management affects the financial performance of Microfinance Institutions in Cameroon.

The study adopted a descriptive survey design. The population of the study consisted of 30 MFIs in the South West Region. A census study was used to carry out the research. Primary data was collected using questionnaires where all the issues on the questionnaire were addressed. Descriptive statistics were used to analyze data. Furthermore, descriptions were made based on the results of the tables.

The study found that client appraisal; credit risk control and collection policy had an effect on the financial performance of MFIs in Cameroon. The study found out that there was a strong relationship between the financial performance of MFIs and client appraisal, credit risk control, and collection policy. The study found out that client appraisal, credit risk control, and collection policy significantly influence the financial performance of MFIs in Cameroon.

Collection policy was found to have a higher effect on financial performance and that a stringent policy is more effective in debt recovery than a lenient policy. The study recommends that MFIs should enhance their collection policy by adopting a more stringent policy to a lenient policy for effective debt recovery. The study concluded that an increased consideration of client appraisal; credit risk control and collection policy, has greatly improved the efficiency of financial performance of microfinance institutions.

CHAPTER ONE

INTRODUCTION

1.1 Background of the study

Credit is one of the many factors that can be used by a firm to influence demand for its products. According to Horne and Wachowicz (1998), firms can only benefit from credit if the profitability generated from increased sales exceeds the added costs of receivables. Myers and Brealey (2003) define credit as a process whereby possession of goods or services is allowed without spot payment upon a contractual agreement for later payment.

Timely identification of potential credit default is important as high default rates lead to decreased cash flows, lower liquidity levels, and financial distress. In contrast, lower credit exposure means an optimal debtor’s level with reduced chances of bad debts and therefore financial health. According to Scheufler (2002), in today’s business environment risk management and improvement of cash flows are very challenging.

With the rise in bankruptcy rates, the probability of incurring losses has risen. Economic pressures and business practices are forcing organizations to slow payments while on the other hand resources for credit management are reduced despite the higher expectations. Therefore, it is a necessity for credit professionals to search for opportunities to implement proven best practices.

By upgrading your practices five common pitfalls can be avoided. Scheufler (2002) summarizes these pitfalls as failure to recognize potential frauds, underestimation of the contribution of current customers to bad debts, getting caught off guard by bankruptcies, failure to take full advantage of technology, and spending too much time and resources on credit evaluations that are not related to the reduction of credit defaults.

The microfinance concept has operated for centuries in different parts of the world for example, “uses” in Ghana, “tandas” in Mexico, “tontines” in West Africa, and “pasanaku” in Bolivia. One of the earliest and longest-serving micro-credit organizations providing small loans to rural poor dwellers with no collateral is the Irish Loan Fund system initiated in the early 1700s by Jonathan swift. His idea began slowly in the 1840s and became a widespread institution of about 300 branches all over Ireland in less than one decade.

The principal purpose was to advance small loans with interest for short periods.  However, the pioneering of modern microfinance is often credited to Dr. Mohammad Yunus, who began experimenting with lending to poor women in the village of Jobra, Bangladesh during his tenure as a professor of economics at Chittagong University in the 1970s.

Microfinance is the supply of loans, savings, and other basic financial services to the poor.” As these financial services usually involve small amounts of money – small loans, small savings, the term “microfinance” helps to differentiate these services from those which formal banks provide. Microfinance institutions provide a reliable source of financial support and assistance compared to other sources for financing.

Sources operating outside the microfinance industry typically form informal relationships with borrowers and have no real legal or substantial ties with their customers. Thus, loan terms tend to carry high costs with no guarantee that lenders will remain in one place for any length. In contrast, microfinance institutions typically work alongside government organizations and have ties with larger global organizations.

Credit management is one of the most important activities in any company and cannot be underlooked by any economic enterprise engaged in credit irrespective of its business nature. It is the process to ensure that customers will pay for the products delivered or the services rendered. Myers and Brealey (2003) describe credit management as methods and strategies adopted by a firm to ensure that they maintain an optimal level of credit and its effective management.

The higher the amount of accounts receivables and their age, the higher the finance costs incurred to maintain them. If these receivables are not collectible on time and urgent cash needs arise, a firm may result in borrowing and the opportunity cost is the interest expense paid.

Nzotta (2004) opined that credit management greatly influences the success or failure of commercial banks and other financial institutions. This is because the failure of deposit banks is influenced by the quality of credit decisions and thus the quality of the risky assets. He further notes that credit management provides a leading indicator of the quality of deposit banks’ credit portfolios.

A key requirement for effective credit management is the ability to intelligently and efficiently manage customer credit lines. To minimize exposure to bad debt, over-reserving, and bankruptcies, companies must have greater insight into customer financial strength, credit score history, and changing payment patterns. Credit management starts with the sale and does not stop until the full and final payment has been received. It is as important as part of the deal as closing the sale.

In fact, a sale is technically not a sale until the money has been collected. It follows that principles of goods lending shall be concerned with ensuring, so far as possible that the borrower will be able to make scheduled payments with interest in full and within the required time otherwise, the profit from an interest earned is reduced or even wiped out by the bad debt when the customer eventually defaults.

Credit management is concerned primarily with managing debtors and financing debts. The objectives of credit management can be stated as safeguarding the company’s‟ investments in debtors and optimizing operational cash flows. Policies and procedures must be applied for granting credit to customers, collecting payment, and limiting the risk of non-payments.

According to the business dictionary, financial performance involves measuring the results of a firm’s policies and operations in monetary terms. These results are reflected in the firm’s return on investment, return on assets, and value-added. Stoner (2003) as cited in Turyahebya (2013), defines financial performance as the ability to operate efficiently, profitably, survive, grow and react to environmental opportunities and threats.

In agreement with this, Sollenberg and Anderson (1995) assert that performance is measured by how efficient the enterprise is in the use of resources in achieving its objectives. Hitt, et al (1996) believes that many firms’ low performance is the result of poorly performing assets.

MFIs earn financial revenue from loans and other financial services in the form of interest fees, penalties, and commissions. Financial revenue also includes income from other financial assets, such as investment income. An MFI‟s financial activities also generate various expenses, from general operating expenses and the cost of borrowing to provisioning for the potential loss from defaulted loans. Profitable institutions earn a positive net income (i.e., operating income exceeds total expenses).

Today, Microfinance institutions are seeking financial sustainability. Many MFIs were restructured to achieve financial sustainability and finance their growth. Sustainability is defined as the capacity of a program to stay financially viable even if subsidies and financial aids are cut off (Woolcock, 1999). It embraces “generating sufficient profit to cover expenses while eliminating all subsidies, even those less-obvious subsidies, such as loans made in hard currency with repayment in local currency” (Tucker and Miles, 2004).

Tucker and Miles (2004) studied three data series for the period between March 1999 and March 2001 and found that self-sufficient MFIs are profitable and perform better, on return on equity (ROE) and return on assets (ROA), than developing-world commercial banks and MFIs that have not attained self-sufficiency. To optimize their performance, MFIs are seeking to become more commercially oriented and stress more on improving their profitability; therefore, self-sustainability.

Credit management is the method by which you collect and control the payments from your customers. Myers and Brealey (2003) describe credit management as methods and strategies adopted by a firm to ensure that they maintain an optimal level of credit and its effective management. It is an aspect of financial management involving credit analysis, credit rating, credit classification, and credit reporting.

Proper credit management will lower the capital that is locked with the debtors and reduces the possibility of getting into bad debts. According to Edwards (1993), unless a seller has built into his selling price additional costs for late payment, or is successful in recovering those costs by way of interest charged, then any overdue account will affect his profit.

In some competitive markets, companies can be tempted by the prospects of increased business if additional credit is given, but unless it can be certain that additional profits from increased sales will outweigh the increased costs of credit, or said costs can be recovered through higher prices, then the practice is fraught with danger.

Effective management of accounts receivables involves designing and documenting a credit policy. Many entities face liquidity and inadequate working capital problems due to lax credit standards and inappropriate credit policies. According to Pike and Neale (1999), a sound credit policy is a blueprint for how the company communicates with and treats its most valuable asset, the customers. Scheufler (2002) proposes that a credit policy creates a common set of goals for the organization and recognizes the credit and collection department as an important contributor to the organization’s strategies.

Though the growth of microfinance truly began to escalate in the early 1990s, it has existed in Cameroon for almost 50years. During the early 1980s, banks in Cameroon became increasingly unable to support themselves as it became more difficult to receive international credit and largely unable to get internal resources within the country. In the late 1980s, it resulted in the government action completely restructuring all financial institutions, making many banks to close their doors with unpaid savings. The act articulated the expansion and intensity of microfinance in Cameroon.

1.2 Research Problem

Sound credit management is a prerequisite for a financial institution’s stability and continuing profitability while deteriorating credit quality is the most frequent cause of poor financial performance and condition. According to Gitman (1997), the probability of bad debts increases as credit standards are relaxed. Firms must therefore ensure that the management of receivables is efficient and effective.

Such delays in collecting cash from debtors as they fall due have serious financial problems, increased bad debts, and affects customer relations. If payment is made late, then profitability is eroded and if payment is not made at all, then a total loss is incurred. On that basis, it is simply good business to put credit management at the forefront by managing it strategically.

As with any financial institution, the biggest risk in microfinance is lending money and not getting it back. Credit risk is a particular concern for MFIs because most micro-lending is unsecured (i.e., traditional collateral is not often used to secure microloans) Craig Churchill and Dan Coster (2001).

The people covered are those who cannot avail credit from banks and other financial institutions due to the lack of the ability to provide guarantees or security against the money borrowed. Many banks do not extend credit to these kinds of people due to the high default risk for repayment of interest and in some cases the principal amount itself. Therefore, these institutions are required to design sound credit management that entails the identification of existing and potential risks inherent in lending activities.

1.3 Research Questions

This study will help the researcher answer the main research question which is, how does credit management affect the financial performance of Microfinance Institutions

 Specific research questions include;

1. What is the effect of credit collection policy on the financial performance of MFIs?
2. How does client appraisal affect the financial performance of MFIs?
3. How do credit risk controls affect the financial performance of MFIs?

1.4 Research Objectives

The main objective of the study is;

To establish the effect credit management affects the financial performance of Microfinance Institutions

Specific objectives include:

1. To determine the effect of credit collection policy on the financial performance of Microfinance institutions
2. To assess how client appraisal affects the financial performance of MFIs
3. To examine how credit risk controls affect the financial performance of MFIs
4. To make necessary recommendations.

Further Readings 

THE EFFECT OF CREDIT RISK MANAGEMENT ON THE FINANCIAL PERFORMANCE OF COMMERCIAL BANKS IN CAMEROON: CASE STUDY NFC BANK BAMENDA

 

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