CHAPTER TWO LITERATURE REVIEW
2.3 The relationship between Credit collection Practices and Financial Performance
There are various policies that an organization should put in place to ensure that credit management is done effectively; one of these policies is a collection policy which is needed because all customers do not pay the firms bills in time. Some customers are slow payers while some are non-payers. The collection effort should, therefore aim at accelerating collections from slow payers and reducing bad debt losses (Kariuki, 2010).
McNaughton (2008) defines a collection policy as the procedure an institution follows to collect past due account. Collection policy refers to the procedures micro finance institutions use to collect due accounts. The collection process can be rather expensive in terms of both product expenditure and lost good will (Brighan, 2010).
Collection efforts may include attaching mandatory savings forcing guarantors to pay, attaching collateral assets, courts litigation (Myers, 2011). ). Methods used by Micro finance institutions could include letters, demand letters, telephone calls, visits by the firm‟s officials for face to face reminders to pay and legal enforcements. Dickerson et al, (1995) asserts that collection policy is a guide that ensures prompt payment and regular collections. The rationale is that not all clients meet their obligations, some just take it for granted, others simply forget while others just don‟t have a culture of paying until persuaded to do so. According to Myers (2011) many micro finance institutions may send a letter to such individuals (borrowers) when say ten days elapse or phone calls and if payment is not received with in thirty days, it may turn over the account to a collection agency.
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The credit collection policies adopted by microfinance institution had an effect on financial performance, stringent policy had a great impact on loan performance, and the lenient policy had an effect but was not as great as that of stringent policy (Kosmidou, 2008).
Credit collection policy is a systematic way required to recover the past due amount from clients within the lawful jurisdiction. The collection aspects may vary from institution but those should be complaint to existing laws such as third party collection agencies may involve in a collection process. It does not just involve in collection procedure details provided by the institution but also the procedure in which the lawful collection takes place (Latifee, 2006). Well administered collection is needed for better performance of the loan and financial performance.
If financial institutions do not follow well administered collection procedures, this would results in loan defaults (Boldizzoni, 2008).
Credit Collection policy is required because some clients do not pay the loan in time some are slower while others never pay. Thus collection efforts aim at accelerating collections from slower payers to avoid bad debts. Prompt payments are aimed at increasing turn over while keeping low and bad debts within limits (Pandey, 1995).
Semukono, (2009) states that collection efforts are directed at accelerating recovery from slow payers and decreases bad debts losses .This therefore calls for vigorous collection efforts .The yardstick to measurement of the effectiveness of the collection policy is its slackness in arousing slow paying customers.According to Dawkin (2010) posited that prompt payments aimed at increasing turnover and keeping bad debts low. Collection efforts are directed at accelerating recovery from slow payers and decreases bad debt losses and increases profitability of the banking institution.
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Previous studies indicated that microfinance institutions need to have strong and effective credit collection policies for ensuring consistent recoveries from clients (Frank et al., 2014).
For microfinance institutions, the main source of income is the credit, which is why they need to have strong policies for credit risk management. The advance reimbursements may be questionable and the accomplishment of giving out credit relies on the philosophy connected to assess and to grant the credit (Moti et al., 2012).
Firms that are efficient in credit risk management determine their optimal credit, which minimizes the total costs of granting credit and observed that An increase in the level of accounts receivables in a firm increases both the fund and the costs of holding and managing accounts receivables and both lead to a decrease in the value of the firm and financial performance. (Ross2008).
Studies by Lazaridis and Dimitrios (2005) found that firms who pursue increase in credit management to an optimal level increase their profitability.
Juan &Martinez (2002) emphasized that firms can create value by reducing their number of days of accounts receivable, thus confirmed the finding of Deloof (2003) who established that the length of credit collection period has a negative effect on a firm‟s financial performance and also affirmed that, putting in place a sound credit policy ensures proper debt collection procedures and is pivotal in improving efficiency in receivables management hence the performance of firms
According to Van Horne (1995) the firm‟s credit collection policies are the chief influences on the level of debtors, measuring the manager‟s position to invest optimally in its debtors and be able to trade profitably with increased revenue. And good credit collection policy will be able to maximize its investment revenue in debtors and this improves and promotes its
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financial standing and performance therefore a good credit policy decision is positively related to high financial performance.