Turkey

Effects of Working Capital Management on Profitability of Manufacturing Firms
in Kenya
James Ndirangu Kungu
A Thesis submitted in partial fulfillment for the Award of Doctor of Philosophy

Degree in Business Administration of Jomo Kenyatta University of Agriculture and
Technology
2015
DECLARATION
This Thesis is my original work and has not been presented for a doctorate degree
in any other University.
Signature: . Date:
This thesis has been submitted for examination with our approval as University
Supervisors.
Signature: Date:
Dr. Geoffrey M. Gekara
East African University,
School of Business,
Kenya
Signature: Date:..
Dr. Kenneth L. Wanjau
Karatina University,
School of Business,
Kenya
Signature: Date
Dr. Antony G. Waititu
JKUAT,
College of Pure & Applied Sciences,
Kenya
ii
DEDICATION
This Thesis is dedicated to my family Monica, Charles and Peter Kenneth.
iii
ACKNOWLEDGEMENT
I want to register my gratitude to my supervisors Dr Kenneth Lawrence Wanjau,
Dr. Geoffrey Mouni Gekara and Dr. Anthony Gichuhi Waititu for having provided
valuable guidance during the thesis period. I also owe gratitude to Nairobi CBD
Campus for great atmosphere, competent personnel and interesting courses offered
during my study.
I want to mention the support of my dear wife Monica and sons Charles and Peter
Kenneth. My sincere hope is that the findings of this research will stimulate and
benefit the research about working capital management in future.
iv
TABLE OF CONTENT
DECLARATION ...................................................................................................... ii
DEDICATION ......................................................................................................... iii
ACKNOWLEDGEMENT ...................................................................................... iv
TABLE OF CONTENT ........................................................................................... v
LIST OF FIGURES ................................................................................................. ii
IST OF APPENDICES ........................................................................................... iii
ACRONYMS ........................................................................................................... iv
DEFINITION OF KEY TERMS ............................................................................ v
ABSTRACT ............................................................................................................. vi
CHAPTER ONE ...................................................................................................... 1
INTRODUCTION .................................................................................................... 1
1.1 Background of the Study ...................................................................................... 1
1.1.1 Global Perspective ............................................................................................ 1
1.2 Statement of the Problem ..................................................................................... 7
1.3 Objective of the Study .......................................................................................... 9
1.3.1 General Objective of the Study ......................................................................... 9
1.3.2 Specific Objectives of the Study ....................................................................... 9
1.4 Hypo Kenya, Republic of theses of the Study...................................................... 9
1.5 Significance of the Study.................................................................................... 10
1.6 Scope of the Study .............................................................................................. 11
1.7 Limitations of the Study ..................................................................................... 11
CHAPTER TWO ................................................................................................... 12
LITERATURE REVIEW...................................................................................... 12
2.0 Introduction ........................................................................................................ 12
2.1 The Concept of Working Capital Management.................................................. 12
2.2 Conceptual Framework ...................................................................................... 15
v
2.3 Review of Related Literature.............................................................................. 16
2.3.1 Credit Policy ................................................................................................... 16
2.3.1.4 Creditworthiness of Customers .................................................................... 22
2.3.1.1.1 Loss Given Default Model of Credit Policy ............................................. 23
2.3.2 Accounts Payable Practices............................................................................. 23
2.3.2.1 Relationship with Suppliers ......................................................................... 24
2.3.2.2 Delays in Payments ...................................................................................... 24
2.3.2.3 Payment Period ............................................................................................ 24
2.3.2.1.1 Transaction Cost Theory ........................................................................... 25
2.3.3 Inventory Control Practices............................................................................. 26
2.3.3.1 Inventory Level ............................................................................................ 26
2.3.3.2 Inventory Control System ............................................................................ 27
2.3.4 Liquidity Management Practices..................................................................... 29
2.3.4.2 Quick Ratio .................................................................................................. 31
2.3.4.3 Cash Management ........................................................................................ 31
2.3.4.1.1 Baumols Cash Management Model ......................................................... 32
2.3.4.1.2 Miller-Orr Cash Management Model........................................................ 34
2.3.5 Working Capital Levels .................................................................................. 35
2.3.5.1 Aggressive Investment Policy ...................................................................... 36
2.3.5.2 Conservative Investment Policy................................................................... 36
2.3.5.3 Aggressive Financing Policy ....................................................................... 37
2.3.5.1.1 Risk Return Tradeoff Theory .................................................................... 38
2.3.6 Profitability ..................................................................................................... 39
2.4 Critique of the Related Literature ...................................................................... 40
2.5 Research Gaps .................................................................................................... 41
CHAPTER THREE ............................................................................................... 43
RESEARCH METHODOLOGY ......................................................................... 43
3.0 Introduction ........................................................................................................ 43
3.1 Research Design ................................................................................................. 43
vi
3.2 Population ........................................................................................................... 44
3.3 Sampling Frame.................................................................................................. 45
3.4 Sample Size and Sampling Technique ............................................................... 45
3.5 Data Collection Instruments ............................................................................... 47
3.6 Data Collection Procedure .................................................................................. 48
3.7 Pilot Test............................................................................................................. 49
3.7.1 Validity of Research Instrument ..................................................................... 50
3.7.2 Reliability of the Research Instrument ............................................................ 51
3.8 Data Analysis...................................................................................................... 52
3.9 Statistical Model and Hypothesis Testing .......................................................... 54
3.9.1 Testing Hypothesis 1 ....................................................................................... 55
3.9.6 Overall Model ................................................................................................. 57
CHAPTER FOUR .................................................................................................. 58
RESEARCH FINDINGS AND DISCUSSIONS.................................................. 58
4.1 Introduction ........................................................................................................ 58
4.2 Pilot Test Results ................................................................................................ 58
4.3 Response Rate .................................................................................................... 59
4.4 Firms Characteristics ......................................................................................... 60
4.4.1 Industry Experience ........................................................................................ 60
4.4.2 Firms Duration with KAM ............................................................................ 61
4.4.3 Firms KAM Classification ............................................................................. 62
4.4.4 Firms Organizational Form ............................................................................ 63
4.4.5 Workers Employed by the Firms .................................................................... 64
4.4.6 Firms Manufactured Products ........................................................................ 65
4.4.7 Firms Organizational Structure...................................................................... 66
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4.5 Assumptions of Multiple Regression Analysis .................................................. 66
4.5.1 Normality Tests for the Profitability ............................................................... 66
4.5.2 Autocorrelation Test for Profitability ............................................................. 68
4.5.3 Homoscedastic Test for Profitability .............................................................. 69
4.5.4 Testing for Outliers ......................................................................................... 70
4.6 Effects of Credit Policy on Profitability in Manufacturing Firms ...................... 71
4.6.1 Reliability Measurement for Credit Policy ..................................................... 78
4.6.2 Correlation Analysis between Credit Policy and Profitability ........................ 79
4.6.3 Regression Line Fitting between Credit Policy and Profitability ................... 80
4.6.4 Conclusion on Credit Policy ........................................................................... 82
4.7 Effects of Accounts Payable Practices on Profitability ...................................... 83
4.7.1 Reliability Measurement for Accounts Payable Practices .............................. 87
4.7.2 Correlation between Accounts Payable Practices and Profitability ................ 89
4.7.3 Curve Fit between Profitability and Accounts Payable Practices ................... 90
4.7.4 Conclusion on Accounts Payable Practices .................................................... 92
4.8 Effects of Inventory Control Practices on Profitability ...................................... 93
Table 4.32: Inventory Control Practices Results...................................................... 96
4.8.1 Reliability Measurement for Inventory Control Practices .............................. 96
4.8.2 Correlation between Inventory Control Practices and Profitability ................ 98
4.8.3 Regression Line between Inventory Control Practices and Profitability ........ 99
4.8.4 Conclusion on Inventory Control Practices .................................................. 101
4.9 Effects of Liquidity Management Practices on Profitability ............................ 102
4.9.1 Reliability Measurement for Liquidity Management Practices .................... 106
4.9.2 Correlation between Liquidity Management Practices and Profitability ...... 108
4.9.3 Regression Line between Liquidity Management Practices & Profitability. 108
4.9.4 Conclusion on Liquidity Management Practices .......................................... 111
4.10 Effects of Working Capital Levels on Profitability........................................ 111
4.10.2 Correlation between Working Capital Levels and Profitability.................. 117
4.10.3 Curve Fit between Working Capital Levels and Profitability..................... 118
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4.10.4 Conclusion on Working Capital Levels ...................................................... 120
4.11 Effects of Working Capital Management on Profitability ............................. 121
4.11.1 Combined Correlation Matrix for the all Variables .................................... 121
4.11.2 Test for Multicollinearity ............................................................................ 122
4.11.3 Combined Effect of the Independent Variables on the Profitability ........... 123
4.11.4 Optimal Conceptual Model ......................................................................... 126
CHAPTER FIVE .................................................................................................. 128
SUMMARY, CONCLUSIONS AND RECOMMENDATIONS ..................... 128
5.1 Introduction ...................................................................................................... 128
5.2 Summary of the Findings ................................................................................. 128
5.2.1 Credit Policy and its Effect on Profitability .................................................. 129
5.2.2 Accounts Payable Practices and their Effect on Profitability ....................... 129
5.2.3 Inventory Control Practices and their Effect on Profitability ....................... 130
5.2.4 Liquidity Management Practices and their Effect on Profitability ............... 130
5.2.5 Working Capital Levels and their Effect on Profitability ............................. 131
5.2.6 Combined Effect of all Independent Variables on Profitability.................... 131
5.3 Conclusion ........................................................................................................ 132
5.4 Recommendations of the Study ........................................................................ 133
5.5 Areas for Further Research ............................................................................... 135
ix
5.6 Policy Implication ............................................................................................ 135
REFERENCES ..................................................................................................... 136
x
LIST OF TABLES
Table 1.1: Key Contributors to Export / Foreign Exchange Earnings in 2012 .......... 2
Table 1.2: Key Contributors to GDP between 2008 and 2012 .................................. 3
Table 1.3: Total Number of Workers in Manufacturing Sector between 2008 &
2012 .................................................................................................................... 4
Table 3.4: Determination of Sample Size ................................................................ 46
Table 4.5: Factor Analysis Results........................................................................... 58
Table 4.6: Reliability Test Results ........................................................................... 59
Table 4.7: Rate of Response by the Respondents .................................................... 60
Table 4.8: Industry Experience ................................................................................ 60
Table 4.9: Firms Duration with KAM .................................................................... 61
Table 4.10: Firms KAM Classification .................................................................. 63
Table 4.11: Firms Organizational Form ................................................................. 64
Table 4.12: Workers Employed by the Firms .......................................................... 65
Table 4.13: Firms Manufactured Products ............................................................. 65
Table 4.14: Firms Organizational Structure ........................................................... 66
Table 4.15: Normality Results for Profitability ....................................................... 68
Table 4.16: Autocorrelation Test for Profitability ................................................... 69
Table 4.17: Cooks Distance Statistics..................................................................... 71
Table 4.18: Reliability Measurement Results of Credit Policy ............................... 78
Table 4.19: KMO and Bartletts Test Results of Sphericity for Credit Policy ........ 79
Table 4.20: Correlation between Credit Policy and Profitability............................. 80
Table 4.21: Linear Estimation of Credit Policy and Profitability ............................ 81
Table 4.22: ANOVA for Credit Policy and Profitability ......................................... 82
Table 4.23: Regression Coefficients of Credit Policy and Profitability .................. 82
Table 4.24: Accounts Payable Practices Results...................................................... 86
Table 4.25: Reliability Measurement Results of Accounts Payable Practices......... 87
Table 4.26: KMO and Bartletts Test Results for Accounts Payable Practices ....... 88
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Table 4.27: Component Matrix of Accounts Payable Practices .............................. 89
Table 4.28: Correlation between Accounts Payable Practices and Profitability...... 90
Table 4.29: Model Summary for Accounts Payable Practices ................................. 91
Table 4.30: ANOVA for Accounts Payable Practices and Profitability .................. 92
Table 4.31: Regression Coefficients of Accounts PayablePractices & Profitability92
Table 4.32: Inventory Control Practices Results...................................................... 96
Table 4.33: Reliability Measurement Results of Inventory Control Practices......... 96
Table 4.34: KMO and Bartletts Test Results for Inventory Control Practices ....... 97
Table 4.35: Component Matrix of Inventory Control Practices .............................. 97
Table 4.36: Correlation between Inventory Control Practices and Profitability...... 99
Table 4.37: Model Summary of Inventory Control Practices ................................ 100
Table 4.38: ANOVA for Inventory Control Practices and Profitability ................ 101
Table 4.39: Regression Coefficients of Inventory Control Practices &Profitability
........................................................................................................................ 101
Table 4.40: Reliability Measurement Results of Liquidity Management Practices
........................................................................................................................ 106
Table 4.41: KMO and Bartletts Test Results for Liquidity Management Practices
........................................................................................................................ 107
Table 4.42: Component Matrix of Liquidity Management Practices .................... 107
Table 4.43: Correlation of Liquidity Management Practices and Profitability...... 108
Table 4.44: Model Summary of Liquidity Management Practices ........................ 110
Table 4.45: ANOVA for Liquidity Management Practices and Profitability ........ 110
Table 4.46: Prediction of Profitability from Liquidity Management Practices ..... 111
Table 4.47: Working Capital Levels Results ......................................................... 115
Table 4.48: Reliability Measurement Results of Working Capital Levels ............ 116
Table 4.49: KMO and Bartletts Test Results for Working Capital Levels ........... 116
Table 4.50: Component Matrix of Working Capital Levels .................................. 117
Table 4.51: Correlation between Working Capital Levels and Profitability ......... 118
Table 4.52: Model Summary for Working Capital Levels .................................... 119
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Table 4.53: ANOVA for Working Capital Levels and Profitability ...................... 120
Table 4.54: Prediction of Profitability from Working Capital Levels ................... 120
Table 4.55: Co linearity Statistics .......................................................................... 123
Table 4.56: Model Summary on Combined Effect ................................................ 124
Table 4.57: ANOVA for Multiple Regression Analysis ........................................ 125
Table 4.58: Beta Coefficients of the Variables of the Combined Model ............... 126
Table 4.59: Credit Policy Results .......................................................................... 158
Table 4.60: Component Matrix of Credit Policy ................................................... 161
Table 4.61: Liquidity Management Practices Results............................................ 162
Table 4.62: Correlation Matrix of all Variables ..................................................... 163
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LIST OF FIGURES
Figure 2.1: Conceptual Framework.......................................................................... 15
Figure 4.2: Normal Histogram for Profitability ....................................................... 67
Figure 4.3: Homoscedastic Test Profitability .......................................................... 70
Figure 4.4: Curve Fit of Credit Policy and Profitability .......................................... 81
Figure 4.5: Curve Fit of Accounts Payable Practices and Profitability ................... 91
Figure 4.6: Curve Fit of Inventory Control Practices and Profitability ................. 100
Figure 4.7: Curve Fit of Liquidity Management Practices and Profitability ......... 109
Figure 4.8: Curve Fit between Working Capital Levels and Profitability ............. 119
Figure 4.9: Optimal Conceptual Framework ......................................................... 127
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LIST OF APPENDICES
APPENDIX 1 Questionnaire ................................................................................. 150
APPENDIX 11 Record Survey Sheet .................................................................... 157
APPENDIX III Letter to the Company Chief Finance Officer .............................. 157
APPENDIX IV Credit Policy Results .................................................................... 158
APPENDIX V Component Matrix of Credit Policy .............................................. 161
APPENDIX VI Liquidity Management Practices Results ..................................... 162
APPENDIX VII Correlation Matrix of all Variables ............................................. 163
APPENDIX VIII LIST OF MANUFACTURING FIRMS UNDER KAM
164
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ACRONYMS
AKI: Association of Kenya Insurers
ANOVA: Analysis of Variance
BIS: Business Innovation and Skills
EOQ: Economic Order Quantity
FPEAK: Fresh Produce Exporters Association of Kenya
GDP: Gross Domestic Product
ICPAK Institute of Certified Public Accountants of Kenya
KAM: Kenya Association of Manufacturers
MSEs: Micro and Small Enterprises
NSE: Nairobi Securities Exchange
OECD: Organization for Economic Co-operation and Development
ROA: Return on Assets
ROCE: Return on Capital Employed
ROI: Return on Investment
ROK: Republic of Kenya
RON: Republic of Namibia
SMEs: Small and Medium Enterprises
SPSS: Statistical Package for Social Sciences
VIF: Variance Inflation Factor
WCM: Working Capital Management
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DEFINITION OF KEY TERMS
Aggressive Financing Policy: It is defined as a working capital management
policy that uses high levels of short term liabilities and low level of long term
liabilities (Hussain, Farooz & Khan, 2012).
Aggressive Investment Policy: It is a working capital management policy that

deals with the firms active control and management of current assets with the aim
of minimizing them (Hussain et al. 2012).
Average Collection Period: It the days sales outstanding and it is the average
amount of time that a company holds its accounts receivables (Ross, Westerfield,
Jaffe & Jordan, 2008)
Average Payment Period: It is the time taken to pay firms suppliers (Mathuva,
2010). It is the figure that measures the average amount of time that a company
holds its accounts payable.
Cash Conversion Cycle: It is the net time interval between cash collections from
sale of a product and cash payments for the resources acquired by the firm (Pandey,
2008).
Current Ratio: It is ratio that is given by total current assets divided by total
current liabilities. It is the ratio that indicates whether short term assets are
sufficient to meet short term obligations (Pandey, 2008).
Inventory Turnover in Days: It is the days sales inventory and is the figure that
measures the average amount of time that a company holds its inventory (Ross,
Westfield, Jaffe & Jordan, 2008).
v
Large Enterprises: They are enterprises that employ over 100 workers (Kenya,
Republic of, 1999; Kenya, Republic of, 2005)
Liquidity Ratios: Liquidity ratios are ratios that measure the relationship between
a firms liquidity or current assets and liabilities (Cornett, Adair, & Nofsinger,
2009). Liquidity ratios are computed by comparing the relationship between the
various groups of current assets and current liabilities to measure the liquidity
position of a company.
Medium Enterprises: These are enterprises that employ between 51 100 workers
(Kenya, Republic of, , 1999; Kenya, Republic of, 2005).
Small Enterprises: These are enterprises that employ between 11 and 50 workers
(Kenya, Republic of, 1999; Kenya, Republic of, , 2005).
Small and Medium Enterprises: These are enterprises that employ between 11
and 100 workers (Kenya, Republic of, , 1999; Kenya, Republic of, , 2005).
Working Capital: It is a firms investment in short term assets such as cash, short
term securities, bills receivable, inventory of raw materials and finished goods
(Radhika & Azhagaiah, 2012)
Working Capital Management: It is the management of current assets and

liabilities, and financing of those current assets. It is the financing, investment and
control of the net assets within the policy guidelines (Khan, Jawaid, Arif & Khan,
2012).
vi
ABSTRACT
In Kenya, manufacturing sector is the second most important sector after
agriculture. It is important in terms of contribution to gross domestic product,
employment and foreign exchange earnings. In the last decade, the manufacturing
sector has been struggling to thrive and some key firms in the sector have closed
operations. This is due to unfavorable working conditions. These problems compel
companies to maintain either excessive or inadequate working capital levels. Both
levels are undesirable. Therefore, the purpose of this research was to determine the
effects of working capital management on profitability of manufacturing firms in
Kenya. The study had five objectives, that is, to determine whether credit policy
influences profitability of manufacturing firms in Kenya, establish the degree to
which accounts payable practices influence profitability of manufacturing firms in
Kenya, examine how inventory control practices influence profitability of
manufacturing firms in Kenya, establish whether liquidity management practices
influence profitability of manufacturing firms in Kenya and investigate whether
working capital levels influence profitability of manufacturing firms in Kenya. The
study employed a correlational research design. A questionnaire was used to collect
primary data for the independent variables and a record survey sheet was used to
collect secondary data for the dependent variable (profitability). The target
population was 413 manufacturing firms in Nairobi industrial area and its environs.
These firms were registered with Kenya association of manufacturers and were in
the KAM 2011 directory. A sample of 81 chief finance officers filled in the
questionnaire. The sample was determined using stratified random sampling
method. Data received from secondary sources and from the chief finance officers
was analyzed using Statistical Package for Social Sciences (SPSS) version 20.0.
Both descriptive and quantitative analyses were used. In descriptive analysis,
percentages of the responses and the mean were computed. Under quantitative
analysis, Karl Pearsons correlation, regression and ANOVA analyses were used.
The results of the study showed that there was positive linear relationship between
vii
all independent variables (credit policy, accounts payable practices, inventory
control practices, liquidity management practices and working capital levels) and
the dependent variable (profitability) and all the models were significant. The null
hypotheses in this study were rejected. The overall model was tested using the F-
test at 5% level of significance. The findings of the analysis revealed that all the
independent variables had a significant combined effect (R2 = 0.933) on
profitability of manufacturing firms in Kenya and can be used to predict
profitability. The study makes the following recommendations; manufacturing
firms to regularly review their credit policies, make early payments to their
suppliers to enjoy good relationship with their suppliers, install and maintain
modern inventory control systems, establish optimal cash targets, lower and upper
limits and employ accountants with adequate knowledge in financial matters. On
policy implication, the government of Kenya through the ministry of
industrialization should create an authority to oversee the development and success
of manufacturing sector so as to be in line with vision 2030. Companies should
employ qualified accountants who are members of the institute of certified public
accountants of Kenya.
viii
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Manufacturing sector in an economy remains one of the most powerful engines for
economic growth. It acts as a catalyst to transform the economic structure of countries
from simple, slow growing and low value activities to more vibrant and productive
economies. Its productive economic activities are driven by technology and therefore
enjoy great margins (Amakom, 2012). This brings about growth prospects in the
economies. Manufacturing sector today has become the main means for developing
countries to benefit from globalization and bridge the income gap with the industrialized
world (Amakom, 2012). Manufacturing sector may be looked global, regional and local
perspective.
1.1.1 Global Perspective

In the west, particularly, countries under organization for economic co-operation and
development (OECD) are experiencing a declining trend in the manufacturing sector.
There is loss of employment and manufacturing output. However, the sector continues to
dominate in technology (OECD, 2006). Despite the decline in manufacturing sector in
the west, in UK, the sector was third largest in 2009 after business services and
wholesale/retail in terms of share of UK GDP. Manufacturing sector generated one-
hundred billion pounds in gross value added. This represents more than 11% of the UK
economy. It employed 2.6 million people, representing over 8% of total UK employment
(BIS, 2010). In Ireland, the sector accounts for 46% of its GDP, 29% of total
employment and 80% of its exports (Namimbia Republic of, 2007). The manufacturing
sector in the developed nations is large and contributes a lot to the economic
development.
In the east manufacturing sector is vibrant. It is the second largest sector of the economy
of Pakistan after agriculture and it accounts for 19.1% of G.D.P (Raheman, Afza,
1
Qayyum & Bodla, 2010). In Singapore, the sector accounted for 27% of its GDP in
2005, 25% of its total employment and more than 50% of its exports (RON, 2007).
1.1.2 Regional Perspective

In Africa, manufacturing sector is equally important. In Namibia, the sector accounts for
an average of 10.3% of the GDP and 8% of the total employment and 34.8% of its
exports. In South Africa, the sector accounts for an average of 17.4% of its GDP, 9%
employment and 40% of its total exports (Namimbia, Republic of, 2007). As nations
achieve higher levels of economic growth, manufacturing sector seems to contribute
more to the GDP, employment levels and the exports.
1.1.3 Local Perspective

In Kenya Manufacturing sector leads in foreign exchange earning accounting for 34% of
the total earnings (Kenya Association Manufacturing [KAM], 2013). This fact has never
been reported and should be seen in light of the need to promote exports. Table 1.1
below shows key contributors to export/foreign exchange earnings in 2012.
Table 1.1: Key Contributors to Export / Foreign Exchange Earnings in 2012

Item Value in Billion Kshs % Share
Manufactured Goods 175.3 34
Tourism 100.0 19
Horticulture 97.0 19
Tea 96.0 19
Coffee 17.0 3
Petroleum Products 13.5 3
Others 18.0 3
Total 516.8 100
Source: KAM (2013)
2
The manufacturing sector contributes about 10% to GDP. This is quite below what
advanced countries in the east and west contribute to their GDP. However, the sector
ranks second after agriculture in its contribution to GDP. In the period 2008 to 2012, the
five most important sectors of the economy contributed together over 60% to GDP as
shown in table 1.2 below:
Table 1.2: Key Contributors to GDP between 2008 and 2012

Sector 2008 2009 2010 2011 2012
Agriculture 21.7 22.3 23.5 21.4 24.0
Manufacturing 10.4 10.8 9.9 9.9 9.4
Construction 3.8 3.8 4.1 4.3 4.1
Trade 9.7 10.2 9.8 10.2 10.6
Transport & Communication 10.6 10.3 9.9 10.0 9.7
Financial Intermediaries 4.8 4.6 5.4 5.6 6.4
Source:Kenya, Republic of. (2013)
Manufacturing sector employs about 20% of the total workers in the economy. This
proportion is higher than what other economies employ. This shows that the
manufacturing sector is an important sector in the Kenyan economy. Thus, developing
this sector further will generate more employment, foreign exchange and increased gross
domestic product. In 2012, the total number of workers employed in the formal, private,
public and informal sector stood at 2,105,000 against the total workers population of
11,399,800 (Kenya, Republic of. 2013). There was a constant increase in the number of
workers employed between 2008 and 2012 in the manufacturing sector. The total
increase between 2008 and 2012 was 273,100 workers as shown in table 1.3:
3
Table 1.3: Total Number of Workers in Manufacturing Sector between 2008 &
2012
Category 2008 2009 2010 2011 2012
Private Sector 237,900 237,200 238,600 242,400 247,600
Public Sector 26,900 26,900 27,800 27,900 28,100
Informal Sector 1,567,100 1,644,200 1,711,200 1,780,800 1,829,300
Total Manufacturing 1,831,900 1,908,300 1,977,600 2,051,100 2,105,000
Total Economy 9,411,400 9,886,400 10,389,000 10,885,300 11,399,800
Source: Kenya, Republic of (2013)
There are about 2071 manufacturing firms in Kenya according to the ministry of
industrialization data bank. Majority of manufacturing firms in Kenya, employ up to 100
workers (Kenya, Republic of, 2007). However, there are a few manufacturing firms that
are large and others micro in the cottage industry employing less than 10 workers. There
were 670 manufacturing firms in the directory of Kenya association of manufacturers
(KAM, 2011).
The KAM is a membership organization whose role is to provide leadership and services
aimed at enhancing the development of a competitive manufacturing sector in Kenya.
The manufacturing firms registered under KAM are more formal than other unregistered
firms. This made this sector a appropriate area of study especially in a study requiring
sensitive financial information. Four hundred and thirteen (413) manufacturing firms
operating in Nairobi industrial area and its environs and were in the 2011 directory of
KAM formed the target population of this study.
The decision to study the manufacturing sector was due to several factors; first, the
manufacturing sector was expected to remain a vibrant and strong contributor to
sustained recovery and growth of the Kenyan economy. The manufacturing sector was
expected to pick up and grow at a better rate after the post election violence (PEV),
global financial crisis of 2008 and 2009 and the shrinking of the Kenyan shilling against
4
the major world hard currencies in 2011. Secondly, the manufacturing sector remains the
largest source of employment opportunities, accounting for about 20% of the total
employment or 2,105,000 persons in 2012 (Kenya, Republic of, 2013). Based on the
forecasted favorable economic outlook, employment was expected to grow in the
foreseeable future. As an important sector in the overall economic growth,
manufacturing sector requires an in-depth analysis at industry as well as firm level.
1.1.4 Aspect of Profitability and Manufacturing Firms in Kenya

Companies must earn a good return from their investments that will enable the board of
directors make a good dividend payout. Profitability refers to a companys ability to
generate an adequate return on invested capital (Wild, Larson & Chiapetta, 2007).
Therefore, companies are interested in the ability to use their assets efficiently to
produce profits (and positive cash flows). A return is judged by assessing earnings
relative to the level and sources of financing. Profitability is also relevant to solvency.
The key measures of profitability are return on capital employed, return on assets and
return on investment.
The most important goal in operating a company is to earn an income for its owners. A
business that is not profitable cannot survive. Conversely, a business that is highly
profitable has the ability to reward its owners with a large return on their investment.
Increasingly, profitability is one of the most important tasks of the business managers.
Managers constantly look for ways to change the business to improve profitability
(Refuse, 1996).
A study carried out by Makori and Jagongo (2013) on working capital management and
firms profitability on manufacturing companies listed on Nairobi Securities Exchange
found that working capital has a a significant impact on profitability of the firms and
play a key role in the value creation for shareholders as longer cash conversion cycle has
a negative impact on profitability of a manufacturing firm.
5
1.1.5 Overview of Working Capital Management and Manufacturing Firms
One aspect that needs investigation is the management of working capital in
manufacturing firms. Working capital is the difference between current assets and
current liabilities. Working capital meets the short term financial requirements of a
business enterprise. It is a trading capital, not retained in the business in a particular
form for longer than a year (Padachi, 2006). The money invested in it changes form and
substance during the normal course of business operations. Working Capital
Management (WCM) is a tool used to immunize corporations from financial upheavals
and when managed strategically can improve a companys competitive position and
profitability (Gill, 2011). The wider perspective of WCM contributes to the greater
opportunities to create wealth. Increasing the speed of a cash conversion cycle through
receivable and payable management helps improve on profitability and liquidity
(Johnson & Soenen, 2003). Further, effective inventory management is also critical to
the management of liquidity and profitability in many companies.
Working capital management efficiency is vital for manufacturing firms, where a major
part of the assets is composed of current assets (Horne & Wachowitz, 2004). One of the
major components of working capital is inventory. The inventory of a manufacturing
concern comprise of finished goods, work in progress and raw materials. The sum of the
three components of the inventory constitutes a heavy investment in a manufacturing
firm. Current assets for a typical manufacturing company account for over half of its
total assets (Raheman & Nasr, 2007).
In the present day of rising capital cost and scarce funds, the importance of working
capital needs special emphasis. It has been widely accepted that the profitability of a
business concern likely depends upon the manner in which working capital is managed
(Kaur, 2010). Both excessive and inadequate working capital positions are dangerous
from the firms point of view (Islam & Mili, 2012). Excessive working capital leads to
unproductive use of scarce funds. Excessive working capital means holding costs and
6
idle funds which earn no profits for the firm (Islam & Mili, 2012). This leads to reduced
profits although it guarantees a low liquidity risk.
The inefficient management of working capital impairs profitability and interrupts

normal operations of a business as well (Kaur, 2010). This may ultimately lead to a
financial crisis and bankruptcy. On the other hand, proper management of working
capital leads to material savings and ensures financial return at the optimum level even
on the minimum level of capital employed (Kaur, 2010). Both excessive and inadequate
working capital is harmful for a business. Working capital and its importance is
unquestionable (Filbeck & Krueger, 2005). It directly influences the liquidity and
profitability of firms (Raheman & Nasr, 2007). Just as circulation of blood is very
necessary in the human body to maintain life, the flow of funds is very necessary to
maintain business (Padachi, 2006). If it becomes weak, the business can hardly survive.
Therefore, ignore proper management of working capital at your own peril.
Working capital management is important to manufacturing firms because it comprises

over half of the total assets of a firm. Many manufacturing firms are said to be struggling
to thrive and that some key players have been forced to move their operations to other
countries. Others have shut down their operations as evidenced by recent closure of pan
paper mills in Webuye town. All these firms cite high operation costs as the main cause
of the precarious financial situation (Kenya, Republic of 2007). Firms are closing doors
and others are operating at breakeven point (KAM, 2006). Closure of a business can
only be brought about by profitability and liquidity problems. Therefore, there was a
need to investigate the problem of profitability and management of working capital in
the manufacturing firms in Kenya.
1.2 Statement of the Problem
This study arises from the need to manage working capital of manufacturing firms more
effectively and efficiently keeping viability and continuity in view. In Kenya, many
manufacturing firms are struggling to thrive and some key players have been forced to
move their operations to the countries. Others have shut done their operations as
7
evidenced by recent closure of Pan Paper Mills in Webuye and Cadbury East Africa.
Other firms like Eveready East Africa have contemplated closure of their operations. All
these companies cite high operation costs as the main cause of the precarious financial
situation (Kenya, Republic of, 2007). Companies are closing doors and others are
operating at breakeven point (KAM, 2006). If this trend continues unabated, Kenyas
hope of rising to a middle level economy as envisioned by vision 2030 is in doubt.
The foregoing notwithstanding, vast majority of companies either maintain excessive or

inadequate working capital levels both levels are inappropriate. Too much working
capital means that a firm ties up capital on unproductive assets thus reducing profit
maximization. This further means that the market share of the company is not
maximized. However, too little working capital is a threat to the liquidity of a company.
With little working capital a company can easily collapse despite optimal profit levels.
Therefore, all types of businesses must maintain an ideal level of working capital.
Nkwankwo and Osho (2010) assert that a firm that manages its working capital
inefficiently has every possibility that a lot of mayhem will fall on the organization.
Such mishap may range from setting, inability to expand, reduction in value of the
company as well as its shares; inability of the management to cope up with
organizational technical improvement; and financial losses, liquidity, susceptibility to
liquidation and insolvency.
Two most recent studies carried out in Kenya show that manufacturing firms in Kenya
in general are currently facing working capital management problems. Muchina and
Kiano (2011) and Nyabwanga, Ojera, Lumumba, Odondo and Otieno (2012) found that
manufacturing firms in Kenya are facing problems with their collection and payment
policies as well as not paying attention to inventory levels. These have affected
profitability of the manufacturing firms and in turn have affected the value of
companies. If these problems are not addressed manufacturing firms can go under and
this can have a significant ripple effect on the whole economy (Ali, 2009). This
8
represents a serious impediment to Kenyas effort to achieve middle level economy by
the year 2030 and will have a difficult time rising economically to the level of Asian
tigers such as Malaysia and Singapore.
To better understand these assertions, the study sought to carry out a working capital
management diagnosis in Kenya with the objective of determining the effects of
working capital management on profitability of manufacturing firms in Kenya. Such a
diagnosis has not been carried out in Kenya and the outcome of the study forms a basis
of future study on working capital management in manufacturing firms in Kenya.
1.3 Objective of the Study

1.3.1 General Objective of the Study
The purpose of this study was to determine the effects of working capital management
on profitability of manufacturing firms in Kenya.
1.3.2 Specific Objectives of the Study

(i) To determine whether credit policy influences profitability of
manufacturing firms in Kenya
(ii) To establish the degree to which accounts payable practices influence
profitability of manufacturing firms in Kenya
(iii) To examine how inventory control practices influence profitability of
(iv) To establish whether liquidity management practices influence
profitability of manufacturing firms in Kenya
(v) To investigate whether working capital levels influence profitability of
1.4 Hypo Kenya, Republic of theses of the Study

H01: Credit policy does not influence profitability of manufacturing firms in
Kenya
9
H02: Accounts payable practices do not influence profitability of
H03: Inventory control practices do not influence profitability of
H04: Liquidity management Practices do not influence profitability of
H05: Working capital levels do not influence profitability of manufacturing
firms in Kenya
1.5 Significance of the Study

The aim of this study was to determine the effects of working capital management on
profitability of manufacturing firms in Kenya. The following are the benefits of this
study.
A). Kenya Association of Manufacturers

The findings of this study will enable firms under Kenya Association of Manufacturers
(KAM) realize the importance of working capital management and the influence of
WCM on profitability because KAM office will get a copy the findings of this study.
B). Chief Finance Officers

The findings of the study will help the chief finance officers of manufacturing firms in
designing intervention strategies aimed at maximizing profit for their firms. A copy of
the findings will be availed to the 71 chief finance officers who were respondents in this
study.
C). Researchers, Policy Makers, Professionals and Managers

Finally, the findings of the study will contribute to the body of knowledge by identifying
how Kenyan manufacturing firms manage their working capital in the local setting. A
10
general WCM framework for research, policy makers, professionals and managers has
been formulated that will guide further research, reappraise current business practices
and provide basic guidelines for new policies in dynamic business environment.
1.6 Scope of the Study

The study focused on manufacturing firms in Kenya only. It narrowed down to firms
registered with the Kenya Association of Manufacturers (KAM). There were 670
manufacturing firms registered with the KAM in 2011 (KAM, 2011). Some of the
registered organizations deal with consultancy and services. These firms were eliminated
from the study. The target population was 413 manufacturing firms registered with
KAM and operating in Nairobi industrial area and its environs. Over 80% of all
manufacturing firms in Kenya are located in Nairobi industrial area and its environs
(KAM, 2011). Therefore, this study was carried out in manufacturing firms in Nairobi
industrial area and its environs.
1.7 Limitations of the Study

There were two challenges in this study. First, the population was highly heterogeneous.
As such the study adopted stratified random sampling method to give chances to all
members of the targeted population. Secondly, the study experienced an initial slow
response from the respondents who complained about the length of the questionnaire.
This was mitigated by having constant follow up on phone and physical visits to the
respondents offices.
11
CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
This chapter focused on the theories, models and empirical literature relevant to effects
of working capital management on profitability of manufacturing firms in Kenya. The
section was divided into the following sections; the concept of working capital
management, conceptual framework, review of related literature, critique of the related
literature and research gaps.
2.1 The Concept of Working Capital Management

Working capital is the amount of funds that a business has made available to meet the
day to day cash requirements of its operations (Pandey, 2008). It is the difference
between current assets and current liabilities. Current assets are the resources in cash or
readily convertible into cash. Current assets include all those assets that in the normal
course of business return to the form of cash within a short period of time, ordinarily
within a year and such temporary investment as may readily be converted into cash upon
need (Raheman & Nasr, 2007). They include bank balance, cash, marketable securities,
inventories and accounts receivables. A business must maintain an appropriate level of
current assets. Over investment in current assets is not desirable. Excessive level of
current assets can easily result in a company realizing a sub-standard return on
investment (Raheman & Nasr, 2007; Horne & Wachowitz, 2004). However, companies
with too little amount of current assets may incur shortages and difficulties in
maintaining smooth operations (Horne & Wachowicz, 2004).
Current liabilities are organizations commitments for which cash will soon be required.
They include bank overdraft, accounts payables and unpaid bills (Pandey, 2008). A
company is responsible for paying these obligations on a time basis. Liquidity for the on
going company is not reliant on the liquidation value of its assets, but rather on
operating cash flows generated by those assets (Soenen, 1993).
12
Working capital is regarded as life giving force for any economic unit and its
management is considered among the most important functions of corporate
management (Pandey, 2008). Every organization, profit oriented or not, irrespective of
size and nature of business requires necessary amount of working capital. Working
capital is the most crucial factor for maintaining liquidity, survival, solvency and
profitability of business (Mukhopadhy, 2004).
The management of working capital is important to the financial health of businesses of

all types and sizes. The amounts invested in working capital are often high in proportion
to the total assets employed and so it is very vital that these amounts are used in an
efficient and effective way (Pandey, 2008). A firm can be very profitable, but if this is
not translated into cash from operations within the same operating cycle, the firm would
need to borrow to support its continued working capital needs (Padachi, 2006). Thus, the
twin objectives of profitability and liquidity must be synchronized and one should not
impinge on the other for long.
Working capital management is important due to many reasons. For one thing, the
current assets of a typical manufacturing company, account for over one half of its total
assets (Reheman & Nasr, 2007). Eiteman, Stonehill, Moffett and Pandey (2008) assert
that credit terms extended by manufacturers to retailers are of such magnitude as to
constitute purchase of the retailer, such purchase being necessary to build an operational
distribution system between the manufacturer and the ultimate customer. In a
Manufacturing company, working capital cycle is the average time that raw materials
remain in stock less the period of credit taken from suppliers and the sum of time taken
to produce the goods, the time the goods remain in the finished goods store, and the time
taken by credit customers to pay for the goods (Reheman & Nasr, 2007). For a
manufacturing concern the working capital cycle is longer than that of merchandised
business. Thus, a manufacturing concern requires more funds to finance working capital.
13
Companies may have an optimal level of working capital that maximizes their value.
Large inventory and a generous trade credit policy may lead to high sales. Trade credit
may stimulate sales because it allows customers to assess product quality before paying
(Long, Maltiz & Ravid, 1993; and Deloof & Jegers, 1996). A popular measure of
working capital management (WCM) is the cash conversion cycle; the time lag between
the expenditure for purchases of raw materials and the collection of sales of finished
goods. The longer this time lag, the larger the investment in working capital (Deloof,
2003). A longer cash conversion cycle might increase profitability because it leads to
higher sales. However, corporate profitability might also decrease with the cash
conversion cycle, if the cost of higher investment in working capital rises faster than the
benefits of holding more inventories and/or granting more trade credit to customers.
Many surveys have indicated that many managers spend considerable time on the day to
day problems that involve working capital decisions. One reason for this is that current
assets are short lived investments that are continually being converted into other assets
types (Rao, 1989). Taken together, decisions on the level of different working capital
components become frequent, repetitive and time consuming. Working capital
management is a very sensitive area in the field of financial management (Joshi, 1994).
It involves the decision of the amount and composition of current assets and the
financing of these assets. The working capital management of a company in part affects
its profitability.
Improving Working Capital Management (WCM) is reasonably important for companies

to withstand the impacts of economic turbulence (Reason, 2008). Alternatively, efficient
WCM is also essential for companies during the booming economic periods (Lo, 2005)
for the reason that WCM is related to all aspects of managing current assets and current
liabilities (Emery, Finerty & Stowe, 2004; Hampton & Wagner, 1989; Hill & Sartoris,
1992; Scherr, 1989; Vander, Weider & Maiser, 1985). Efficient working capital
management involves planning and controlling current assets and liabilities in a manner
14
that eliminates the risks of inability to meet due short term obligations on one hand and
avoid excessive investment in these assets on the other hand (Eljelly, 2004).
2.2 Conceptual Framework

In order to hold existing and new knowledge, theory should provide a conceptual
framework, so that knowledge can be interpreted for empirical application in a
comprehensive manner. In this study the conceptual framework comprise of five
independent variables and one dependent variable.
Credit Policy
Credit Standards
Credit Terms
Collection Efforts
Credit Worthiness
Accounts Payable Practices
Relationship with Suppliers
Payment period
Delays in Payment
Inventory Control Practices PROFITABILITY
Inventory Levels Return on Assets
Inventory Control System
Liquidity Management Practices
Current Ratio
Quick Assets Ratio
Cash Management
Working Capital Level
Aggressive Investment Policy

Conservative Investment Policy
Aggressive Financing Policy
Conservative Financing Policy
Independent Variables Dependent Variable

Figure 2.1: Conceptual Framework
Figure 2.1 shows the conceptualization of the dependent and independent variables of
the related study. The independent variables of this study indicate the statistics that were
used to measure effects of Working Capital Management. They include credit policy
which was measured by credit standards, credit terms, collection efforts and
15
creditworthiness of customers. Accounts payable practices were measured by
relationship with suppliers, delays in payments and payment period allowed by
suppliers. Inventory control practices were measured by inventory control system and
inventory levels. Liquidity management practices were measured using current ratio,
quick ratio, and cash management. Working capital levels were measured using
aggressive investment policy, conservative investment policy, aggressive financing
policy and conservative financing policy. The dependent variable was the profitability
which was measured by return on assets (ROA).
2.3 Review of Related Literature

2.3.1 Credit Policy
Business enterprises today use trade credit as a prominent strategy in the area of
marketing and financial management. Thus, credit is necessary in the growth of
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
accounts receivables which the firm is expected to collect in future. Kalunda, Nduku
and Kabiru (2012) state that trade credit is created where a supplier offers terms that
allow a buyer to delay payments. Accounts receivables are executed by generating an
invoice which is delivered to the customer, who in turn must pay within 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 manufacturing
firm (Dunn, 2009). Investment in receivables takes a big chunk of organizations 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 attract potential customers to buy at favorable terms
(Kakuru, 2001). As long as there is competition in the industry, selling on credit
becomes inevitable. A business will loose its customers to competitors if it does not
extend credit to them. Thus, investment in accounts receivables may not be a matter of
16
choice but a matter of survival (Kakuru, 2001). 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
(Dunn, 2009).
To remain profitable, businesses must ensure proper management of their receivables

(Foulks, 2005). The management of receivables is a practical problem. Businesses can
find their liquidity under considerable strain if the levels of their accounts receivables
are not properly regulated (Filbeck & Krueger, 2005). 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 definitely results into
bad debts which lowers the business profitability (Filbeck & Krueger, 2005).
Credit policy is the most popular medium of managing and regulating receivables. To
ensure optimal investment in receivables, a business is required to have an appropriate
credit policy. Credit policy is designed to minimize costs associated with credit while
maximizing the benefits from it. Credit policy refers to guidelines that spell out how to
decide which customers are sold on open account, the exact payment terms, the limits
set on outstanding balances and how to deal with delinquent accounts (Filbeck &
Krueger, 2005). According to (Pandey, 2008; Atkinson, Kaplan & Young, 2007;
Brigham, 1985) credit policy is defined in the manner as the combination of such terms
as credit period, credit standards, collection period, cash discounts and cash terms.
Therefore, despite the fact that organizations have different credit policies, the content of
these policies must touch on credit period, credit standards, collection period and credit
terms (Filbeck & Krueger, 2005).
Credit policy is either lenient or stringent. Kalunda et al. (2012) argue that a lenient
credit policy tends to give credit to customers on very liberal terms and standards such
that credit is granted for longer periods even to those customers whose credit worthiness
is not well known. A stringent credit policy on the other hand is restrictive and allows
17
credit only to those customers whose credit worthiness have been ascertained and are
financially strong. There are no two organizations with a similar credit policy. Whether
lenient or stringent credit policy is adopted by an organization, it must ensure that it
attracts and retains good customers, without having a negative impact on the cash flow
(Kalunda et al., 2012).
Miller (2008) argues that there are four reasons why organizations have written credit
policies. First, the undertaking of managing receivables is a serious responsibility. It
involves limiting bad debts and improving cash flow. Outstanding receivables become a
major asset of a firm and therefore require a reasoned and structured approach and
therefore credit management is necessary. Second, a credit policy assures a degree of
consistency among departments. By writing down what is expected, the aims of the
company (whether marketing, production or finance) will realize that they have a
common set of goals. Also, a written policy can delineate each department functions so
that duplication of effort and needless friction are avoided. Third, it provides for a
consistent approach among customers. Decision making becomes a logical function
based on pre-determined parameters. This simplifies the decision process and yields a
sense of fairness that will only improve customer relations. Finally, it can provide some
recognition of the credit department as a separate entity, one which is worthy of
providing input into the overall strategy of the firm. This allows the department to be an
important resource to top management (Kalunda et al., 2012).
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 (Szabo, 2005). 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.
18
Organizations differ so do their credit policies. 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 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, 2012).
Clarke and Survirvarma (1999) argue that granting credit is a journey, the success of
which depends on the methodology applied to evaluate and award the credit. This
journal starts from the application for credit through acquisition of credit sales and ends
at the time the debt is fully paid. Granting credit exists to facilitate sales. However, sales
are pointless without due payment, therefore the sales and credit functions must work
together to achieve the well known objective of maximum sales within minimum length
of time (Miller, 2008). Atkinson et al(2007) and Brigham (1985) assert that a credit
policy touches on credit period, credit standards, collection efforts and credit terms. This
study looks at credit standards, credit terms, collection efforts and credit worthiness of
customers and loss given default theory.
2.3.1.1 Credit Standards

Pandey (2008) states that credit standards are the criteria used by a firm to decide on the
type of customers to whom goods could be sold on credit. If the firms credit standards
are too strict, the volume of credit sales will be too low but the firm will have little
collectable debts. Before extending credit, the firm probably wishes to investigate the
credit worthiness of the customer. This investigation may simply focus on the firms
customers credit history with the firm or may include contacting various credit
reporting agencies, checking the customers bank and other suppliers of credit and
examining the customers financial statements and operations. The financial statements
19
analysis requires the use of financial ratios, particularly those reflecting the firms
liquidity position (Pandey, 2008).
Credit standards involve application of well defined procedures to ensure a standard way
of granting credit. Credit procedures are specific ways in which top management
requires credit department to achieve the best results for the organization (Dunn, 2009).
Credit procedures include instructions on what data to be used for credit investigation
and analysis process, provide information for data approval process, accounts
supervision and instances requiring management notification.
According to (Weston & Copeland, 1995; Kalunda et al., 2012) there are six Cs of
credit which should be considered by credit managers in any industry. They are
character, capacity, capital, collateral, condition and contribution. The six Cs can help
manufacturing firms to decrease the default rate, as they get to know their customers.
The six Cs of credit represent the factors by which credit risk is judged (Kalunda et al.,
2012). Information on these is obtained from a number of sources, including the firms
prior experience with the customer, audited financial statements for previous years,
credit reporting agencies or customers commercial banks
2.3.1.2 Credit Terms

This refers to the period allowed to the customers. It also includes cash discount offered
to encourage prompt payment. Many firms establish a credit period for their customers
and offer discounts to encourage them to pay early. Chee and Smith (1999) assert that
there are two basic forms of trade credit: the simpler form, net terms, specifies that full
payment is due within a certain period after delivery. For example, net 30 means full
payment is due 30 days after invoice; after that the buyer is in default. Invoicing
normally occurs either around the delivery or at the end of a billing cycle. The more
complex form of credit, two part terms, has three basic elements; the discount
percentage, the discount period and the effective interest rate. The most common two
part terms are 2/10 net 30. This means a 2% discount for payment within 10 days and a
20
net period ending on day 30. As with net terms; the buyer is in default if payment is not
made by the end of the net period.
Chee and Smith (1999) assert that unless transactions occur instantaneously, payment
arrangement is in effect credit terms. Longer credit periods or more liberal credit terms
are likely to stimulate sales, but at the same time, the firm forgoes the use of its money
for a greater length of time and increases the potential for bad debts losses. According to
Pandey (2008) a firm can shorten its credit period if customers are defaulting too
frequently and bad debts are building up. However, the firm will lengthen credit period
to increase its operating profit through expanded sales.
2.3.1.3 Collection Efforts

This refers to the procedure followed by a firm in an attempt to pursue the customers
who do not pay on the due dates. It may involve reminding the debtor through a politely
worded letter, a strongly worded letter, sending a representative and eventually
contemplating a legal action or writing off the debt altogether (Dunn, 2009). Collection
efforts may involve reminding the debtor by sending a demand note to inform him of the
amount due. If no response is received, progressive steps using tighter measures are
taken (Pandey, 2008). These other measures include sending a polite letter to the
customer and if no response, the customer is contacted through telephone or through
visiting him or her and as last resort taking legal measures (Kakuru, 2001).
Use of litigation against a customer who fails to meet his obligation is a collection effort
geared to collect a debt that is already bad. A creditor takes this direction when there is a
major break down in the repayment agreement resulting in undue delays in collection in
which it appears that legal action may be required to effect collection (Kakuru, 2001).
This collection effort arises when the creditors relationship with the debtor has become
soar.
21
Finally, the debt may be written off. The debt is written off when the creditor feels that
the debt is uncollectable. If a debt is deemed to be bad and the company has lost it, it is
better to write it off from the books of accounts to give a true and fair view of the
companys financial position (Kakuru, 2001). A collection effort is a control process. It
ensures that trade debts are recovered early enough before they become un-collectable
and therefore a loss to the organization (Saleemi, 1993).
2.3.1.4 Creditworthiness of Customers

Average collection period determines the speed of payment by customers (Pandey,
2008). Delayed payment by customers is a potential ground for bad debts and
subsequent low profitability. Pandey (2008) argues that a firm can shorten its credit
period if customers are defaulting too frequently and bad debts are building up. There
should be strict control on customers who carry goods on credit. The purpose of credit
control is to ensure that trade debts are recovered early enough before they become un-
collectable and therefore a loss to the organization (Saleemi, 1993).
Customers should only be allowed credit on the basis of their creditworthiness in order
to minimize the level of default and bad debts. Dunn (2009) asserts that creditors must
apply the techniques of credit selection and standard for determining which customers
should receive credit. In the process of determining the creditworthiness of a customer,
the creditor has to apply the six Cs of credit; character, capacity, capital, collateral,
condition and contribution (Weston & Copeland, 1995).
Managers can create profit for their companies if they maintain accounts receivables at
optimal level (Gill, Biger & Mathur, 2010). Systems can be installed to decrease
investment in inventories and can enable companies increase profitability. Managers can
create value for shareholders by means of decreasing receivable accounts (Deloof, 2003;
Mohammad, 2011). There is a significant negative relationship between profitability and
the average collection period (Deloof, 2003; Raheman & Nasr, 2007; Mathuva, 2010;
Muchina & Kiano, 2011). According to Padachi (2006) high investment in accounts
receivable is associated with low profitability. Therefore, the objective of the study was
22
to determine whether credit policy influences profitability of manufacturing firms in
Kenya. The null hypothesis was stated as follows;
H01: Credit policy does not influence profitability of manufacturing firms in

Kenya
2.3.1.1.1 Loss Given Default Model of Credit Policy

This model is more often applied by financial institutions when lending money. The
model is used to estimate the amount of risk and therefore loss that may be incurred by
an institution on the amount of loan lend to a customer or to be lend to a prospective
customer. This model is also be applicable by merchandized organizations that sell
goods on credit. Loss given default is defined as the loss incurred in the event of default
and is equal to one minus recovery rate of default (Alvarez-Diez, Baixauli-Soler and
Beida-Ruiz, 2009). This can be stated mathematically as; 1 Ri where; Ri is the value
received at default resolution or recovery rate of default instrument. Therefore, loss
given default helps to predict the amount of loss in a credit in the event of default. If the
value of collateral given is high, then the amount of loss on default is minimal or zero.
2.3.2 Accounts Payable Practices

Accounts payable is the amount of money promised by a recipient of goods to a supplier
where a credit transaction is involved (Kinunda, 2008). It is the amount money a firm
owes to its suppliers. It is one of the major sources of unsecured short term financing
(Gitman, 2009; Hill & Sartoris, 1992). Management of accounts payables is an
important aspect of ensuring efficient management of working capital. It is important for
a firm to ensure that it has a good working relationship with its suppliers so that there
can be a constant supplies of inventories. Firms should avoid delays in paying for their
supplies because of the disadvantages attached to such delays that include lost cash
discounts and reduced trust by the suppliers.
23
2.3.2.1 Relationship with Suppliers
Utilizing the relationship with the creditor is a sound objective that should be
highlighted as important as having the optimal level of inventories (Hill & Sartoris,
1992). Accounts payable should be maximally used by firms. Sound management of
suppliers credit requires current up to date information on account and aging of
payables to ensure proper payments (Helfert, 2003). Proper management of creditors
enables a firm to maintain good relationship with the suppliers. This ensures that the
firm has a continuous provision of trade credit which is a cheap source of finance.
2.3.2.2 Delays in Payments

Delaying payments to suppliers allows a firm to assess the quality of purchased products
and can be an inexpensive and flexible source of financing the firm. On the other hand,
late payment of invoices can be very costly if the firm is offered a discount for early
payment (Raheman & Nasr, 2007; Gill et al., 2010). A study by Mathuva (2010)
found that an increase in the number of days payable by 1 day was associated with
increased profitability. However, Deloof (2003) and Reheman and Nasr (2007) found
that more profitable firms wait longer to pay their bills. This means that they withhold
their payment to their suppliers so as to take the advantage of cash available for their
working needs. Delaying payments to suppliers is in line with the working capital
management rule that firms should strive to lag their payments to creditors as much as
possible, taking care not to spoil their business relationships with them (Mathuva, 2010).
2.3.2.3 Payment Period

Mathuva (2010) discovered that firms in Kenya take an average time of 64 days to pay
their creditors with a standard deviation of 103 days. They discovered that the maximum
time the firms take to pay for their supplies is 534 days and a minimum of 0 days. The
average payment period is considered by firms because it has a direct relationship with
profitability. Mathuva (2010) defines average payment period as the length of time that a
firm is able to defer payments for various resources purchased. It is the time taken by the
firm to pay its creditors. Using data from financial statements the average payment
24
period is obtained by dividing accounts payable by cost of sales and multiplying the
results by 365days (Deloof, 2003; Padachi, 2006; Reheman & Nasr, 2007; Saghir,
Hashmi & Hussain, 2012).
Mathuva (2010) argues that there is a highly significant relationship between the time it
takes the firm to pay its creditors and profitability. However, this contradicts the opinion
of Deloof (2003) who asserts that there is a negative relationship between average
payment period and profitability. Muchina and Kiano (2011) carried out a study about
the influence of working capital management on firms profitability. The study did not
confirm nor reject that average payment period affects profitability.
Under this study, the objective was to establish the degree to which accounts payable
practices influence profitability of manufacturing firms in Kenya and the null hypothesis
was stated as follows
H02: Accounts payable practices do not influence profitability of

2.3.2.1.1 Transaction Cost Theory

Transaction cost theory is used to explain a number of different behaviors. Often this
involves considering as transactions not only the obvious cases of buying and selling but
also day to day emotional interactions and informal gift exchanges (Williamson, 1975).
The transaction cost theory suggests that there are certain costs that people normally
incur without knowing that they are a cost to them. These costs must be incurred
whenever a transaction takes place. These costs are known as transaction costs. The idea
that transactions form the basis of an economic thinking was introduced by John R.
Common in 1931 (Williamson, 1975).
Transaction cost theory focuses on transactions and costs that attend completing
transactions by one institutional mode rather than another (Williamson, 1975). The
25
theorys central claim is that the transactions will be handled in such a way as to
minimize the costs involved in carrying them out (Muchina & Kiano, 2011). A
transaction, a transfer of good or service is the unit of analysis in transaction cost theory
and the means of effecting the transaction is the principal outcome of interest
(Williamson, 1975). Accounts payable practices can be explained by transaction cost
theory in that the loss in discounts from the suppliers is a cost to the debtor.
2.3.3 Inventory Control Practices

Inventory is the stock purchased with the purpose of resale in order to gain a profit. It
represents the largest cost to a manufacturing firm. For a manufacturing firm, inventory
consists of between 20% and 30% of the total investment (Garcia Teruel & Martinez,
2007). Inventory should therefore be managed well in order to facilitate the firms
operations. There are three main types of inventories namely; raw materials, work in
progress and finished goods. However, Hopp and Spearman (2000) classify inventory
into raw materials, work in progress, finished goods and spare parts. Raw materials are
the stocks that have been purchased and will be used in the process of manufacture while
work in progress represents partially finished goods. Finished goods on the other hand,
represent those items of stock that are ready to be monetized (Nwankwo & Osho, 2010).
Since the level of inventory is large, the financial manager has to put into consideration
the ordering cost, carrying cost and stock out cost of the inventory in determining the
inventory level. For the purpose of this study Inventory level and inventory control
systems were considered.
2.3.3.1 Inventory Level

In the management of inventory the firm is always faced with the problem of meeting
two conflicting needs: - maintaining a large size of inventory for efficient and smooth
production and sales operations and maintaining a minimum level of inventory so as to
maximize profitability (Pandey, 2008). Both excessive and inadequate inventories are
not desirable. The dangers of excessive inventories are that stockholding costs are too
high and as a result the firms profitability is reduced. According to Mohammad (2011)
26
managers can create value for shareholders by means of decreasing inventory levels.
However, maintaining inadequate level of inventory is also dangerous because ordering
costs are too high. It may also lead to stock out costs. Saleemi (1993) asserts that there
are advantages of maintaining an ideal level of inventory. This includes economies of
scale to be gained through quantity and trade discounts, less risks of deterioration and
obsolescence, and reduced cost of insurance among others. A study carried out by
Mathuva (2010) on the influence of working capital management components on
corporate profitability found that there exists a highly significant positive relationship
between the period taken to convert inventories into sales and profitability. This meant
that firms maintained sufficiently high inventory levels which reduced costs of possible
interruptions in the production process and loss of business due to scarcity of products.
Nyabwanga et al(2012) found that small scale enterprises often prepare inventory
budgets and reviewed their inventory levels. These results were in agreement with the
findings of Kwame (2007) which established that majority of businesses review their
inventory levels and prepare inventory budgets. These findings had already been
stressed by Lazaridis and Tryponidis (2006) that enhancing the management of
inventory enables businesses to avoid tying up excess capital in idle stock at the expense
of profitable ventures. Nyabwanga et al(2012) assert that good performance is
positively related to efficiency inventory management.
2.3.3.2 Inventory Control System

A firm needs a control system to effectively manage its inventory (Pandey, 2008). There
are several control systems in practice that range from simple to very complicated
systems. A firm must ensure that the system it adopts must be the most efficient and
effective. Pandey (2008) argues that small firms may opt to adopt simple two bin
systems and the very large firms may choose to adopt very complicated systems such as
ABC inventory control systems or Just in Time (JIT) systems. A study carried out by
Grablowsky (2005) found that only large firms had established sound inventory control
systems for determining inventory re-order and stock levels. The firms used quantitative
27
techniques such as EOQ and Linear Programming to provide additional information for
decision making. Small firms on the other hand used management judgement without
quantitative back up.
Under this study, the objective was to examine how inventory control practices influence
profitability of manufacturing firms in Kenya and the null hypothesis was stated as
follows;
H03: Inventory control practices do not influence profitability of

2.3.3.1.1 Economic Order Quantity Model of Inventory Management

This model is an inventory control model and is based on minimization of costs,
between stock holding and stock ordering. It requires the determination of economic
order quantity (EOQ) which is the ordering quantity at which stock holding costs are
equal to stock ordering costs (Saleemi, 1993). It suggests that the optimal inventory size
is the point at which stock ordering costs are equal to the stock holding costs. The
optimal inventory size is also known as economic order quantity (EOQ). This model
helps an organization to put in place an effective stock management system to ensure
reliable sales forecasts to be used in ordering purposes (Atrill, 2006). In order to ensure
applicability of the EOQ model several assumptions must be taken into consideration.
First, the usage of stored product is assumed to be steady. Second, ordering costs are
assumed to be constant, i.e. The same amount has to be paid for any order size. Finally,
the carrying costs of inventory which are composed of cost of storage, handling and
insurance are assumed to be constant per unit of inventory, per unit of time. The EOQ
model therefore merely takes variable costs into consideration, although it can easily be
extended so as to include fixed costs (Ross et al., 2008). This model has been used in
the past by Nyabwanga et al(2012) in Kenya.
28
The basic EOQ model is based on the assumptions that only one product is produced,
annual demand requirements are known, demand is spread evenly throughout the year so
that demand rate is reasonably constant, lead time does not vary, each order is received
in a single delivery and there is no quantity discounts. The model is expressed as
follows:
EOQ = 2DS
H
Where D = Demand in units per year

S = Ordering cost per unit
H = Cost of Holding Inventories per unit per year
EOQ = Economic Order Quantity
Maintaining optimal inventory levels reduces the cost of possible interruptions or loss of
business due to the scarcity of products, reduces supply costs and protects against price
fluctuations (Nyabwanga et al., 2012).
2.3.4 Liquidity Management Practices
Manufacturing firms need cash and other liquidity assets or current assets to pay their
bills or current liabilities as they fall due. Liquidity ratios measure the relationship
between a firms liquid or current assets and its current liabilities as they fall due
(Cornett et al., 2009). If a company has insufficient current assets in relation to its
current liabilities, it might be forced into liquidation.
Liquidity problems can arise from the failure to convert current assets into cash in a
timely manner or from excessive bad debt losses. Therefore, liquidity is an important
aspect that conveys a good picture about the ability of the firm to generate cash and pay
short term liabilities and long term debts as they fall due (Award & Al-Ewesat, 2012).
Hence, Liquidity ratios are computed to compare the relationship between various
groups of current assets and current liabilities to measure the liquidity position of a firm.
29
Saleemi (1993) argues that liquidity ratios help in ascertaining the effectiveness of the
working capital management. Current, quick and cash ratios are the three types of
liquidity ratios that are normally computed. Amalendu and Sri (2011) in their study on
liquidity management on profitability in steel industries in India used current ratio and
absolute liquidity ratio as measures of liquidity. They found a positive relationship
between liquidity and profitability. However, for the purpose of this study, current and
quick ratios as well as cash management were considered.
2.3.4.1 Current Ratio

This ratio compares total current assets to total current liabilities. Current assets are the
assets which can be converted into cash within an accounting year and include short
term securities, debtors, bills receivable and stock (Pandey, 2008). Current liabilities on
the other hand, are claims from outsiders which are expected to mature for payment
within an accounting year and include creditors, bills payable and outstanding expenses
(Pandey, 2008). Current ratio is intended to indicate whether short term assets are
sufficient to meet short term liabilities.
Cornett et al(2009) assert that current ratio measures the shilling of current assets
available to pay each shilling of current liabilities. Wood and Sangster (1999) argue that
current ratio is so sector dependent as to be incapable of being defined as generally best.
They suggest factors that need to be considered when calculating this ratio. The factors
are put in a form of questions. First, what is the norm in this industrial sector? Secondly,
is this company significantly above or below that norm? And finally, if so, can this be
justified after an analysis of the nature of these assets and liabilities, and of the reasons
for the amounts of each held? The ratio when calculated is expressed as either a ratio to
1, with current liabilities being set to 1, or as a number of times representing the relative
size of the amount of total current assets compared with current liabilities. The most
acceptable current ratio is 2:1. Current ratio is computed by dividing current assets with
current liabilities.
30
Current ratio indicates the liquidity position of a company. It measures the ability of a
company to meet its current liabilities as they fall due. If a company has insufficient
current assets in relation to its current liabilities, it might be unable to meet its
commitments and be forced into liquidation (Saleemi, 1993).
2.3.4.2 Quick Ratio

Quick ratio measures the shillings of more liquid assets i.e. Cash and marketable
securities and accounts receivable that are available to pay each shilling of current
liabilities. An asset is liquid if it can be converted into cash immediately or reasonably
soon without a loss of value (Pandey, 2008). Quick ratio is found out by dividing quick
assets by current liabilities. Inventories are considered to be less liquid. Inventories
normally require some time for realizing into cash; their value has a tendency to
fluctuate (Pandey, 2008). Quick assets ratio measures firms ability to pay off short term
obligations without relying on inventory sales (Cornett et al., 2009). Quick ratio is
computed by getting the sum of accounts receivable, cash and marketable securities and
dividing the results by current liabilities. The most ideal ratio is 1:1.
Scholars have different opinion on the relationship between liquidity ratios and
profitability. According to a study carried out by (Radhika & Azhagaiah, 2012; Singh &
Pandey, 2008) current ratio has a high significant positive co-efficient with profitability
while Eljelly (2004) found that the relationship between current ratio and profitability is
negative. Smith and Begemann (1997) found insignificant association between current
ratio and profitability. Finally, Radhika and Azhagaiah (2012) found a negative
association between quick ratio and profitability.
2.3.4.3 Cash Management

Cash management is the process of planning and controlling cash flows into and out of
business, cash flows within the business, and cash balances held by a business at a point
in time (Pandey, 2008). Naser, Nuseibel and Al-Hadeya (2013) see cash management as
the process of ensuring that enough cash is available to meet the running expenses of a
business and aims at reducing the cost of holding cash. Efficient cash management
31
involves the determination of the optimal cash to hold by considering the trade-off
between the opportunity cost of holding too much cash and the trading cost of holding
too little cash (Ross et al2008). Atrill (2006) asserts that there is a need for careful
planning and monitoring of cash flows over time so as to determine the optimal cash to
hold.
A study by Kwame (2007) established that the setting up of a cash balance policy
ensures prudent cash budgeting and investment of surplus cash. These findings agreed
with the findings of Kotut (2003) who established that cash budgeting is useful in
planning for shortage and surplus of cash and has an effect on the financial performance
of the firms. Ross et al(2008) assert that reducing the time cash is tied up in the
operating cycle improves a businesss profitability and market value. This further
supports the significance of efficient cash management practices in improving business
performance. Nyabwanga et al(2012) in their study on effects of working capital
management practices on financial performance found that small scale enterprises
financial performance was positively related to efficiency of cash management.
In this study, the objective was to establish whether liquidity management practices
influence profitability of manufacturing firms in Kenya and the null hypothesis was
stated as;
H04: Liquidity management practices do not influence profitability of

2.3.4.1.1 Baumols Cash Management Model

The model was designed to minimize the sum of opportunity cost associated with
holding cash and trading costs associated with converting other to cash. The procedure is
very similar to the EOQ Model for inventory size but it deals with different variables. It
assumes that the firm holds a portfolio of marketable securities which can easily be
converted into cash (Baumol, 1952).
32
According to this model, cash is assumed to start from a replenishment level, C, and
then declines smoothly to a value zero. When cash declines to zero, it can be
immediately replenished by selling another C worth of marketable securities, for which
the firm has to pay a trading cost of F (Cornett et al., 2009).
In Baumol model, the financial manager has to decide on the repartition of liquid funds
between cash and marketable securities (Pandey, 2008). Once again, there is a trade-off
which constitutes the basis for the calculation. Yet, this trade-off is related to the
opportunity costs of holding cash which increase along with the cash level and the
trading costs which are incurred with every transaction and which decrease when the
cash level increases (Cornett et al., 2009).
The opportunity costs represent the interest forgone for funds which are held in cash
instead of being invested. The trading costs correspond to fixed costs which are incurred
when a company decides to either buy or sell marketable securities (Pandey, 2008). If a
company decides to maintain a low cash level it will have to carry out many transactions
leading to high trading costs but low opportunity costs because there are little idle cash
funds. If it maintains a high level of cash, the firms opportunity costs will be higher due
to the relatively large amount of un-invested cash but the trading costs will decrease
since only a few transactions will be necessary (Pandey, 2008).
Baumols cash management model has three assumptions; first, the firm uses cash at a
steady predictable rate, cash flows from operations also occur at a steady state and
finally the net cash out flow occur at a steady state. Under these assumptions the model
can be stated as follows:
C* = 2TF / i
Where: C= is the optimal cash replenishment level
T = is the annual demand for cash
33
F = is the trading cost per transaction
I = is the interest rate on marketable securities
Hence, using this formula an organization can determine the optimal cash replenishment
level. Despite the fact that Baumols cash management is an important tool in
management, it suffers from a number of short comings; first, the model assumes that
the firm has a constant, perfectly disbursement rate for cash. In reality, disbursement
rates are much more variable and unpredictable; secondly, the model assumes that no
cash will come in during the period in question. Since most firms hope to make more
money than they pay out, and usually have cash inflows at all times, this assumption is
obviously at odd with what we see. Finally, the model does not allow for any safety
stock of extra cash to buffer the firm against unexpectedly high demand for cash
(Cornett et al., 2009).
2.3.4.1.2 Miller-Orr Cash Management Model

This model was derived by Morton Miller and Daniel Orr (Cornett et al., 2009) in an
attempt to produce a more realistic approach to cash management over Baumols model.
The model manages to achieve a reasonable degree of realism while not being too
elaborate. It assumes that the net cash flows are uniformly distributed with zero value of
mean and standard deviation. The model uses some information to derive a
mathematical formula. First, the lower control limit, L, second, the trading cost for
marketable securities per transaction, F, third, the standard deviation in net daily cash
flows, , and finally, the daily interest rate on marketable securities, iday.
The model is given by the pair of mathematical notion:
Z* = 3 3F2 /4idays +L
H* = 3Z* - 2L
The firm determines L, and the firm can set it to a non-zero number to recognize the use
of safety stock. Z* is the optimal cash return point and is the replenishment level to
34
which cash is replenished when the cash level hits L. H* is the upper limit for cash
balances and cash balances are brought down to Z* when cash balance hits H* (Cornett
et al., 2009).
The firm sets the lower limit as per its requirements of maintaining cash balance and
upper limit as the control limit as well as its return point. If cash balance reaches the
upper limit, the firm buys sufficient securities to return the cash balance to a normal
level called the return point. When cash balances reach a lower limit, the firm sells
securities to bring the balance back to return point (Pandey, 2008).
ODonnell & Goldberger (1964) assert that the adequacy of cash and current assets
together with their effective handling virtually determines the survival or demise of a
concern. An enterprise should maintain adequate working capital for its smooth
functioning. If materials are recklessly purchased, it will result in dormant slow moving
and absolute inventory. However, inadequate amount of inventory will result to stock
outs and interruption in operations (ODonnell & Goldberger, 1964). Cash must also be
maintained at an ideal level. It may also result to increased cost due to mishandling,
waste and theft. Too much or inadequate level of cash balances mean cash is not
properly utilized. Inadequate level of cash balance for example can lead to stoppage in
business operations (Padachi, 2006). A company may be profitable but with no liquid
cash which can result to operations interruptions. The company can also be forced into
winding up by its creditors.
2.3.5 Working Capital Levels

Working capital is the amount of funds which a company needs to finance its day to day
operations (Nkwankwo & Osho, 2010). It is the difference between current assets and
current liabilities. A company can maintain a high level of its working capital in relation
to its total assets or may maintain its working capital at a low level. Whatever the level
of working capital maintained by a firm, there is an opportunity cost that is incurred. It
may either be liquidity risk or reduced profit. The opportunity cost depends on whether
the firm adopts a conservative or aggressive working capital policy. For the purpose of
35
this study, aggressive investment, conservative investment, aggressive financing and
conservative financing policies were considered.
2.3.5.1 Aggressive Investment Policy

An aggressive investment policy deals with the firms active control and management of
current assets with the aim of minimizing them (Hussain, Farooz & Khan, 2012). Under
this policy current assets are only demanded as they are needed to facilitate the operation
of the business. According to Al-shubiri (2011) aggressive investment policy results in
minimal level of investment in current assets versus fixed assets. Aggressive investment
policy indicates the smallest level of investment in short term assets versus long term
assets (Nasir & Afza, 2009).
The degree of aggressiveness of working capital investment policy is measured by ratio

of current assets to total assets, where the lower value of this ratio shows more
aggressiveness (Weinraub & Visscher, 1998; Nasir & Afza, 2009). Other things being
the same, an aggressive investment policy results in lower current assets, lower
expenses, a shorter cash conversion cycle, higher risk and higher required return to
compensate the risk (Pinches, 1997). Hussain et al(2012) found that firms that use an
aggressive investment policy with low level of current assets increase profitability.
2.3.5.2 Conservative Investment Policy

Conservative assets management is a passive approach, in which current assets grow in
size whatever the situation (Pinches, 1997). A conservative investment policy sets a
greater proportion of funds in short term assets versus long term assets with opportunity
cost of low level profit (Nasir & Afza, 2009). Conservative investment policy places a
greater proportion of capital in liquid assets as opposed to productive assets (Al-shubiri,
2011). In managing current assets, the policy is more conservative, if the firm uses more
current assets in proportion to total assets (Weinraub & Visscher, 1998). Al-mwalla
(2012) found that a conservative investment policy has a positive impact on a firms
profitability and value.
36
Raheman et al(2010) found that firms follow a conservative working capital policy.
However, Weiraub and Visscher (1998) had found that industries do not significantly
follow either aggressive or conservative working capital policies. Therefore, some firms
follow aggressive and others conservative working capital policies. There is no strong
tendency that a more aggressive approach in one area is balanced by a more
conservative approach in the other (Weinraub & Visscher, 1998). According to
Sathymoorthi and Wally-Dima (2008) companies tend to adopt a conservative
investment approach during the time of high business volatility and an aggressive
investment approach in the time of low volatility.
2.3.5.3 Aggressive Financing Policy

According to Campsey, Brigham, Gilroy and Hutchinson (1994) current liability is a
desirable source of financing because it is usually cheaper than long term liabilities.
Aggressive financing policy utilizes higher levels of current liabilities and less long term
debt (Nasir & Afza, 2009; Al-shubiri, 2011). Using aggressive financing policy the firm
finances its seasonal and possibly some permanent requirements of current assets with
current liabilities (Gitman, 2009). Other things remaining the same, the higher the
current liabilities, the more aggressive the firms financing policy and low level of
current liability leads to conservative financing policy (Pinches, 1997).
Firms put the liquidity at risk, if they concentrate more on the utilization of current
liabilities by using aggressive current liability policy (Nasir & Afza, 2009). The level of
aggressiveness of working capital financing policy is measured by ratio of short term
liabilities to total assets, where the higher value of this ratio shows more aggressiveness
(Weinraub & Visscher, 1998; Nasir & Afza, 2009). An aggressive financing policy
results in higher shorter term liabilities, shorter cash conversion cycle, lower interest
cost, higher risk and higher required return (Pinches, 1997). Hussain et al(2012) found
that firms that use an aggressive financing policy with high level of current liabilities
37
increase profitability. However, Al-mwalla (2012) found that an aggressive financing
policy has a negative impact on firms profitability and value.
2.3.5.4 Conservative Financing Policy

A conservative financing policy uses more long term debt and capital. In an aggressive
financing policy, a firm uses high levels of short term liabilities and low level of long
term debt (Weinraub & Visscher, 1998). According to Sathymoorthi and Wally-Dima
(2008) companies tend to adopt a conservative financing approach during the time of
high business volatility and an aggressive financing approach in the time of low
volatility. Across the board firms use either an aggressive or conservative financing
policy and there is no strong tendency that a more aggressive approach in one area is
balanced by a more conservative approach in the other (Weinraub & Visscher, 1998).
Since the working capital levels have some influence on profitability as per the empirical
evidence, the study proposed to investigate whether working capital levels influence
profitability of manufacturing firms in Kenya and the null hypothesis was stated as
follows:
H05: Working capital levels do not influence profitability of manufacturing
Firms in Kenya
2.3.5.1.1 Risk Return Tradeoff Theory

The risk return trade off theory advocates that financial managers and investors
maximize their returns from their investments and at the same time minimize the risk.
Brooks (2013) asserts that the risk return trade off theory is concerned with how much
risk one can bear and at the same time remain comfortable and satisfied with the return
that an investment generates. Risk return trade off is defined as the relationship that
exists between risk and return that usually hold, in which one must be willing to accept
greater risk if one wants to purse greater returns (Pandey, 2008). The relationship
between risk and return is often expressed as follows; Return = Risk-free-rate + Risk
premium
38
The risk and the expected returns are expected to move in the same direction. The higher
the risk, the higher is the expected return. Very low risk investments provide a low
return and high risk investments provide a high return. A proper balance between risk
and return should be maintained to maximize the value of a firms shares (Pandey,
2008). Investors take higher risk investments in expectation of earning higher returns
(Weinraub & Visscher, 1998).
Cornett et al(2009) assert that in the short run, higher risk investments often significantly
under perform the lower risk investments. However, firms and investors should expect
higher risk investments to earn higher returns only over the long term. This theory was
used by Weinraub & Visscher (1998) Industry Practice relating to aggressive and
conservative working capital policies.
2.3.6 Profitability
Profitability is the ability for an organization to make profit from its activities. Agha
(2014) defines profitability as the ability of a company to earn profit. Profit is
determined by deducting expenses from the revenue incurred in generating that revenue.
Profitability is therefore measured by incomes and expenses. Income is the revenues
generated from activities of a business enterprise. The higher the profit figure the better
it seen as the business is earning more money on capital invested. For a manufacturing
firm, revenues are generated from sales of products produced. Expenses are the costs of
the resources used up and consumed in the manufacturing process together with other
selling and administrative expenses. Drucker (1999) asserts that for a business enterprise
to continue running, it must make profits. However, a business can not shut down its
doors simply because it has made a loss in a single financial year but when the firm
makes losses continuously in consecutive years this jeopardizes the viability of that
business (Dunn, 2009).
39
The amount of profit can be a good measure of performance of a company. So profit is
used as a measure of financial performance of a company as well as a promise for the
company to remain a going concern in the world of business (Agha, 2014). The
profitability position of the manufacturing firms was analyzed using return on assets
(ROA). Return on assets indicates how profitable a business is relative to its assets and
gives how well the business is able to use its assets to generate earnings calculated.
Nyabwanga, Ojera, Otieno and Nyakundi (2013) assert that return on assets must be
positive and the standard figure for return on assets is 10% - 12%. The higher the ROA
the better because the business is earning more money on the capital invested.
Working capital management plays an important role in improving profitability of firms.

Firms can achieve optimal management of working capital by making trade off between
profitability and liquidity (Makori and Jagongo, 2013). There is always a trade off
between liquidity and profitability. When one gains, the other one ordinarily means
giving up some of the other (Saleem and Rehman, 2011). Proper working capital
management ensures that the company increases its profitability. Effective working
capital management is very important due to its significant effect on profitability of
company and thus the existence of a company in the market (Agha, 2014)
2.4 Critique of the Related Literature

Studies carried out in Kenya by (Muchina and Kiano, 2011; Nyabwanga et al., 2012;
& Nyabwanga et al., 2013) were targeting SMEs and excluding large enterprises.
The results can only be interpreted in relation to small and medium enterprises.
Ikram, Mohamad, Khalid and Zaheer (2011) studied working capital management on
profitability in the cement industry. The results of the study were based on only one sub
sector within the manufacturing sector. Therefore, the results of this study should be
used with caution and should only be generalized to the cement industry and not entire
manufacturing sector.
40
Mathuva (2010) concentrated on the firms listed in Nairobi securities exchange. The
companies listed in the stock exchanges are large companies. Small companies were
excluded from this study. Therefore, the results of study can only be generalized on
large and listed companies.
Studies on working capital management use secondary data. Mousavi and Jari (2012),
Kaddumi and Ramadan (2012) and Gakure et al(2012) used record survey sheet to
collect the secondary data. However, Nyabwanga et al(2012) studied the effects of
working capital management practices on performance of small enterprises in Kisii
South District in Kenya. They used a questionnaire to collect the primary data.
Secondary data from financial statements give values at a specific date and therefore
require to be supplemented by primary data collected from opinions of finance
managers.
2.5 Research Gaps

Despite the fact that working capital management is a frequent area of research in
finance and accounting, there is very little study that has been carried out on
manufacturing firms. Most of the studies carried out ignore to include an explanation on
the relationship between the studies and the related theories and models. More so,
studies on the working capital management tend to be carried out more in the east.
However, Gill et al(2010) carried out their research on American manufacturing
companies. They argued that the results of their findings could only be generalized to
manufacturing firms similar to those that they included in their research. The sample
size that they used was also small. They further argued that future research should
investigate generalization of the findings beyond the American manufacturing
companies.
Padachi (2006) studied the trends in working capital management and its impact on
firms performance in small manufacturing companies in Mauritius. His study concluded
that there is a pressing need for further empirical studies to be undertaken on small
business financial management, in particular their working capital practices by
41
extending the sample size so that an industry wise analysis can help to uncover the
factors that explain the better performance for some industries and how these best
practices could be extended to other industries.
Muchina and Kiano (2011) studied the influence of working capital management on
firms profitability of small and medium enterprises sector. They argued that despite
significant role played by smes, their financial management environment is not well
understood especially in the area of working capital management. However, in their
study they attempted to analyze the relationship between working capital management
efficiency and profit in SME sector in Kenya. They looked at the whole spectrum of
enterprises and did not confine themselves on manufacturing firms. They also used
secondary data only.
Raheman and Nasr (2007) in their study on working capital management and
profitability concluded that if firms properly manage their cash, accounts receivables
and inventories, it will ultimately lead to increased profitability of the firms. They
suggested that further research be conducted on the same topic with different firms.
They also argued that further research be extended to working capital components
management including cash, marketable securities, receivables and inventory
management. There has been no study on cash management, receivables and inventory
management since the proposal to study on the same was given.
Therefore, this study was an attempt to fill the gap in knowledge concerning effects of
working capital management on profitability in the whole spectrum of the manufacturing
industry in Kenya both in quoted and unquoted companies. The study used primary data
for the independent variables and secondary data for the dependent variable.
42
CHAPTER THREE
RESEARCH METHODOLOGY
3.0 Introduction
This chapter describes the methodological design that was used to achieve the aims and
objectives of the study. Part 3.1 discussed the research design. The justification of the
chosen research design was given. Part 3.2 to 3.9 describe the target population,
sampling technique, sample size, research instruments, data collection procedures, pilot
test, data analysis and presentations, statistical model and hypothesis testing that were
used in the study.
3.1 Research Design

Research design is the plan, structure of investigation conceived so as to obtain answers
to research questions and to control variance (Kerlinger, 1973). Kothari (2004) states
that research design is the arrangement of the conditions for collection and analysis of
data in a manner that aims to combine relevance to the research purpose with economy
in procedure. In a study, a plan or program is prepared on what is to be done from
writing the hypothesis all through to data analysis. As Kothari (2004) puts it, it is the
blue print for the collection, measurement and analysis of data and includes an outline of
what is to be done from writing the hypothesis and its operational implications to the
final analysis of data. It implies how research objectives will be reached and how the
problem encountered in the research will be tackled (Kerlinger, 1973).
Shaughnessy, Zechmeister and Zechmeister (2002) assert that there are many different
types of research designs that can be used in research. However, historical research
design, case and field research design, descriptive research, correlational research
design, ex post facto research design, time series research design, experimental research
design and quasi experimental research design are the most used in social sciences. Each
research design has its own merits. This research design used correlational research
design because this research design attempts to explore relationships to make
predictions. Correlational research design is also appropriate because only one set of
43
subjects with six variables was used. Therefore, this research design was used to
identify, describe, show relationships and analyze variables of working capital
management that affect profitability in manufacturing firms in Kenya. The main
objective of a correlational research design is the discovery of associations among
different variables (Cooper & Schindler, 2011). Thomson, Diamond, mcwilliams and
Snyder (2005) argue that correlational evidence is more informative when exemplary
practices are followed as regards to measurements, quantifying effects, avoiding
common analysis errors and using confidence intervals to portray the range of possible
effects and the precision of the effects estimates. Correlational research design has been
used in similar past studies. Two most recent studies that used correlation research
designs are Mousavi and Jari (2012) and Kaddumi and Ramadan (2012). Mousavi and
Jari (2012) used correlational research design in their study to investigate the
relationship between working capital management and corporate performance of
companies listed in the Tehran stock exchange. Kaddumi and Ramadan (2012) used
correlational research design to investigate the effects of working capital management
on profitability on Jordan industrial firms listed at Amman Stock Exchange.
3.2 Population
A population is defined as total collection of elements about which we wish to make
some inferences (Cooper & Schindler, 2011). Other scholars (mcmillian & Schumacher
2010; Zikmund, 1997) define population as a large collection of subjects from where a
sample can be drawn. Kothari (2004) refers population to all items in any field of
inquiry which is also known as the universe.
Kitchenham and Pfleeger (2002) assert that a target population is the group of
individuals to whom the survey applies. It is the collection of individuals about whom
conclusions and inferences are made (Enarson, Kennedy & Miller, 2004). Mugenda and
Mugenda (2004) term target population as that population to which a researcher wants to
generalize the results of his study.
44
The studys target population was 413 manufacturing firms operating in Nairobi
industrial area and its environs. The respondents were the chief finance officers of
manufacturing firms registered with KAM and were in KAMs 2011 directory. The
study focused exclusively on the manufacturing firms that deal with transformation of
raw materials and semi finished products into more complex form or for the final
consumers. The 413 firms operated in twelve major industry groups as shown in
appendix V111.
3.3 Sampling Frame

Sampling frame is defined as a list of elements from which a sample is actually drawn
(Cooper & Schindler, 2011). It is a list containing items from which the sample is drawn
(Kothari, 2004). For the purpose of this study sampling frame constituted the firms
names contained in the KAMs 2011 directory.
3.4 Sample Size and Sampling Technique

The term sample is defined in various ways by different scholars. Bryman (2008) and
Spiegal (2008) define a sample as a part of the total population. However, Kothari
(2004) defines a sample as a collection of units chosen from the universe to represent it.
The sample should be as representative as possible of the entire population. Kerlinger
(1973) asserts that the smaller the sample, the larger is the sampling error and the larger
the sample, the smaller the error.
Kerlinger (1973) indicates that a sample size of 10% of the target population is large
enough so long as it allows for reliable data analysis by cross tabulation, provides
desired level of accuracy in estimates of the large population and allows for testing the
significance of differences between the estimates. Jayarathne (2014) while studying the
impact of working capital management on profitability from listed companies in Sri
Lanka used Naasiuma (2000) model to calculate the sample size from a population of 39
listed companies. Jayarathne (2014) arrived at a sample of 28 companies. In Kenya,
Nyanamba (2013) used Naasiuma (2000) model in his study on effects of corporate
45
reforms on corporate governance in coffee societies. This study used Naasiuma (2000)
model to determine the sample size. The sample size in this study was determined using
the following formula:
N= N (cv2) / {cv2 + (N-1) e2}

Where n = sample size
N = target population
Cv = co-efficient of variation which is taken as 0.5
E = Tolerance at desired level which is taken at 0.05 or at 95% confidence level
Using this formula, the sample size was computed thus:

N = 413 * (0.5)2 / {(0.5)2 + (413-1) (0.05)2}
N = 413 * 0.25 / {0.25 + (412 * 0.0025)}
N = 103.25 / {0.25 + 1.03}
N = 103.25 / 1.28
N = 80.66. This constituted 19.61% of the target population.
Proportional allocation was used to determine the size of each sample for different strata
Saunders, Lewis and Thornhill (2007). The sample was stratified into the twelve sub-
sectors as per KAM 2011 directory classification. The sample was determined as shown
in table 3.4 below:
Table 3.4: Determination of Sample Size

Category of Manufacturer Total No. %age Sample Size
Of Firms Ratio % age * 81
Building, Mining & Construction 10 2.42 2
Chemical & Allied Sector 61 14.77 12
46
Energy, Electrical & Electronics 18 4.39 4
Foods & Beverages Sector 88 21.31 17
Leather & Footwear Sector 6 1.45 1
Metal & Allied Sector 45 10.90 9
Motor Veh. Assembly & Accessories 20 4.84 4
Paper & Board Sector 52 12.59 10
Pharmaceutical & Med. Equip. 19 4.60 4
Sector
Plastics & Rubber Sector 53 12.83 10
Textile & Apparels Sector 27 6.54 5
Timber, Wood & Furniture Sector 14 3.39 3
Total 413 100.00 81
The study used stratified random sampling technique in the selection of the sample.
Bryman (2008), Cooper and Schindler (2011) and Saunders et al., (2007) assert that
stratified random sampling technique is appropriate where most population can be
segregated into several mutually exclusive sub-populations or strata.
3.5 Data Collection Instruments

The study used a questionnaire and a record survey sheet to obtain primary data and
secondary data respectively. Data for the dependent variable (profitability) was collected
from financial statements using a record survey sheet. Using record survey sheet,
important figures from statements of comprehensive income and financial position were
recorded for subsequent analysis. Data was obtained from Nairobi Securities Exchange
(NSE), web sites of different manufacturing firms, from the firms offices and from the
registrar of companies. The data collected span a period of five years covering the period
2008 to 2012. The reason to restrict the period of the study to five years was that the
latest data was readily available for this period.
47
Saunders et al(2007) indicate that most studies use questionnaires. Newing (2011) and
Bryman (2008) explain that questionnaires consist of a series of specific, usually short
questions that are either asked verbally by an interviewer or answered by the
respondents on their own. Questionnaires may be close or open ended. In close ended
questionnaires, the response categories are exhaustive and include possible responses
expected from respondents that include opinions and policy issues. A questionnaire was
used to collect data for the independent variables. A questionnaire was used in Kenya by
Nyabwanga et al(2012) and Kalundu et al(2012) to collect data on the effects of working
capital management practices on financial performance on small and medium scale
enterprises in Kisii South District and credit risk management practices in
pharmaceutical manufacturing companies in Kenya respectively.
3.6 Data Collection Procedure

Data was collected from the stratified sample of 81 firms. The data was collected
through the use of record survey sheet and a self administered questionnaire. Record
survey sheet was used to collect secondary data from financial statements that were
obtained from the registrar of companies, Nairobi securities exchange, companies
offices and websites.
A questionnaire was used to collect primary data. Cooper and Schindler (2011) support
the use of self administered questionnaires in descriptive studies because they cost less.
Saunders et al(2007) argue that self administered questionnaires are usually completed
by the respondents electronically using internet, posted to respondents who return them
by post after completion, or delivered by hand to each respondent and collected later. In
this study drop and pick method was used to administer the questionnaires. This method
is convenient to use, cheap, easier and quicker to administer. It is also highly convenient
for the respondents as they can complete the questionnaire during their spare time when
their work load is manageable. In the recent past the use of drop and pick administered
questionnaire method was used in Bangladesh by Rahman (2011) to collect primary data
on working capital management on profitability in textile industry. In Africa, Dumbu
48
and Chabaya (2012) successfully used drop and pick method to administered their
questionnaire on their study on the impact of working capital management practices on
performance of manufacturing micro and small enterprises in Zimbabwe.
3.7 Pilot Test

The purpose of a pilot test is to detect weaknesses in the design and implementation of a
questionnaire and to provide proxy for data collection of a probability sample (Cooper &
Schindler, 2011). Other scholars argue that the purpose of pilot testing is to establish the
accuracy and appropriateness of the research design and instrumentation (Saunders et
al., 2007; Sekaran, 2006; Bryman, 2008). Pilot testing has dual advantages; first, is to
catch potential problems, costly mistakes, provide an indication of time required for
actual field work and possible modifications of the instrument and modality of data
collection, second, enhancing the training of field staff, review of the instrument,
prevention of wasteful expenditures on a full blown survey whose results may not be
acceptable (Star, 2008). Thus, to check the validity and reliability of the questionnaires
in gathering the data required for the purposes of the study, a pilot study was carried out.
Baker (1988) argues that the size of a sample for the purpose of pilot testing can range
between 5% and 10%. However, Mugenda and Mugenda (2004) argue that the pretest
sample should be between 1% and 10% depending on the size of the sample, the larger
the sample, the smaller the percentage. In this study, the questionnaire was pilot tested
on 10% of the sample to ensure that the instrument was relevant and reliable. The
questionnaire was tested on eight (8) respondents. In a pilot test the respondents do not
have to be statistically selected when testing for validity and reliability (Cooper &
Schindler, 2006). Nyabwanga et al(2012) assert that the respondents for a pilot study
must come from outside the sample selected from the main sample of the study and they
effectively used this method in their study on effects of working capital management
practices on financial performance of small and medium enterprises in Kisii south
district. They administered 10 questionnaires to small and medium enterprises in the
neighbouring Kisii central district. For the purpose of this study, the pilot test was done
49
on firms registered with KAM that were within Nakuru region. This minimized the cost
of carrying out the pilot test because the companies are close to each other. Nakuru
region also neighbours Nairobi environ where the main study was carried out.
3.7.1 Validity of Research Instrument

Validity refers to whether the questionnaire is measuring what it purports to measure
(Bryman & Cramer, 2006; Bryman, 2008). Mcmillan & Schumacher (2010) describe
validity as the degree of congruence between explanations of phenomena and the
realities of the world. While absolute validity is difficult to establish, demonstrating the
validity of a developing measure is very important in research (Bryman, 2008). This
study used both construct validity and content validity.
Saunders et al(2007) explain construct validity as the extent to which the measurement
questions actually measure the presence of those constructs one intended to measure. In
this study and for the purpose of construct validity, the questionnaire was divided into
several sections to ensure that each section assessed information for a specific objective,
and also ensured that the same closely tied to conceptual framework of the study.
Content validity is the extent to which the measurement device provides adequate
coverage of investigative questions. Creswell (2003) suggests that a colleague and / or
an external auditor can provide additional insight into the study and research findings.
To ensure content validity the questionnaire was subjected to though examination by
two independent resource persons, from the institute of certified public accountants of
Kenya. The resource persons were asked to evaluate the statements in the questionnaire
for relevance and whether they were meaningful and clear.
On the basis of evaluation, the instrument was adjusted appropriately before subjecting it
to the final data collection exercise. Quality items were chosen from review of relevant
theoretical and empirical literature of credit policy, accounts payable practices,
inventory control practices, liquidity management practices, working capital levels and
50
profitability. These items were used to construct the questionnaire in Appendix 1.
Nyabwanga et al(2012) used this approach of enhancing content validity in testing their
questionnaires.
3.7.2 Reliability of the Research Instrument

Reliability has been defined by various scholars as the repeatability, stability or internal
consistency of a questionnaire (Bryman, 2008; Cooper & Schindler, 2011; mcmillan &
Schumacher, 2010). In this study, the Cronbachs alpha was used to determine how
reliable the instrument was. Items in the questionnaire underwent reliability analysis in
accordance with the six factors extracted. The reliability co-efficient tells the
consistency of the questionnaire. Cronbachs alpha was used to calculate the average of
all possible split-half reliability co-efficients.
Cronbachs alpha was used to test the reliability of the measures in the questionnaire
(Cronbach, 1951). Bryman (2008) suggests that where cronbach alpha is used for
reliability test, as a rule of thumb, cronbach alpha values for items included in a study
should not be lower than 0.8. Nunnally (1978) suggested that where the cronbachs
alpha is used for reliability test, as a rule of thumb, cronbachs alpha values for items
included in a study should not be lower than 0.7. Gliem and Gliem (2003) recommend a
cronbach that exceeds 0.7. In this study, reliability of 0.7 and above was considered
acceptable and the formula developed by Cronbach was used to calculate the alpha
(Cronbach, 1951).
Sekaran (2006) and Cooper and Schindler (2011) assert that cronbachs alpha has the
most utility for multi-item scales at the interval level of measurement. Cronbachs alpha
requires only a single administration of questionnaire and provides a unique, quantitative
estimate of the internal consistency of a scale. To increase the reliability of the
questionnaire, this study used cronbachs alpha for separate domains of the
questionnaire rather than the entire questionnaire. Sekaran (2006) states that in almost
all cases, cronbachs alpha can be considered a perfectly adequate index of the inter item
51
consistency reliability. This study ensured that the questionnaires were self administered
(drop and pick later). This ensured that the targeted respondents filled the questionnaire.
3.8 Data Analysis

The data collected was first cleaned, sorted and coded using numerical numbers. Then it
was entered in the SPSS software after which analysis was done. The data was analyzed
in accordance with the objectives of the study. Statistical Package for Social Sciences
(SPSS) version 20.0 was used as a tool to analyze the data. SPSS program is the most
frequent used for data analysis. In the past, a number of studies used SPSS program to
analysis their data with the same theme of working capital management and profitability.
These studies include; Raheman et al. (2010), Saleem and Rehman (2011), Mohammad
(2011), Afza and Nazir (2011), Radhika and Azhagarah (2012), Hussain et al(2012),
Ahmad et al(2012) and Kaddumi and Ramadan (2012).
Descriptive analysis was the first step in the analysis. Descriptive statistics show the
percentages and mean of different items in the study. In the second step, the study
applied quantitative analysis. Before, quantitative analysis was carried out, factor
analysis was conducted. Principal component analysis (PCA) was used as a data
reduction technique to reduce a large set of measures to smaller, more manageable
number of composite variables to be used in subsequent analysis. All composite
variables with factor loading of less than 0.4 were eliminated from further analysis
(David, Patrick and Philip, 2010).
Before carrying out factor analysis, two tests were carried out to determine whether
factor analysis was necessary. Kaiser-Meyer-Olkin (KMO) and Barttletts test of
spherity analysis were carried out. The Kaiser-Meyer-Olkin (KMO) measure is used to
examine the appropriateness of factor analysis. High values (0.5 - 1.0) indicate that
factor analysis is appropriate. Therefore, if the KMO is more than 0.5 and Bartletts
value is less than 0.05, then factor analysis is necessary (Tabachnick & Fidell, 2007;
William, Brown & Osman, 2010). Values of below 0.5 imply that factor analysis may
52
not be appropriate (Paton, 2002). Vijayakumar (2013) in their study of working capital
efficiency and corporate profitability from Indian Automobile industry used Kaiser-
Merger-Olkin (KMO) measure to examine the appropriateness of the use of factor
analysis. They found KMO measure to be 0.582. This signified that factor analysis was
appropriate to be used in that analysis. Bartletts test of Sphericity gave a chi square
value of 155.445 with a p-value of 0.000. This further supported the use of factor
analysis in the study. In Kenya, Omesa, Maniagi, Musiega and Makori (2013) carried
out a study on working capital management and corporate performance. They used
Kaiser-Meyer-Olkin and Bartletts measure of Sphericity to examine the appropriateness
for the use of factor analysis. They found KMO measure to be 0.520 that signified that
factor analysis was appropriate to be used in that study. Bartletts test of Sphericity gave
a chi square value of 207.922 with a p-value of 0.000 which was significant at 99%
confidence. This further supported the use of factor analysis in the study.
Pearsons correlation, regression and ANOVA analysis were used. Karl Pearsons
correlation was used to show the relationship between variables such as those between
working capital management and profitability. Pearsons correlation was used to
measure the degree of association between different variables under consideration. A
number of recent studies have used Pearsons correlation, regression and ANOVA
analysis. Kaddumi and Ramadan (2012) used the models to determine the effects of
working capital management on profitability of Jordan industrial firms listed at Amman
stock exchange. Hussain, Farooz and Khan (2012) used these three models to investigate
the relationship between aggressiveness investment policy and aggressiveness financing
policy with profitability in Pakistan manufacturing firms.
In this study, an analysis of partial correlation between variables was also determined.
Kothari (2004) points out that partial coefficient of correlation measures separately the
relationship between two variables in a way that the effects of other related variables are
eliminated; the aim of the analysis was to measure the relationship between an
independent variable on the dependent variable holding all other variables constant; thus
53
each partial coefficient of correlation measures the effect of its independent variable on
dependent variable. Coefficient correlation between each set of pairs of variables was
computed guided by research hypothesis. A t-test at 5% level of significance was used to
determine the significance of partial correlation coefficient
Finally, the study used the regression analysis to estimate causal relationship between
profitability and other chosen independent variables. Multiple regression analysis was
used. Multiple regression analysis was used in the past by Uremadu, Egbide and Enyi
(2012) in their study on effects of working capital management and liquidity on
corporate profitability among Nigerian quoted firms. They used multiple analytical
models to estimate the relationship between the level of corporate profitability and four
independent variables; inventory conversion period, debtors collection period,
creditors payment period and cash conversion cycle.
3.9 Statistical Model and Hypothesis Testing

A standard multiple regression analysis was conducted to evaluate how well the
independent variables were significantly related to profitability (dependent variable). In
a standard multiple regression analysis all the independent variables are entered into the
regression equation at once because there are no control variables (Cameron, 2005). The
model was used in the past by Raheman et al(2010) in their study on working capital
management and corporate performance of manufacturing sector in Pakistan as well as
Hussain et al(2012) in their study on aggressiveness and conservativeness of working
capital management in Pakistan manufacturing sector. In this study the standard multiple
regression model had one dependent variable (Y) - for profitability and five independent
variables (X1, X2, X3, X4 & X5) being X1 (Credit Policy), X2 (Accounts payable
Practices), X3 (Inventory Control Practices), X4 (Liquidity Management Practices) and
X5 (Working Capital Levels) that were used to show that the stated independent
variables had an influence on profitability. The regression model was given by the
following equation: Y = 0 + 1x1 + 2 X2 + 3x3 + 4x4 + 5x5 +
Where
54
Y = Profitability
0 = Constant
X1 = Credit policy
X2 = Accounts payable practices
X3 = Inventory Control Practices
X4 = Liquidity Management Practices
X5 = Working Capital Levels
1 = Regression Coefficient of variable X1 (Credit Policy)
2 = Regression Coefficient of Variable X2 (Accounts Payable
Practices)
3 = Regression Coefficient of Variable X3 (Inventory Control
practices)
4 = Regression coefficient of variable X4 (Liquidity management
Practices)
5 = Regression Coefficient of variable X5 (Working Capital Levels)
= Error term
This study determined the sample size using a stratified sampling technique which is
probabilistic. Testing of the study hypotheses was done through the use of probability.
The method of hypothesis testing or significance testing is said to be probabilistic only
when the sample from the population is determined using probability sampling method
(Mosteller, Rourke & Thomas, 2000; Kingoriah, 2004).
3.9.1 Testing Hypothesis 1

To test the first hypothesis that credit policy does not have any influence on profitability
of manufacturing firms in Kenya, the following regression was used;
Y= 1 + 1(X1) +
Where 1 was the regression coefficient of credit policy, X1 was credit policy. The other
independent variables; accounts payable practices, inventory control practices, liquidity
management practices and working capital levels were held constant.
55
To test the second hypothesis that accounts payable practices do not influence
profitability of manufacturing firms in Kenya, the following regression was used;
Y= 2 + 2(X2) +
Where 2 was the regression coefficient of accounts payable practices, X2 was the
accounts payable practices. The other independent variables credit policy, inventory
control practices, liquidity management practices and working capital levels were held
constant.

To test the third hypothesis that inventory control practices do not influence profitability
of manufacturing firms in Kenya, the following regression was used;
Y= 3 + 3(X3) +
Where 3 is the regression coefficient of inventory control practices, X3 was inventory
control practices. The other independent variables credit policy, accounts payable
practices, liquidity management practices and working capital levels were held constant.
To test the fourth hypothesis that liquidity management practices do not influence
profitability of manufacturing firm in Kenya, a fourth regression was used;
Y= 4+ 4(X4) +
Where 4 was the regression coefficient of liquidity management practices, X4 was

liquidity management practices. The other independent variables credit policy, accounts
payable practices, inventory control practices and working capital levels were held
constant.
56
To test the fifth hypothesis that working capital levels do not influence profitability of
manufacturing firms in Kenya, a fifth regression was used;
Y= 5 + 5(X5) +
Where 5 was the regression coefficient of working capital levels, X5 were working
capital levels. The other independent variables credit policy, accounts payable practices,
inventory control practices and liquidity management practices were held constant.
3.9.6 Overall Model

The test for significance of coefficient of multiple regression was determined by the use
of F- test. This test was to check the significance of the whole regression model with the
prediction that all independent variables i.e. Credit policy, accounts payable practices,
inventory control practices, liquidity management practices and working capital levels
had no influence on dependent variable that is 1 = 2 = 3 = 4 = 5 = 0 and the
alternative prediction that at least one of the independent variable was not equal to zero
that is j 0; j = 1, 2, 3, 4, 5. The hypothesis to test is here below stated;
H0: 1 = 2 = 3 = 4 = 5 = 0
H1: At least one of (1, 2, 3, 4, 5 0)
57
CHAPTER FOUR
RESEARCH FINDINGS AND DISCUSSIONS
4.1 Introduction
The purpose of the study was to determine the effects of working capital management on
profitability of manufacturing firms in Kenya. This chapter presents the response rate,
sample firms characteristics, and descriptive analysis of the data, reliability, factor,
correlation, regression and ANOVA analysis. The chapter further presents the findings
from the tests of the five hypotheses that were drawn from the objectives.
4.2 Pilot Test Results

A pilot study was carried out to check on validity and reliability of the questionnaire in
gathering the data. A sample of 8 manufacturing firms was picked. Return rate was
100%. Factor analysis was carried out with a threshold of a factor loading of 0.3. All
composite measures that gave a factor loading of less than 0.3 were subsequently
dropped from the questionnaire. The composite measures that were retained constituted
all the questions in the questionnaire that were administered to the respondents during
main study. The results of factor analysis are as shown in table 4.5 below:
Table 4.5: Factor Analysis Results

Composite Dropped Retained
Measures Measures Measures
Credit Policy 19 2 17
Accounts Payable Practices 8 2 6
Inventory Control Practices 8 3 5
Liquidity Management Practices 12 4 8
Working Capital Levels 6 0 6
The results of the reliability test are shown in table 4.6.The study used cronbachs alpha
statistic with a threshold of more than 0.7. All variables gave a cronbachs alpha of
more than 0.7and therefore were retained for further study.
58
Table 4.6: Reliability Test Results
Variable Cronbachs Alpha
Credit Policy 0.913
Accounts Payable Practices 0.713
Inventory Control Practices 0.703
Liquidity Management Practices 0.833
Working Capital Levels 0.833
4.3 Response Rate

A total of 81 questionnaires were distributed to sampled respondents who were the chief
finance officers of the sampled manufacturing firms. Completed questionnaires received
were 71 in number which represented 87.7% response rate and 10 questionnaires were
not received which represented 12.3% of the total questionnaires distributed. Mugenda
and Mugenda (2004) assert that a response rate of more than 50% is adequate for
analysis. Babbie (2004) also asserts that a return rate of 50% is acceptable for analysis
and publishing. Babbie (2004) also stated that a 60% return rate is good and a 70%
return rate is very good. The overall response rate attained in this study of 87.7% was
higher compared to other similar studies. For example, Ojeka (2012) reported a response
rate of 85% in his study on credit policy and its effect on liquidity in manufacturing
firms in Nigeria. Kalunda et al(2012) reported a response rate of 70% in their study on
pharmaceutical manufacturing companies in Kenya and their credit risk management
practices. From the 71 questionnaires received there were no inconsistencies and errors.
Therefore, information from all the questionnaires was used for analysis. The drop and
pick method was used in administering questionnaires and this method partly
contributed to the high response rate achieved in this study. In addition, the higher
response rate was attributable to the fact that anonymity was assured as the potential
respondents were not required to disclose traceable identities. Response rate for the
returned and unreturned questionnaires is presented in table 4.7
59
Table 4.7: Rate of Response by the Respondents
Response Respondents (%)
Returned 71 87.7
Not Returned 10 12.3
Total Distributed 81 100.0
4.4 Firms Characteristics

Several aspects to describe the targeted manufacturing firms were used. The key factors
of the interest to this study were organizational form; whether listed company, other
listed companies, partnership or a co-operative society. The second aspect of interest
was the organizational structure of the manufacturing firm; whether simple, functional
form, divisional or matrix form. The other aspects of interest within the sample were;
firms number of years of operation, types of manufactured products, number of workers
employed by the firms, classification of the firms under KAM and the duration of the
firms under KAM. The sample characteristics information was considered crucial in
understanding the in-depth characteristics among sampled manufacturing firms. The
findings of these sample characteristics are presented in sections 4.4.1 to 4.4.7.
4.4.1 Industry Experience

The study sought to establish the period the firms had been in operation. The distribution
of firms industry experience is shown in table 4.8. A significant majority (61.9%) of
the respondents indicated that their firms were aged less than thirty years and only (25.
4%) were above 40 years old since they started their operations. This shows that the
firms have little experience in the manufacture and majority of the firms are small.
However, this study dealt with all sorts of firms; small, medium and large.
Table 4.8: Industry Experience
Category (%)
1 10 Years ago 12.7
11 20 Years ago 25.4
60
Over 50 Years ago 8.5
Total 100.0
4.4.2 Firms Duration with KAM

The study sought to establish the length of time the firms have been members of Kenya
Association of Manufacturers. Table 4.9 below shows the distribution of the firms by
length of time they have been members of Kenya Association of Manufacturers. Table
4.9 indicates that (11.3%) of the respondents had been members of KAM for between 1
5 years, (19.7%) between 6 10 years, (18.3%) between 11 15 years, (16.9%)
between 16 20 years, (18.3%) between 21 25 years and (15.5%) over 25 years. This
indicated that over (50%) of the firms were members of KAM for a period less than 15
years. This is in conformity to table 4.6 above that shows that majority of the firms
commenced their operations recently. Kenya Association of Manufacturers was
established in 1954 (KAM, 2006). Therefore, it has been in existence for the last 60
years. Only old and established firms wish to be under the umbrella of KAM. Moreover,
this indicates that industrial manufacturing is a young sector in Kenya that has yet to
gain experience and skills to profitably compete in international market.
Table 4.9: Firms Duration with KAM

Category (%)
1 5 Years 11.3
6 10 Years 19.7
11 15 Years 18.3
16 20 Years 16.9
21 25 Years 18.3
61
Over 25 Years 15.5
Total 100.0
4.4.3 Firms KAM Classification

The study sought to establish the class under which the firms have been grouped by the
Kenya Association of Manufacturers. As reflected in table 4.10 below, only (2.8%) of
the firms have been grouped under building, mining and construction sector, (14.1%)
chemical and allied sector, (5.6%) energy, electrical and electronics sector, (19.7%)
foods and beverages sector, (1.4%) leather and footwear sector, (9.9%) metal and allied
sector, (5.6%) motor vehicles assemblers and accessories sector, (12.8%) paper and
board sector, (5.6%) pharmaceutical and metal equipment sector, (12.8%) plastic and
rubber sector, (5.6%) textile and apparels and (4.2%) timber, wood and furniture sector.
This shows that foods and beverages sector had the highest number of firms followed by
chemical and allied sector and leather and footwear sector had the least number of firms.
This is because agribusiness is one of the oldest economic activities in Kenya. The
sector has grown rapidly over the years alongside astronomical population growth to
support ever increasing demand for foodstuffs and beverages. The byproducts of food
processing are used as derivatives for some chemical manufacturing. Thus, foods and
beverages and chemical and allied sectors are interrelated in terms of technology and
production inputs. Technology for leather and footwear is not well developed in Kenya
and such products cannot be competitively produced in Kenya. This explains the
concentration nature of these two sectors.
62
Table 4.10: Firms KAM Classification
Category (%)
Building, Mining and Construction 2.8
Chemical and Allied Sector 14.1
Energy, Electrical and Electronics Sector 5.6
Foods and Beverages Sector 19.7
Leather and Footwear Sector 1.4
Metal and Allied Sector 9.9
Motor Vehicles Assemblers and Accessories Sector 5.6
Paper and Board Sector 12.8
Pharmaceutical and Metal Equipment Sector 5.6
Plastic and Rubber sector 12.8
Textile and Apparels Sector 5.6
Timber, Wood and Furniture Sector 4.2
Total 100.0
4.4.4 Firms Organizational Form

The study sought to establish the firms form of organization. The distribution of the
firms by organization form is shown in table 4.11. A significant majority (94.4%) of the
respondents indicated that their firms are organized as limited companies while the rest
(5.6%) are organized as other forms of organizations. This indicates that about all the
firms are formal and abide with statutory requirements that include filing of annual
returns with Kenya Revenue Authority. It was expected that such formal organizations
have no problem in responding to questionnaires with information on issues pertaining
to finance. Kalunda et al (2012) carried out a study in pharmaceutical companies and
their credit risk management in Kenya. All the 20 firms were organized as limited
companies. The response rate was 70% (14).
63
Table 4.11: Firms Organizational Form
Category (%)
Listed Company 25.4
Other Limited Companies 69.0
Partnership 1.4
Sole Proprietorship 1.4
Co operative Society 1.4
Others 1.4
Total 100.0
4.4.5 Workers Employed by the Firms

The study sought to establish the number of workers employed by the firms. The
distribution of the companies in respective of workers they employed is shown in table
4.12 below. The respondents indicated that (5.6%) of their firms employed between 1
10 workers, (16.9%) between 11 50 workers, (25.4%) between 51 - 100 workers,
(33.7%) between 101 250 workers, (9.9%) between 251 - 500 workers and (8.5%) of
the firms employed over 500 workers. This indicates that majority of the firms (76%)
employed between 11 - 250 workers. This further indicates that majority of the firms in
the manufacturing industry in Kenya are small, medium and large (Kenya, Republic of
1999 & Kenya, Republic of, 2005). This was expected because majority of
manufacturing firms employ up to 100 workers (Kenya, Republic of, 2007). This reflects
that Kenya is a nascent industrializing nation whose manufacturing sector has not grown
as much as comparable nations in the Middle East. Manufacturing sector does not
contribute greatly to employment in Kenya.
64
Table 4.12: Workers Employed by the Firms
Category (%)
Between 1 and 10 Workers 5.6
Above 500 Workers 8.5
Total 100.0
4.4.6 Firms Manufactured Products

The study sought to establish the types of products manufactured by the firms. The
distribution of the types of the products manufactured by the firms is shown in table
4.13. Majority (80.3%) of the respondents indicated that their firms deal with either raw
materials or finished products. A significant number of respondents (64.8%) indicated
that their firms deal with finished goods. This shows that most manufacturing firms in
Kenya are engaged in primary and processing industrial activities. Thus, value addition
is largely minimal leading to the firms inability to competitively offer their products in
the world market. This means that majority of the firms have the ability to participate in
the international market through exports, but command low prices relative to their
counterparts in the developed nations.
Table 4.13: Firms Manufactured Products

Category (%)
Raw Materials 15.5
Parts 4.2
Semi Assembled Components 14.1
Finished Goods 64.8
All above 1.4
Total 100
65
4.4.7 Firms Organizational Structure
The study sought to establish the form of organization structure established in the firms.
Table 4.14 shows the distribution of the firms with their organization structure. A
significant majority (70.5%) of the firms shows that the firms organizational structures
are either simple or functional. The rest of the firms (29.5%) are organized either as a
division or matrix. This is expected because the firms employ up to 100 workers and
therefore they are small and medium (ROK, 2007). Table 4.14 also shows that the firms
are small and medium. Small firms do not require complex organizational structures.
Table 4.14: Firms Organizational Structure

Category ( %)
Simple Form 31.0
Functional Form 39.5
Divisional Form 22.5
Matrix 7.0
Total 100.0
4.5 Assumptions of Multiple Regression Analysis

4.5.1 Normality Tests for the Profitability
Inferential statistics are meant to infer whether there is underlying relationship within
the respective variables. For the purpose of subsequent analysis, the dependent variable
was subjected to normality test to check whether the data provided was normally
distributed or not. If the dependent variable is not normally distributed then there would
be problems in subsequent statistical analysis until the variable assumes normality
(Child, 1990). The best way to evaluate how far data is from normal is to look at a graph
and see if the distribution deviates grossly from a bell-shaped normal distribution
(Garson, 2012). Normality has been visually assessed by looking at a normal histogram
of frequencies with a superimposed curve.
66
Figure 4.2 shows that profitability is approximately normally distributed with a mean of
19.89 and a standard deviation of 5.902 and the number of manufacturing firms that
responded were 71 represented by N = 71.
Figure 4.2: Normal Histogram for Profitability
Shapiro Wilk (W) test was used to test normality of profitability (Dependent Variable).
Shapiro Wilk (W) Test for normality of profitability was used because the sample size
was small (71 respondents). Shapiro Wilk (W) test is appropriate where the sample is
between 7 to 2000 respondents (Shapiro and Wilk, 1965). For large samples of between
2000 and 5000 respondents, Kolmogorov Smirnov (D) test is appropriate (Park, 2008;
Garson, 2012). The hypothesis to test was whether the data was normally distributed is
given by H0 and H1, set = 0.05, the rule is reject H0, if p-value is less than , else fail to
reject H0: (Park, 2008; Garson, 2012), Where:
H0: The data is normal
H1: The data is not normal
The results of the test are shown in table 4.15. The table indicates that using the Shapiro
Wilk test, the profitability data was normal since the p value for the test was 0.086
67
which is higher than 0.05. The study therefore concluded that the profitability variable
was normal in distribution.
Table 4.15: Normality Results for Profitability

Shapiro - Wilk
Statistic Df Sig.
Profitability 0.957 71 0.086
4.5.2 Autocorrelation Test for Profitability

The study determined whether there was autocorrelation through calculation of Durbin
Watson statistic. The statistic has to lie between 1.5 2.5 (Cameron, 2005; Curwin &
Slater, 2008; Garson, 2012). The hypothesis to test was whether there was evidence of
lack of autocorrelation given by H0 and H1, set = 0.05, the rule was to reject H0, if p
value was less than else fail to reject H0: (Garson, 2012) Where:
H0: There was no evidence of autocorrelation
H1: There was evidence of autocorrelation
The results of the test are shown in table 4.16. Table 4.16 shows a Durbin Watson co-
efficient of 1.8423 with a p-value of 0.1674. Since Durbin Watson coefficient was
between 1.5 and 2.5 and p-value higher than 0.05, the study failed to reject the null
hypothesis that there was no autocorrelation in the data residual. The study therefore
concluded that there was no autocorrelation of the profitability. Thus, linear regression
model was appropriate for this study. Ogundipe, Idowu and Ogundipe (2012) used
Durbin Watson test to determine whether there was autocorrelation in their data
residuals. Since their calculated Durbin Watson coefficient was between 1.5 and 2.5
(i.e. 1.961) they concluded that there was no autocorrelation in the data residuals. This
justified the use of the regression model in their study.
68
Table 4.16: Autocorrelation Test for Profitability
Durbin Watson
Statistic Sig.
Profitability 1.8423 0.1674
4.5.3 Homoscedastic Test for Profitability

Homoscedasticity suggests that the dependent variable has an equal level of variability
for each of the values of the independent variables (Garson, 2012). A test for
homoscedasticity is made to test for variance in residuals in the regression model used.
Lack of an equal level of variability for each value of the independent variables is
known as heteroscedasticity. The probability probability plot (P-P Plot) is a graphical
method that is used to assess the normality as well as homoscedasticity of data
distribution. It compares an empirical cumulative distribution function of a variable with
a specific theoretical cumulative distribution function (Park, 2008). If two distributions
match, the plot forms a linear pattern passing through the origin with a unit slope. The
more the straight line formed by the P-P plot, the more the variable distribution
conforms to normality and homoscedasticity (Garson, 2012). The normal P-P plot of
profitability shown in figure 4.3 shows that there are minimum deviates of the points
from the line that cuts across the plane at 450. This guaranteed that the data used for the
dependent variable (profitability) was normally distributed and homoscedastic and
therefore the study adopted the multiple linear regression model.
69
Figure 4.3: Homoscedastic Test Profitability
4.5.4 Testing for Outliers

Detecting of outlier observations was done using cooks distance statistic. An outlier
refers to an observation that is numerically distant from the rest of the data (Barnett &
Lewis, 1994). Cooks distance statistic of 0.00 1.00 was taken as the standard
threshold in this study. The results of the analysis show minimum cooks distances of
0.000 for all the independent variables and maximum values of between 0.173 and
0.429. The mean values of the all the independent variables range between 0.012 and
0.025. The results showed that there was no problem of outliers. The study therefore
assumed normality assumption in the use of linear regression. The results of the analysis
are shown in table 4.17 below.
70
Table 4.17: Cooks Distance Statistics
Min. Max. Mean Standard N
Value Value Value Deviation
Credit Policy 0.000 0.429 0.025 0.067 71
Accounts Payable Practices 0.000 0.316 0.017 0.043 71
Inventory Control 0.000 0.173 0.012 0.025 71
Liquidity 0.000 0.220 0.017 0.037 71
Working Capital Levels 0.000 0.280 0.017 0.044 71
4.6 Effects of Credit Policy on Profitability in Manufacturing Firms

The first objective of the study was to determine whether credit policy influences
profitability of manufacturing firms in Kenya. The objective was tested through
seventeen (17) composite measures which were laid on scaled questionnaire. The
findings were presented in table 4.59 (Appendix IV) which shows the frequencies of
responses and mean on the effect of credit policy on profitability.
Credit management and policy are the basis for making decisions on extending credit.
The respondents were requested to indicate whether their firms extended credit facilities
to their customers. A significant majority (88.8%) indicated that their firms extended
credit facilities to their customers, (5.6%) did not commit themselves while few (5.6%)
indicated that their firms did not extend credit facilities to their customers. This shows
that the majority of the respondents were of the opinion that their firms extended credit
facilities to their customers. The responses had a mean of 4.28. Most responses were 4,
confirming that firms extend credit facilities to their customers and therefore the firms
were maximizing their profits because the purpose of extending credit is to maximize
profits (Damilola, 2006).
Production cycle of a manufacturing firm is always longer than that of a merchandized

organization. The respondents were requested to indicate whether their firms consider
the production cycle when setting credit standards. A significant majority (83.1%) of the
71
respondents indicated that their firms consider production cycle when setting credit
standards, (8.5%) decline to indicate while few (8.4%) indicated that their firms did not
consider the production cycle. Majority were of the opinion that production cycle of
manufacturing firms is considered before credit standards are set. The responses had a
mean of 4.10. Most of the responses were 4, confirming that the production cycle is
considered when setting the credit standards. This confirms the result of the study
carried out by Ojeka (2012) in Nigeria that found out that manufacturing companies in
Nigeria consider the production cycle when setting their credit standards.
The length of credit period customers are allowed has an implication on both sales and
profitability. The respondents were requested to indicate whether the period of time they
allow their credit customers has any influence on sales. A significant majority (83.1%)
indicated that the length of time customers are allowed on credit sales has an influence
on sales, (9.9%) declined to indicate while few (7%) indicated that the length of time did
not have any influence on sales. Majority of the respondents were of the opinion that the
length of credit period customers are allowed has an implication on both sales and
profitability. The responses had a mean of 4.23. Most of the responses were 4,
confirming the statement that the length of credit period allowed to customers has an
implication on sales and profitability. Lazaridis and Tryfonidis (2006) argue that credit
period whether from suppliers or granted to customers, in most cases, has a positive
impact on profitability.
The respondents were requested to indicate whether their firms frequently reviewed
levels of accounts receivables. A significant majority (95.8%) indicated that their
companies frequently reviewed levels of accounts receivables, (2.8%) declined to
indicate while few (1.4%) indicated that their companies did not review the levels of
their accounts receivables. Most of the respondents opined that their firms frequently
reviewed levels of accounts receivables. The responses had a mean of 4.41. Majority of
the responses were 4 and this confirms the statement that firms frequently review levels
of accounts receivables. This is in line with the argument of Elliots (2009) that
72
management must review and revise their credit policies periodically to incorporate
changes in strategic direction and risk tolerance or market conditions.
Credit sales are a sign that a firm is able to maximize its sales and therefore the profits.
However, the debts from customers must be recoverable. The respondents were
requested to indicate whether their firms reviewed the level of their debts. A significant
majority (87.3%) indicated that their firms reviewed the level of their debts, (9.9%) did
not commit themselves while few (2.8%) indicated that their firms did not review the
level of their debts. This shows that majority of the respondents showed that their firms
review the level of their bad debts. The responses had a mean of 4.23. Most of the
responses were 4 meaning that firms review the level of their bad debts. Eugene (1992)
and Owolabi and Obida (2012) argue that where goods are sold on credit a monitoring
system is important because without it, receivables will build up to excessive levels and
bad debts will off set 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.
The respondents were requested to indicate whether their firms investigated the
creditworthiness of their customers. A significant majority (84.5%) indicated that their
firms investigated the creditworthiness of their customers before they extended credit
facilities to them, (5.6%) declined to indicate while few (9.9%) indicated that their firms
did not investigate creditworthiness of their customers before extending credit facilities.
This indicates that the majority of the respondents were in agreement that their firms
investigate creditworthiness of their customers. The response question had a mean of
4.14. Most responses were 4 and this confirms that firms investigate creditworthiness of
their customers. So that credit is not allowed to customers who may default, creditors
must apply the techniques of credit selection and standard for determining which
customer should receive credit (Dunn, 2009). This process involves evaluating the
customer creditworthiness.
73
The respondents were requested to indicate whether their firms write off bad debts from
customers who do not pay. A majority (56.4%) of the respondents indicated that their
firms write off bad debts from customers who do not pay, (22.5%) declined to indicate
while few (21.1%) indicated that their firms do not write off bad debts from customers.
Majority of the respondents were of the opinion that their firms write off as bad debts
from customers who do not pay. The responses had a mean of 3.42. Most of the
responses were 3. This indicates that on average the respondents were neutral as to
whether their firms write off bad debts from customers who do not pay. This shows that
the firms have optimal credit policies that ensure that credit facility is granted only to
customers who pay their debts. Ross et al. (2008) assert that firms that are efficient in
receivable management should determine their optimal credit which minimizes the total
costs of granting credit.
The respondents were requested to indicate whether their firms had set credit terms that
stipulated credit period extension. A majority (63.4%) indicated that their firms had set
credit terms that had stipulated credit period extension, (8.5%) declined to indicate while
(28.1%) indicated that their firms had not set credit terms. The responses had a mean of
3.37. This indicates that most of the responses were 3 which mean that the respondents
were indifference. This further means that (50%) of the firms set credit terms that
stipulate credit period extension and (50%) of the firms do not. Ojeka (2012) carried out
a study in Nigeria that showed that manufacturing companies set credit terms that
stipulate credit period extension and that the credit terms are reasonable enough to
induce sales.
The respondents were requested to indicate whether their firms allowed cash discounts
to their customers to induce them to pay promptly. A significant majority (70.5%)
indicated that their firms allowed cash discounts to their customers to induce them pay
promptly, (22.5%) declined to indicate while few (7%) indicated that their firms did no
allow cash discounts to their customers. Majority of the respondents opined that their
firms allow cash discounts to their customers to induce them pay promptly. The
74
responses had a mean of 3.9. Therefore, most responses were 4 indicating that firms
allow cash discounts to their customers to induce them pay promptly. Reigner and Hill
(2010) argue that a cash discount acts as a tool to accelerate credit collection from the
customers and this helps the firm reduce on the level of receivables and their associated
costs. This means that the credit policy is designed well enough to bring about maximum
profit.
The respondents were requested to indicate whether their firms stipulated the amount of
discount allowed to a customer. A majority (69%) indicated that their firms stipulated
the amount of discount allowed to their customers, (19.7%) declined to indicate while
few (11.3%) indicated that their firms did not stipulate the amount of discount allowed
to their customers. The responses had a mean of 3.76. Hence, most of the responses were
4. This indicates that firms stipulate the amount of discount allowed to their customers.
Dunn (2009) asserts that once a credit decision has been made, the creditor has to decide
on the credit period, specify cash discount if any and credit instrument to be used. This
enables the debtor know with certainty the actual amount that he will pay and when to
pay.
The respondents were requested to indicate whether their firms considered production
cycle when setting the collection period. A significant majority (73.3%) indicated that
their firms considered production cycle when setting the collection period, (15.5%) did
not commit themselves while few (11.2%) indicated that their firms did not consider the
production cycle when setting the collection period. Majority of the respondents opined
that their firms considered production cycle when setting the collection period. The
responses had a mean of 3.86 and this is an indication that most responses were 4. This
shows that firms considered production cycle when setting collection period. This is in
line with the results of the study by Ojeka (2012) that found that manufacturing
companies in Nigeria consider production cycle when setting collection period.
75
The respondents were requested to indicate whether the period between credit sales and
cash collection was longer than 30 days. A majority (60.6%) indicated that the period
between credit sales and cash collection period was longer than 30 days, (14.1%) did not
commit themselves while (25.3%) indicated that the period between credit sales and
cash collection was shorter than 30 days. Majority of the respondents were of the opined
that the credit period allowed to customers is longer than 30 days. The responses had a
mean of 3.62. This is an indication that most of the responses were 4. Hence, the support
of the fact that the period allowed to customers is longer than 30 days. Ojeka (2012)
found that debtors collection period of manufacturing companies in Nigeria on average
was 30.65. However, Muchina and Kiano (2011) while studying small scale enterprises
in Kenya found that on average debtor collection period was 37 days. These two past
studies support the findings of this study that on average credit period between credit
sales and cash collection period is longer than 30 days
The respondents were requested to indicate whether their firms had set lenient credit
policies. A majority (56.4%) indicated that their firms credit policies were lenient,
(19.7%) did not commit themselves while (23.9%) indicated that the firms credit
policies were not lenient. Majority of the respondents indicated that their firms had set
lenient credit policies. The responses had a mean of 3.35. This indicates that most
responses were 3. This further indicates that the respondents were indifference as to
whether the credit policies set are lenient or stringent. This is an optimal credit policy.
According to Owolabi and Obida (2012) a loose credit policy increases sales and
profitability at the expense of liquidity and risk of bad debts. A strict credit policy on the
other hand increases liquidity and reduces the risk of bad debts but also reduces sales
and profitability. Therefore, a firm should strike a balance between loose and strict credit
policies.
The respondents were requested to indicate whether their firms overall credit policy had
an ability to increase sales. A significant majority (81.7%) indicated that their firms
overall credit policy had an ability to increase sales, (12.7%) did not commit themselves
76
while few (5.6%) indicated that the firms overall credit policy did not have an ability to
increase sales. Majority of the respondents were of the opinion that their firms overall
credit policy had an ability to increase sales. The responses had a mean of 4.17. Thus,
most responses were 4 implying that firms overall credit policies have the ability to
increase sales. This is an optimal credit policy that increases both liquidity and
profitability and reduces risk of bad debts (Owolabi & Obida, 2012).
The mean score of the responses was 3.89 on a scale of one to five. This shows that
there were more respondents who agreed with the statements in support of credit policy
having an influence on profitability. It can therefore be concluded that when credit
policy is well designed, it can adequately increase sales, reduce bad debts and improve
profitability in manufacturing firms.
The findings related to this objective are in concurrence with findings of prior studies.
Lazaridis and Tryfonidis (2006) found that credit period whether from suppliers or
granted to customers, in most cases, have a positive impact on profitability. They found
that firms were able to maximize sales and profits. Further, two collaborative studies
were carried out in Nigeria by (Ojeka, 2012; Owolabi & Obida, 2012) who argue that
where goods are sold on credit a monitoring system is important because without it,
receivables will build up to excessive levels and bad debts will off set 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. Elliots
(2009) suggests a need for management to review and revise their credit policies
periodically to incorporate changes in strategic direction and risk tolerance or market
conditions. Dunn (2009) on the other hand suggests that customers who may default
should not be allowed credit and the suppliers must apply the credit selection and
standard for determining which customer should receive credit and only credit worthy
customers should access credit.
77
Many manufacturing firms in Kenya continue to extend credit to their customers. Due to
bulkiness in production the firms must ensure that the stock does not pile up. The firms
have designed credit policies to ensure efficiency in selling on credit. Although selling
on credit comes with challenges like delay in receiving cash from the customers, bad
debts and increased borrowing to finance credit sales, precautions are taken to ensure
that risk is minimized. At the same time increased credit sales bring about increased total
sales and therefore increased profits. The responses from the respondents indicate the
existence of a high acceptance of the credit policies by the chief finance officers of
manufacturing firms in ensuring that the credit policies are designed in such a manner
that they are capable of increasing profitability of their firms.
4.6.1 Reliability Measurement for Credit Policy

The reliability analysis was done on all the 17 composite measures to determine whether
they met the threshold of more than 0.7. The results of the analysis are as shown on table
4.18. The results of the analysis show cronbachs alpha of 0.828. This implies that the
instrument was sufficiently reliable for measuring credit policy.
Table 4.18: Reliability Measurement Results of Credit Policy

Variable Number of items Cronbachs Alpha
Credit Policy 17 0.828
Two tests were carried out to determine whether factor analysis was appropriate and the
results are displayed in table 4.19. The KMO results indicate a value of 0.689 which is
higher than the recommended value of 0.5 (Tabachnick & Fidell, 2007; William, Brown,
Osman, 2010). Bartletts test of sphericity on the other hand showed a p-value of 0.000
which was lower than 0.05 (Tabachnick & Fidell, 2007; William, Brown, Osman, 2010).
The two tests indicate that it was desirable to perform principal component analysis.
78
Table 4.19: KMO and Bartletts Test Results of Sphericity for Credit Policy
Kaiser- Meyer-Olkin Measure of
Sampling Adequacy 0.689
Bartletts Test of Sphericity Approx. Chi square 614.185
Df 136
Sig. .000
When the 17 composite measures on credit policy were subjected to principal

component analysis, the results indicated that majority of the items, 14 measures loaded
between 0.538 and 0.873 while only 3 measures your firm sometimes take legal action
against customers who refuse to pay, the firm regularly writes to customers reminding
them to pay their debts and the discount allowed to your customers depend on the credit
period allowed had a factor loading of less than 0.4 (David et al., 2010). The factors
with low factor loading (< 0.4) were subsequently dropped and the critical drivers of
profitability are presented in table 4.60 (Appendix V). The rest of the study used the
retained 14 measures as the composite measure of credit policy.
4.6.2 Correlation Analysis between Credit Policy and Profitability

A correlation coefficient statistic that describes the degree of linear association between
credit policy and profitability was determined. Table 4.20 indicates that there is a
positive significant linear relationship between credit policy and profitability of
manufacturing firms in Kenya. This relationship has been illustrated by correlation co-
efficient of 0.346 at 0.01 significant level. This indicates that there is a positive and
significant relationship between credit policy and profitability. These results conform to
previous studies done by Gill et al. (2010) that found that firms that maintain accounts
receivables at optimal level are able to create and maximize their profits. This suggests
that credit policy is good for explaining the financial success of manufacturing firms in
Kenya and it is a critical factor to consider when taking decision to improve profitability.
79
Table 4.20: Correlation between Credit Policy and Profitability
Profitability Credit Policy
Profitability Pearson Correlation 1 .346**
Sig. (2-tailed) .015
N 71 71
Credit Policy Pearson Correlation .346**
N 71 71
** Correlation is significant at the 0.01 level (2-tailed).
4.6.3 Regression Line Fitting between Credit Policy and Profitability

A regression line was superimposed on the scatter plot of profitability versus credit
policy as shown on figure 4.4. The regression line indicates a positive gradient. The
finding of a positive relationship between credit policy and profitability concurs with
findings of past studies. Agha (2014) found a positive relationship between credit policy
measured by debtors turnover and profitability measured by return on assets. Arshad
and Gondal (2013) on the other hand, found a significant relationship between accounts
receivables period and profitability that was measured by return on assets. A positive
gradient means that credit policies used by the manufacturing firms are neither too strict
nor are they lenient. This ensures that the creditworthy customers are allowed to carry
goods on credit and this has an impact of increasing sales and by extension the profits.
Customers who are not creditworthy are not allowed to carry goods on credit. By
extension the firms are able to minimize the amount of bad debts and therefore increased
profits.
80
Figure 4.4: Curve Fit of Credit Policy and Profitability
Regression analysis was conducted to determine the amount of variation in profitability

explained by credit policy. The calculated R value was 0.346. R2 value = 0.12 which
means that 12% of the corresponding variation in profitability can be explained by
change in credit policy. The rest 88% can only be explained by other factors that are not
in the model. The results of the analysis are shown in table 4.21.
Table 4.21: Linear Estimation of Credit Policy and Profitability

R R Square Adjusted R Square Std. Error of the Estimate
.346 .120 .115 5.77739
A one way analysis of variance (ANOVA) that provided information about levels of
variability within the regression model and which formed a basis for tests of significance
was used. ANOVA for the linear model presented in Table 4.22 of credit policy and
profitability has an F - value = 7.248 which is significant with p value = 0.016 < 0.05
meaning that the overall model is significant in the prediction of profitability in
manufacturing firms in Kenya. The study therefore rejected the null hypothesis that
81
credit policy has no influence on profitability of manufacturing firms in Kenya and
confirmed indeed that there is a positive and significant influence of credit policy on
profitability in manufacturing firms in Kenya.
Table 4.22: ANOVA for Credit Policy and Profitability

Sum of Squares Df Mean Square F Sig.
Regression 231.765 1 231.765 7.248 .016

Residual 2206.346 69 31.976
Total 2438.111 70
Analysis of the regression model coefficients is shown in table 4.23. From the table
there is a positive beta co-efficient of 0.323 as indicated by the co-efficient matrix with a
p-value = 0.011 < 0.05 and a constant of 12.512 with a p-value = 0.000 < 0.05.
Therefore, both the constant and credit policy contribute significantly to the model. The
model can provide the information needed to predict profitability from credit policy. The
regression equation is presented as follows: Y = 12.512 + 0.323X1 + ; Where Y =
Profitability, X1 is the credit policy and is the error term
Table 4.23: Regression Coefficients of Credit Policy and Profitability

Coefficients
B Std. Error T Sig.
(Constant) 12.512 3.347 3.738 .000

Credit Policy 0.323 0.123 2.626 .011
4.6.4 Conclusion on Credit Policy

Despite the fact that the results of the study indicate ideal credit policies, there is still a
room for improving the credit policies to ensure maximum profit. Situations, business
environment and customers behavior change. Therefore, credit policy that may be
deemed to be ideal today may not be so sometime later. The finance managers should
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review their credit policies regularly to ensure that they remain ideal. In light of
transaction cost theory, transactions are handled in such a way as to minimize the costs
involved in carrying them. Firms should design credit policies that are capable of
increasing sales and profit at the same time minimizing the risk of bad debts. The firms
must be able to trade off between return and risk.
4.7 Effects of Accounts Payable Practices on Profitability

The second objective of the study was to assess the degree to which accounts payable
practices influence profitability of manufacturing firms in Kenya. The objective was
tested through six (6) composite measures on a scaled questionnaire. The findings were
presented in table 4.24 which shows the frequencies of responses and mean on the effect
of accounts payable practices on profitability.
Firms that receive credit facilities from their suppliers are firms that have good
relationship with their suppliers. The respondents were requested to indicate whether
their firms received credit facilities from their suppliers. A significant majority (91.6%)
indicated that their firms received credit facilities from their suppliers, (2.8%) did not
commit themselves while few (5.6%) indicated that their firms did not receive any credit
facility from their suppliers. The question had a mean of 4.24 and this shows that most
of the responses were 4. This is an indication that firms receive credit facilities from
their suppliers. When a firm carries goods on credit, it sometimes forgoes a cash
discount. Therefore, as argued by Horne and Wachowiwz (2005), a firm must weigh the
advantages of paying cash and therefore receive cash discount and the possibility of
losing cash discount, and any possible late payment penalties.
A significant majority (73.2%) of the respondents indicated that their firms received
cash discounts from their suppliers, (15.5%) did not commit themselves while few
(11.2%) indicated that their firms did not receive cash discounts from their suppliers.
The responses had a mean of 3.79 and this shows that most of the responses were 4. This
implies that the firms receive cash discounts from their suppliers. A customer receives a
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cash discount when he makes payment within the cash discount period offered by the
supplier. Otherwise, the retailer pays the full invoice price within the trade credit period
(Huang, Chou & Liao, 2007). Cash discount period is shorter than the trade credit
period. Huang, Chou & Liao (2007) assert that cash discount has the effect of reducing
the cost of sales for a customer and therefore increased profit.
Interest charged by suppliers to debtors overdue accounts is an indication that all is not
well with the debtor. It is a sign that the debtor is in financial problems and is not able to
meet his financial obligations when they fall due. The respondents were requested to
indicate whether their firms were sometimes charged an interest by suppliers for late
payments. A few (38.1%) of the respondents indicated that that their firms were
sometimes charged an interest by their suppliers for late payment, (33.8%) did not
commit themselves and few others (28.2%) indicated that their firms were never charged
any interest for late payment. The responses had a mean of 3.13 suggesting that
majority of responses were 3 and this shows indifference as to whether the firms are
charged interest on late payment on their accounts. Basically, this shows that a few firms
may be having problems in meeting their financial obligations. A study by Ojeka (2012)
in Nigeria showed that businesses are allowed to charge interest on overdue invoices up
to 2% interest per month on the outstanding amount. By adding this interest to the
invoice prompts reluctant debtors to settle their accounts immediately. This shows that
the debtors are ignorant of settling their accounts unless they are pressurized by the
suppliers.
Waiving of a debt is a sign that the debtor has financial difficulties and other creditors
are cautioned from dealing with those customers. The respondents were requested to
indicate whether their firms past debts have ever been waived by their suppliers. A few
(30.9%) of the respondents indicated that debts of their firms had experienced a waiver
of their debts by their suppliers, (22.5%) did not commit themselves while (46.5%) of
the respondents indicated that their firms suppliers had never waived the debts of their
firms. The responses had a mean of 2.70 which shows that most responses were 3
84
indicating that the respondents were indifference as to whether their firms past debts
had been waived by their suppliers. Creditors do not normally waive debts owed by their
customers unless they are sure that the customers will never pay their debts. Neilthorpe
and Digney (2011) carried out a study on the injustices that creditors do in pursuing
bankrupt debtors whose lives and circumstances are already extremely difficult. They
discovered that creditors only waive debts owed by their customers only when they are
permanently incapacitated to pay the debts. The creditors also ensure that such debtors
are not extended further credit in future. Therefore, this study shows that manufacturing
firms in Kenya have capacity to pay their debts and continue taking credit from their
creditors.
The respondents were requested to indicate whether their firms are sometimes unable to
pay their suppliers. A majority (60.5%) indicated that their firms sometimes are unable
to pay their suppliers, (15.5%) did not commit themselves while few (23.9%) of the
respondents said that their firms had no problems paying their debts. The responses had
a mean of 3.49 that shows that most of the responses had a 3 and this indicates
indifference situation or a 50-50 situation where half of the respondents approved and
the other half disapproved the fact that their firms are sometimes unable to pay their
debts. Further, it is true that firms may have been unable to pay their debts in the past
may be due to financial commitment in the purchase of non current assets. Dominy and
Kempson (2003) argue that despite a firm having problems in paying creditors due to
unavoidable circumstances it must ensure that the debt is paid so that good relationship
continues with the creditor.
Dominy and Kempson (2003) carried out a study on review of creditor and debtor
approaches to non payment of bills in UK. From the study they were able to categorize
customers owing money into three groups according to their ability to pay; there are
those who had money to pay when the debts fell in arrears and were still in a position to
pay when creditors reach the late stages of debt recovery. At the other extreme end, there
are people who do not have money either when the debts fall into arrears or when their
85
creditors seek to recover the money owed. In between was a third group, that comprise
people who are able to pay when the debts fall into arrears, however, as a result of a
change in circumstances, they can no longer afford to pay.
When the respondents were requested to indicate whether the payment period allowed to
their firms by their suppliers was reasonable; a significant majority (80.2%) indicated
that the credit period allowed by their suppliers was reasonable, (12.7%) did not commit
themselves while few (7%) of the respondents indicated that the credit period allowed by
their suppliers was not reasonable. It shows that majority of the respondents agreed that
payment period allowed to their firms by their suppliers was reasonable. The responses
had a mean of 3.94. Majority of the responses were 4 indicating that payment period
allowed to their firms by their suppliers was reasonable. The study by Muchina and
Kiano (2011) shows that on average the firms were taking 64 days to pay their debts.
This is two months or so. This confirms that the creditors allow enough time to the
manufacturing firms to pay their debts.
The mean score of all the responses was 3.55 on a scale of one to five. This shows that
there were more respondents who agreed with the statements in support of accounts
payable practices having an influence on profitability. This means that accounts payable
practices are fairly good. Utilizing the relationship with the suppliers is a sound
objective that should always be highlighted as important just like optimal levels of
inventories and ideal credit policies (Hill & Sartoris, 1992). Accounts payable should
be optimally used by manufacturing firms. Sound management of suppliers credit
requires current up to date information on account of aging of payables to ensure proper
payments (Helfert, 2003).
Table 4.24: Accounts Payable Practices Results
86
Key: 1 = Strongly Disagree, 2 = Disagree, 3 = Neutral, 4 = Agree, 5 = Strongly Agree
Statement 1 2 3 4 5 Likert
% % % % % Mean
1 The firm receives credit facilities 1.4 4.2 2.8 52.1 39.5 4.24
from its suppliers
2 The firm receives cash discounts 5.6 5.6 15.5 50.7 22.5 3.79
from its suppliers upon payment
within a stipulated period of time
3 The firm is sometimes charged an 9.9 18.3 33.8 25.4 12.7 3.13
interest by its suppliers for late
payment
4 The firms past debts have ever 21.1 25.4 22.5 23.9 7.0 2.70
been waived by suppliers
5 The firm is sometimes unable to 7.0 16.9 15.5 40.8 19.7 3.49
pay its suppliers on time
6 The payment period allowed to the 1.4 5.6 12.7 57.7 22.5 3.94
firm by its suppliers is reasonable
Average 7.7 12.7 17.1 41.8 20.7 3.55
4.7.1 Reliability Measurement for Accounts Payable Practices

they met the threshold of more than 0.7. The results of the analysis are as shown on table
4.25. The results of the analysis show cronbachs alpha of 0.844. This implies that the
instrument was sufficiently reliable for measuring accounts payable practices.
Table 4.25: Reliability Measurement Results of Accounts Payable Practices

Variable Number of Items Cronbachs Alpha
87
Accounts Payable Practices 6 0.844
Table 4.26: KMO and Bartletts Test Results for Accounts Payable Practices
Kaiser- Meyer-Olkin Measure of Sampling
Adequacy 0.519
Df 15
Sig. .000
When the 6 composite measures on accounts payable practices were subjected to

principal component analysis and the results indicated that all of the items had measures
loaded between 0.587 and 0.900. This means that all the factors had factor loading of
more than 0.4 (David et al., 2010). Therefore, all the composite measures were retained
as critical drivers of profitability and the results are presented in table 4.27. The rest of
the study used all the 6 measures as the composite measure of accounts payable
practices.
88
Table 4.27: Component Matrix of Accounts Payable Practices
Factor Factor
Loading
The firm receives cash discounts from its suppliers upon payment within a 0.900
stipulated period of time
The firm is sometimes unable to pay its suppliers on time 0.816
The payment period allowed to the firms by its suppliers is reasonable 0.815
The firm receives credit facilities from its suppliers 0.783
The firm is sometimes charged an interest by its suppliers for late payment 0.660
The firms past debts have ever been waived by its suppliers 0.587
4.7.2 Correlation between Accounts Payable Practices and Profitability

accounts payable practices and profitability was determined. Table 4.28 indicates that
there is a positive significant linear relationship between accounts payable practices and
profitability of manufacturing firms in Kenya. This relationship has been illustrated by
correlation co-efficient of 0.403 at 0.01 significant level. The results conform to the
previous studies done by (Mathuva, 2010) that showed that there is a positive and
significant relationship between the time it takes the firm to pay its creditors and
profitability. A positive relationship between accounts payable and profitability may be
due to the fact that the manufacturing firms in Kenya may rely more on credit facilities
offered by the suppliers than loans to finance working capital. Credit facilities from
suppliers are not charged any interest unlike loans from commercial banks. This facility
has an influence on profitability.
89
Table 4.28: Correlation between Accounts Payable Practices and Profitability
Accounts Payable
Profitability Practices

N 71 71
Accounts Payable Practices Pearson Correlation .403** 1
N 71 71
**Correlation is significant at the 0.01 level (2-tailed).
4.7.3 Curve Fit between Profitability and Accounts Payable Practices

A regression line was superimposed on the scatter plot of profitability versus accounts
payable practices as shown on figure 4.5. The regression line indicates a positive
gradient which means that an improvement in accounts payable practices leads to an
increased in profitability. This study contradicts the findings of the study by Saghir,
Hashmi and Hussain (2011) who found that lower profitability was associated with an
increase in the number of days of accounts payables. However, the findings of the study
conform to the study carried out by Kaddumi and Ramadan (2012) who investigated the
effects of working capital management on profitability of Jordan industrial firms listed
at Amman stock exchange. They found a positive relationship between average payment
period with profitability. The positive relation between average payment period and
profitability can be explained by the fact that lagging payments to suppliers ensures that
the firm has some cash to purchase more inventory for sale thus increasing its sales level
hence boosting its profits.
90
Figure 4.5: Curve Fit of Accounts Payable Practices and Profitability
explained by accounts payable practices. The calculated R value was 0.403. R2 value
was 0.162 which means that 16.2% of the corresponding variation in profitability can be
explained by change in accounts payable practices. The rest 83.8% can be explained by
other factors that are not in the model. The results of the analysis are shown in table
4.29.
Table 4.29: Model Summary for Accounts Payable Practices

.403 .162 .157 5.34355
A one way analysis of variance (ANOVA) whose results formed a basis for tests of
significance was used. The ANOVA for the linear model presented in table 4.30 of
accounts payable and profitability has an F value = 16.014 which is significant with p-
value p = 0.000 < 0.05 meaning that the overall model is significant in the prediction of
profitability in manufacturing firms in Kenya. The study therefore reject the null
hypothesis that accounts payable practices do not have any influence on profitability of
91
manufacturing firms in Kenya and confirm indeed that there is a positive and significant
influence of accounts payable practices on profitability of manufacturing firms in
Kenya.
Table 4.30: ANOVA for Accounts Payable Practices and Profitability

Regression 459.268 1 459.268 16.014 .000

Residual 1978.843 69 28.679
Total 2438.111 70
Analysis of the regression model coefficients is shown in table 4.31. From table 4.31
p-value = 0.000 < 0.05 and a constant of 9.892 with a p-value = 0.000 < 0.05. Therefore,
both the constant and accounts payable practices contribute significantly to the model.
Therefore, the model can provide the information needed to predict profitability from
accounts payable practices. The regression equation is presented as follows: Y =
9.892+0.911X2 + ; Where Y = Profitability, X2 is the accounts payable practices and is
the error term
Table 4.31: Regression Coefficients of Accounts Payable Practices & Profitability

Coefficients
B Std. Error T Sig.
(Constant) 9.892 2.671 3.703 .000

Accounts Payable Practices .911 .231 3.944 .000
4.7.4 Conclusion on Accounts Payable Practices

Accounts payable practices should encourage the firms maintain the right amount of
credit with their suppliers. If well utilized accounts payable practices is a major source
of short term financing. However, if not properly utilized, it may bring about more
92
losses to the business than the benefits. This is because the firm may lose future supplies
on credit from suppliers and loss of cash discounts due to late payment (Raheman &
Nasr, 2007; Gill et al., 2010). The study shows that there is a strong relationship between
the firms and the suppliers. However, there is still a room for improvement. Firms
should ensure that they pay for their supplies early enough to avoid a situation where the
suppliers remind them of their debts. Early payment enables the firms enjoy good cash
discounts.
4.8 Effects of Inventory Control Practices on Profitability

The third objective of the study was to examine how inventory control influences
profitability of manufacturing firms in Kenya. The objective was tested through five (5)
composite measures on a scaled questionnaire. The findings were presented in table 4.32
which shows the frequencies of responses and mean on the effect of inventory control on
profitability.
Defined levels of inventories ensure that firms are able to plan when to procure for
additional inventories. The respondents were requested to indicate whether their firms
had defined levels of inventories for their raw materials. A majority (66%) indicated that
their firms had defined levels of inventories for their raw materials, (12.7%) did not
commit themselves while few (11.2%) indicated that their firms did not have defined
levels of inventories for their raw materials. The responses had a mean of 3.85. Majority
of responses had 4 indicating that the firms have defined levels of inventories for raw
materials. With well defined levels of raw materials, firms are able to maintain ideal
levels of stock and this further means minimum cost of ordering and stock holding.
Therefore, the firms are able to maximize their profits. This contradicts the study carried
out by Nyabwanga et al. (2012) that showed that majority of small firms do not stock
optimal quantities of inventories and do not determine re-order points.
An ideal level of inventories is a good indicator that the inventories are well managed
and this leads to increased profitability. The respondents were requested to indicate
93
whether their firms had determined optimal batch sizes. A significant majority (77.4%)
indicated that their firms had determined optimal batch sizes, (16.5%) did not commit
themselves while few (5.6%) indicated that their firms had not determined optimal batch
sizes. The responses had a mean of 3.90. Review of inventory levels helps firms
determine ideal levels of inventory and reduces redundant inventory. Atrill (2006)
asserts that there are certain costs that relate to holding too much inventories and also
costs relating to holding too little inventories. Thus, the management should put in place
an effective management system to ensure reliable sales forecast to be used in stock
ordering purposes.
Respondents were requested to indicate whether their firms reviewed inventory levels
periodically. A significant majority (91.5%) indicated that their firms reviewed
inventory levels periodically, (5.6%) did not commit themselves while few (2.8%)
indicated that their firms do not review their inventories levels. The responses had a
mean of 4.32. This is an indication that most of the responses were 4 implying that firms
review inventory levels periodically. Ross et al. (2008) observed that the economic order
quantity model is one of the approaches of determining the optimum inventory level and
takes into account the inventory carrying costs, inventory shortages costs and total costs
that help in determination of the appropriate inventory level to hold. The holding costs
increase in time e.g. Insurance, rent e.t.c. Therefore, the management needs to keep on
reviewing the level of inventories periodically.
Keeping accurate records helps firms reduce pilferages and theft as well as maintaining
ideal levels of inventories. This has an effect of reducing total cost of operation. The
respondents were requested to indicate whether their firms maintained accurate records.
A significant majority (94.4%) indicated that their firms keep accurate inventory
records, (5.6%) did not commit themselves while few (2.8%) indicated that their firms
did not keep accurate records. The responses had a mean of 4.34 and therefore, many of
the responses were 4 indicating that firms maintain accurate records. The requirements
of inventories keep on changing periodically. Therefore, records well kept help
94
managers determine optimal inventories levels. Lazaridis and Tryfonidis (2006) found
that firms that do not maintain optimal levels of inventories lead to tying up excess
capital at the expense of profitable operations. They argued that managers of firms
should keep their inventories to an optimum level since mismanagement of inventory
will lead to tying up of excess capital at the expense of profitable operations.
A firm that has a sound inventory control system is capable of maximizing profits. The
respondents were asked to indicate whether their firms had inventory control systems. A
significant majority (91.5%) indicated that their firms had inventory control systems,
(4.2%) did not commit themselves while few (4.2%) indicated that they did not have
inventory control systems. The responses had a mean of 4.22 indicating that firms have
established inventory control systems. This contradicts the study carried out by
Grablowsky (2005) that found that only large firms had established sound inventory
control systems for determining inventory order and stock levels. The firms use
quantitative techniques such as EOQ and Linear Programming to provide additional
information for decision making. Small firms on the other hand use management
judgement without quantitative back up.
there were more respondents who agreed with the statements in support of inventory
control having an influence on profitability. This shows that the finance managers of the
firms take precautions to ensure that their firms maintain ideal levels of inventories both
for finished goods and for raw materials to ensure increased profitability. Saleemi (1993)
asserts that firms can derive advantages by maintaining ideal levels of inventories and
these include economies of scale to be gained through quantity and trade discounts, less
deterioration and obsolescence, and reduced cost of insurance. Maintaining ideal levels
of inventories bring about increased profitability and therefore the firms are maximizing
profits. A study carried by Nyabwanga et al. (2012) showed that good performance is
positively related to efficiency of inventory management. They also found that the firms
95
were more efficient in the management of inventory than in the management of either
cash or receivables.
Table 4.32: Inventory Control Practices Results

% % % % % mean
1 The firm has defined levels of 5.6 5.6 12.7 50.7 25.4 3.85
inventories for raw materials
2 The firm has determined 1.4 4.2 16.9 57.7 19.7 3.90
optimal batch sizes
3 The firm reviews inventory 1.4 1.4 5.6 52.1 39.4 4.32
levels periodically
4 The firm keeps accurate 0 1.4 4.2 59.2 35.2 4.34
inventory records
5 The firm has installed an 1.4 2.8 4.2 54.9 36.6 4.22
inventory control system
Average 1.96 3.08 8.72 54.92 31.32 4.11
4.8.1 Reliability Measurement for Inventory Control Practices

The reliability analysis was done on all the items to determine whether they met the
threshold of more than 0.7. The results of the analysis show cronbachs alpha of 0.777.
This implies that the instrument was sufficiently reliable for measuring inventory
control. The results of the analysis are as shown in table 4.33 shown below:
Table 4.33: Reliability Measurement Results of Inventory Control Practices

96
Inventory Control 5 0.777
Table 4.34: KMO and Bartletts Test Results for Inventory Control Practices
Df 10
Sig. .000
When the
5 composite variables on inventory control practices were subjected to principal
component analysis the results indicated that all of the composite variables had measures
loaded between 0.478 and 0.719 which were higher than 0.4 as recommended by David
et al. (2010). All the factors were retained as critical drivers of profitability and the
results are presented in table 4.35. The rest of the study used all the 5 measures as the
composite measures of inventory control practices.
Table 4.35: Component Matrix of Inventory Control Practices

Factor Factor
97
Loading
The firm has installed an inventory control system 0.719
The firms keeps accurate inventory records 0.705
The firm reviews inventory levels periodically 0.680
The firm has determined optimal batch sizes 0.479
The firm has defined levels of inventories for raw materials 0.478
4.8.2 Correlation between Inventory Control Practices and Profitability

inventory control practices and profitability was determined. Table 4.36 indicates that
there is a positive significant linear relationship between inventory control practices and
profitability of manufacturing firms in Kenya. This relationship has been illustrated by a
correlation coefficient of 0.601at 0.01 significant level. This implies that there is a
positive and significant relationship between inventory control practices and profitability
of manufacturing firms in Kenya. The results conform to the previous studies done by
(Nyabwanga et al., 2012) who found that good business performance is positively
related to efficiency of inventory management. This positive relationship between
inventory control practices and profitability indicates that the manufacturing firms have
installed sound inventory control systems that ensure that total cost between stock
holding and ordering are at minimum level.
98
Table 4.36: Correlation between Inventory Control Practices and Profitability
Profitability Inventory Control Practices

N 71 71
Inventory Control Pearson Correlation .601** 1
Practices Sig. (2-tailed) .000
N 71 71
**. Correlation is significant at the 0.01 level (2-tailed )
4.8.3 Regression Line between Inventory Control Practices and Profitability

A regression line was superimposed on the scatter plot of profitability versus inventory
control practices as shown on figure 4.6. The regression line indicates a positive
gradient. The findings of a positive relationship between inventory control practices and
profitability concurs with those of Makori and Jagongo (2013) that found a significant
relationship between inventory control and profitability and where profitability was
measured by return on assets (ROA). A positive relationship indicates that maintaining
high inventory levels reduces the cost of possible interruptions in production process and
loss of business due to scarcity of products. Maintaining of high level of inventories
helps to reduce the cost of supplying the products and protects the firm against price
fluctuations as a result of adverse macro economic factors.
99
Figure 4.6: Curve Fit of Inventory Control Practices and Profitability

explained by inventory control practices. The calculated R value was 0.601. R2 value =
0.361 which means that 36.1% of the corresponding variation in profitability can be
explained by change in inventory control practices. The rest 63.9% can be explained by
other actors that are not in the model. The results of the analysis are shown in table 4.37.
Table 4.37: Model Summary of Inventory Control Practices

.601 .361 .354 4.23445
inventory control practices and profitability has an F value = 48.909 which is significant
with p-value p = 0.000 < 0.05 meaning that the overall model is significant in the
prediction of profitability in manufacturing firms in Kenya. We therefore reject the null
hypothesis that inventory control practices do not have any influence on profitability of
100
influence of inventory control practices on profitability of manufacturing firms in
Kenya.
Table 4.38: ANOVA for Inventory Control Practices and Profitability

Regression 1011.331 1 1011.331 48.909 .000

Residual 1426.780 69 20.678
Total 2438.111 70
p-value = 0.000 < 0.05 and a constant of 5.476 with a p-value = 0.012 < 0.05. Therefore,
both the constant and inventory control practices contribute significantly to the model.
inventory control practices. The regression equation is presented as follows: Y =
5.476+1.239X3+ ; Where Y = Profitability, X3 is the inventory control practices and is
the error term
Table 4.39: Regression Coefficients of Inventory Control Practices &Profitability

Coefficients
B Std. Error T Sig.
(Constant) 5.476 2.130 2.571 .012

Inventory Control
1.239 .177 6.993 .000
Practices
4.8.4 Conclusion on Inventory Control Practices

The results of the study have shown that when firms maintain good inventory control
systems, the firms profits are high. The firms should install modern inventory control
101
systems such as economic order quantity (EOQ) and just in time (JIT). These inventory
control systems help firms maintain optimal inventory levels. Maintaining optimal
inventory levels reduces cost of possible interruptions or loss of business due to scarcity
of products at the same time it reduces high cost of maintaining stock. Cost of high stock
includes stock theft, expiry, insurance and storage. In light of EOQ model, costs have to
be maintained at minimal level between stock holding and ordering. The firms should
also be able to put in place an effective stock management system that ensures reliable
sales forecast to be used in order purposes. Trained accountants should be employed to
help in maintaining accurate inventory records.
4.9 Effects of Liquidity Management Practices on Profitability

The fourth objective of the study was to establish whether liquidity management
practices influence profitability of manufacturing firms in Kenya. The objective was
tested through eight (8) composite measures on a scaled questionnaire. The findings
were presented in table 4.61 (Appendix VI) which shows the frequencies of responses
and mean on the effect of liquidity management practices on profitability.
Current assets are assets that are in liquid or need near liquid form. Liquid assets are
used to meet the short term debts of a firm that fall due within a short time. These short
term debts may include suppliers, various unpaid bills and part of the long loan that falls
due.
The respondents were requested to indicate whether their firms maintained current assets
at a higher level than current liabilities. A significant majority (90.2%) indicated that
their firms maintained current assets at a higher level than the current liabilities, (7%)
did not commit themselves while few (2.8%) indicated that their firms maintained
current assets at a lower level than the current liabilities. The responses had a mean of
4.30. Majority of the responses were 4 and this indicates that current assets are
maintained at a higher level than the current liabilities. Current assets are important to
the financial health of businesses of all sizes as the amounts invested in them are often
high in proportion to the total assets employed. Current ratio which is the ratio of current
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assets over current liability should be maintained at a level of 2:1 for an ideal situation
(Pandey, 2008). A study carried out by Raheman and Nasr (2007) found that firms
maintained liquidity ratio at 1.53. This means that the current assets were 1.53 more than
the current assets. Hence, current assets are maintained at a level higher than current
liabilities.
In manufacturing firms inventories constitute of raw materials, work in progress and

finished stock. If inventories constitute a high percentage value of the current assets then
the assets that are near cash have a small value. Quick ratio will be low and this is a
threat to liquidity. The respondents were requested to indicate whether inventory
constituted a large portion of the total current assets. A significant majority (83.1%)
indicated that inventories constitute a large portion of the total current assets, (5.6%) did
not commit themselves, while few (11.3%) indicated that inventories maintained by their
firms constitute a small portion of the current assets. The responses had a mean of 4.01.
Most responses were 4 indicating that inventories constituted a large portion of the total
current assets. Due to the composition of inventories of manufacturing firms of raw
materials, work in progress and stock of finished goods, manufacturing firms maintain
large inventories. A typical manufacturing firm maintains inventories that are in excess
of 50% of the total assets (Padachi, 2006; Reheman & Nasr, 2007; Mathuva, 2010;
Muchina & Kiano, 2011 and Nyabwanga et al., 2012). Therefore, this study confirms the
result of the previous studies that inventories constitute a large portion of both current
and total assets.
Respondents were requested to indicate whether cash and marketable securities were
maintained at a higher level than the current liabilities. A significant majority (67.6%)
indicated that cash and marketable securities were maintained at a higher level than the
current liabilities, (23.9%) did not commit themselves while few (8.5%) indicated that
their firms maintained cash and marketable securities at a lower level than current
liabilities. The responses had a mean of 3.77. Most responses were 4 indicating that cash
and marketable securities were maintained at a higher level than the current liabilities.
103
Opler, Pinkowitz, Stulz and Willianson (1999) while studying on the determinants and
implication of corporate cash holdings found that firms with strong growth opportunities
and riskier cash flows hold relatively high ratios of cash to non cash assets. They also
found that firms that do well tend to accumulate more cash.
Current, quick assets and cash ratios constitute liquidity ratios. Ideal liquidity ratios
show that a company is not experiencing liquidity problems and at the same time the
firm is able to maximize profits. The respondents were requested to indicate whether
their firms maintained liquidity ratios at optimal levels. A significant majority (78.8%)
indicated that their firms maintained liquidity ratios at optimal levels, (12.7%) did not
commit themselves while few (8.4%) indicated that their firms did not maintain liquidity
ratios at optimal levels. The responses had a mean of 3.92. Majority of the responses
were 4 indicating that the firms maintain liquidity ratios at optimal levels. This,
however, contradicts the findings by Nyabwanga et al. (2013) who established that the
current and quick ratios of smes studied were below standard norm of 2:1 and 1:1
respectively.
Respondents were requested to indicate whether their firms always prepared cash
budgets. A significant majority (88.7%) indicated that their firms prepared cash budgets
while the rest (11.3%) indicated that their firms did not prepare cash budgets. The
responses had a mean of 4.10. Most of the responses were 4. This shows that majority of
the firms prepare cash budgets. This is in agreement with the findings of Kotut (2003)
who established that over 56.25% of businesses studied prepared cash budgets on daily
basis and used them to plan for shortage and surplus of cash. However, it contradicted
the study carried out by Nyabwanga et al. (2012) who found that on average managers in
Kisii did not embrace cash budgeting as a tool to plan and control cash flows of their
businesses.
Respondents were requested to indicate whether cash flow projections aided them in
financial planning. A significant majority (85.9%) indicated that their firms were aided
104
by cash flow projections in their financial planning, (12.7%) did not commit themselves
while few (1.4%) indicated that the cash flow projections did not aid their firms in
financial planning. The responses had a mean of 4.13. Most responses were 4 indicating
that the firms are aided by cash flow projections in their financial planning. Cash flows
are the heart of all businesses and Sebastian (2010) argues that cash flow which is cash
receipts and cash payments determine the ability of firms to generate profit and continue
their operations. Therefore, the use of cash flow projections by the firms enabled the
firms maximize their profits.
Respondents were requested to indicate whether their firms had an optimal cash balance
policy. A significant majority (74.6%) indicated that their firms had an optimum cash
balance policy, (12.7%) did not commit themselves while few (12.7%) indicated that
their firms did not have an optimum cash balance policy. The responses had a mean of
3.84. This means that most responses were 4 indicating that firms have optimum cash
balance policies. A study by Kwame (2007) established that setting up of a cash balance
policy ensures prudent cash budgeting and investment of cash surplus. Further, Ross et
al (2008) assert that reducing the time cash is tied up in the operating cycle improves a
businesss profitability and market value and furthers the significance of efficient cash
management practices in improving business performance.
Both too high and too low liquidity levels are undesirable. The firms need to determine
ideal levels of liquidity. Ideal liquidity levels keep on changing with changing
circumstances and therefore firms need to regularly assess the optimal and minimum
liquidity levels. The respondents were requested to indicate whether their firms regularly
assessed the optimum and minimum levels of liquidity. A significant majority (83.1%)
of the respondents indicated that their firms regularly assess optimum and minimum
liquidity levels, (11.3%) did not commit themselves while few (5.6%) indicated that
their firms do not assess regularly the minimum and optimum liquidity levels. The
responses had a mean of 3.94. Most responses were 4 indicating that firms regularly
assess the optimum and minimum levels of liquidity. According to trade theory, firms
105
set their levels of cash holding by weighing the marginal costs and marginal benefits of
holding cash (Afza & Nasir, 2011). They also argue that firms have to regularly assess
the optimal and minimum levels of liquidity.
there were more respondents who agreed with the statements in support of liquidity
management practices having an influence on profitability. This indicates that firms are
holding a lot of liquid cash and therefore they can not maximize their profit. At the same
time the firms are liquid enough and therefore there is no likelihood of the firms going
bankrupt. High liquidity level means that the firms are putting their resources in liquid or
unproductive assets and this means that the firms can not maximize their profits. Bagchi
and Khamrui (2012) assert that as firms increase the level of liquidity the profitability of
the firm declines. There is a negative relationship between liquidity management
practices and profitability. When liquidity level is high, it is a good picture about the
firms ability to generate cash and pay short term and long term debts as they fall due
and at the same time the profitability level comes down (Award & Al-Ewesat, 2012).
4.9.1 Reliability Measurement for Liquidity Management Practices

they met the threshold of more than 0.7. The results of the analysis show cronbachs
alpha of 0.811. This implies that the instrument was sufficiently reliable for measuring
liquidity. The results of the analysis are as shown in table 4.40 shown below:
Table 4.40: Reliability Measurement Results of Liquidity Management Practices

Liquidity Management Practices 8 0.811
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Table 4.41: KMO and Bartletts Test Results for Liquidity Management Practices
Kaiser- Meyer-Olkin Measure of Sampling
Adequacy 0.759
Df 28
Sig. .000
When the 8 composite measures on liquidity management practices were subjected to

factor analysis the results indicated that all of the composite measures had measures
loaded between 0.357 and 0.722. The factor loadings for all the composite measures met
the threshold of 0.4 (David et al., 2010). Therefore, all the composite measures of
liquidity management practices were retained as critical drivers of profitability and the
results are presented in table 4.42. The rest of the study used all the 8 measures as the
composite measure of liquidity management practices.
Table 4.42: Component Matrix of Liquidity Management Practices

Factor Factor
Loading
The firms always prepares cash budgets 0.722
The inventories constitute a large portion of the total current assets 0.700
The firm has an optimum cash balance policy 0.650
The current assets are maintained at a higher level than the current liabilities 0.634
The firm is aided by cash flow projections in financial planning 0.630
The firm regularly assesses the optimum and minimum levels of liquidity 0.596
The liquidity ratios are maintained at optimal levels 0.553
The cash and marketable securities are maintained at a higher level than the 0.357
current liabilities
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4.9.2 Correlation between Liquidity Management Practices and Profitability
liquidity management practices and profitability was determined. Table 4.43 indicates
that there is a positive significant linear relationship between liquidity management
practices and profitability of manufacturing firms in Kenya. This relationship has been
illustrated by correlation coefficient of 0.711 at 0.01 significant level. This implies that
there is a positive and significant relationship between liquidity management practices
and profitability of manufacturing firms in Kenya. This conforms with the results of the
study carried out by Amalendu and Sri (2011) that found that there is a positive
relationship between current ratio and absolute liquidity ratio with profitability. The
positive relationship between liquidity management practices and profitability suggests
that managers of manufacturing firms are able to handle and manage cash effectively.
Through proper management of cash, the managers are able to create high profits for
their companies.
Table 4.43: Correlation of Liquidity Management Practices and Profitability

Liquidity Management
Profitability Practices

N 71 71
Liquidity Pearson Correlation .711** 1
Management Sig. (2-tailed) .000
Practices
N 71 71
**. Correlation is significant at the 0.01 level (2-tailed).
4.9.3 Regression Line between Liquidity Management Practices & Profitability

A regression line was superimposed on the scatter plot of profitability versus liquidity
management practices as shown on figure 4.7. The regression line indicates a positive
108
gradient which means that maintenance of an ideal level of liquidity leads to increased
profitability. The results conform to the previous studies done by (Hutchison, Farris &
Anders, 2007; Nyabwanga et al., 2012) that found that financial performance was
positively related to efficiency of cash management. A positive relationship between
liquidity management practices and profitability implies that the manufacturing firms in
Kenya are efficient in cash management and are able to set cash targets and maintain
optimal cash balances. They are able to trade off between the opportunity cost of holding
too much cash and the trading cost of holding too little cash.
Figure 4.7: Curve Fit of Liquidity Management Practices and Profitability

explained by liquidity management practices. The calculated R value was 0.711. R2
value = 0.5055 which means that 50.55% of the corresponding variation in profitability
can be explained by change in liquidity management practices. The rest 49.45% can be
explained by other factors that are not in the model. The results of the analysis are
shown in table 4.44.
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Table 4.44: Model Summary of Liquidity Management Practices
.711 .506 .491 3.88568
liquidity management practices and profitability has an F value = 90.677 which is
significant with p-value = 0.000 < 0.05 meaning that the overall model is significant in
the prediction of profitability in manufacturing firms in Kenya. We therefore reject the
null hypothesis that liquidity management practices do not have any influence on
profitability of manufacturing firms in Kenya and confirm indeed that there is a positive
and significant influence of liquidity management practices on profitability of
manufacturing firms in Kenya.
Table 4.45: ANOVA for Liquidity Management Practices and Profitability

Regression 1384.553 1 1384.553 90.677 .000

Residual 1053.558 69 15.269
Total 2438.111 70
p-value = 0.000 < 0.05 and a constant of 3.145 with a p-value = 0.151 > 0.05. Therefore,
the constant does not contribute significantly to the model and it is not different from
zero. However, liquidity management practices contribute significantly to the model.
liquidity management practices. The regression equation is presented as follows: Y =
110
0.912X4 + Where Y is the Profitability, X4 is the liquidity management practices and
is the error term
Table 4.46: Prediction of Profitability from Liquidity Management Practices

Coefficients
B Std. Error T Sig.
(Constant) 3.145 2.248 1.399 .151

Liquidity Management Practices .912 .094 9.702 .000
4.9.4 Conclusion on Liquidity Management Practices

Firms should invest the excess cash they hold to productive assets. This ensures that
firms are able to maximize their profits. The Baumol cash model shows that a firm
incurs an opportunity cost by holding cash. This opportunity cost increases with along
with the cash level. This further shows that when a firm holds a lot of cash, it can not be
able to maximize its profit. According to the Miller Orr model of cash management, a
firm must set a lower cash level, optimal cash return level and the upper limit. Cash
should never be allowed to go beyond the upper limit or below the lower limit. The
results of the study show that the firms hold a lot of cash. This is an indication that the
manufacturing firms in Kenya have not established their optimal cash target, lower and
upper cash limits. This further shows that the firms are not able to maximize their
profits.
4.10 Effects of Working Capital Levels on Profitability

The fifth objective of the study was to investigate whether working capital levels
influence profitability of manufacturing firms in Kenya. The objective was tested
through six (6) composite measures on a scaled questionnaire. The findings were
presented in table 4.47 which shows the frequencies of responses and mean on the effect
of working capital levels on profitability.
111
The study sought to establish whether the firms applied aggressive, moderate or
conservative working capital policies. High risk - high return working capital investment
and financing strategies are aggressive strategies while low risks and low return
strategies are conservative strategies (Moyer, mcguigan & Kretlow, 2002; Pinches,
1997; Brigham & Gapenski, 1994 & Gitman, 2009).
An aggressive investment policy is an indicator that firms are properly utilizing their
current assets optimally. The respondents were requested to indicate whether current
assets are maintained at a low level percentage of the total assets. A majority (69.1%)
indicated that their firms maintain a low level of current assets in relation to total assets,
(12.7%) did not commit themselves while few (18.2%) claimed that their firms
maintained a high level of current assets to the total assets. The responses had a mean of
3.51. Majority of the responses were 4. This is an aggressive investment policy because
current assets are kept low and are not allowed to grow in size and have an effect of
increasing profitability. Empirical studies carried out by Pinches (1997) indicated that an
aggressive investment policy with low levels of current assets results to low expenses
and a higher return. This study is further supported by a recent study carried out by
Hussain et al. (2012) who found that firms use an aggressive investment policy with low
level of current assets increase profitability.
Ideal current assets to current liabilities ratio is 2:1. A firm that is able to maintain this
ratio is a sign that the firm is healthy and is able to maximize its profits. The respondents
were requested to state whether their firms were able to maintain a current ratio of 2:1.
A significant majority (74.7%) indicated that their firms maintained the ideal ratio and
(7%) of the respondents did not commit themselves while few (18.3%) indicated that
their firms did not maintain a current ratio of 2:1. The responses had a mean of 3.65.
This shows that firms are able to maintain current ratio at 2:1. This means that
manufacturing firms in Kenya apply moderate investing policy in managing their
working capital levels. Raheman & Nasr (2007) assert that current assets of a
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manufacturing typical firm accounts for over half of its total assets and excessive level
of current assets can easily result in a firm realizing a substandard return on investment.
However, firms with too little current assets may result to shortages and difficulties in
maintaining smooth operations (Horne & Wachowicz, 2000).
Current liabilities constitute part of the total liabilities. Therefore, current liabilities
should always be less than total liabilities. The ratio between current liabilities and total
liabilities should be kept low to moderate depending on the firm. The respondents were
requested to indicate whether their firms maintained a high ratio of current liabilities to
total liabilities. A slight majority (50.7%) indicated that their firms maintained a high
ratio of current liabilities in relation to total liabilities, (15.5%) did not commit
themselves and (31%) of the respondents indicated that their firms maintain a low ratio
between current liabilities to total liabilities. The responses had a mean of 3.38. Most of
the responses were 3. This shows that the respondents were indifference as to whether
their firms maintain a high or low ratio of current liabilities to total liabilities. This is an
indication that manufacturing firms in Kenya apply moderate financing policies and the
findings contradict the findings of Weinraub and Vissscher (1998) who found that firms
were utilizing high levels of current liabilities to total liabilities.
A high ratio of current Liabilities to total assets ratio is a sign that a firm is using a high
degree of aggressive financing policy. The respondents were requested to indicate
whether their firms were maintaining a high level of current liabilities to total assets. A
slight majority (56.3%) indicated that their firms were maintaining a high ratio, (11.3%)
were indifference while (32.4%) indicated that their firms maintained a low ratio. The
responses had a mean of 3.35. Majority of the responses were 3. This shows that the
number of respondents agreeing and disagreeing on this view was almost equal.
Therefore, this shows that firms are applying moderate financing policy. When a firm is
utilizing a high ratio of current liabilities in relation to total assets then there is a
possibility of a working capital deficit. Working capital deficit exists if current liabilities
exceed current assets. In such a situation, short term funds are used to finance part of the
113
non current assets and the firm is said to be adopting an aggressive working capital
(Bhattacharya, 2001). Empirical studies carried out by (Weinraub & Visscher, 1998;
Nasir & Afza, 2009 and Hussain et al., 2012) show that firms that use aggressive
financing policy with high level of current liabilities increase profitability. However, a
study carried out by Al-mwalla (2012) shows contrary that an aggressive financing
policy has a negative impact on firms profitability.
For a stable organization long term funds, finance non current assets while current assets
are financed by current liabilities. The respondents were requested to indicate whether
current assets in their firms were financed from long term funds. A few (39.5%)
indicated that the current assets of their firms were financed through long term funds,
(11.3%) did not commit themselves while (49.3%) indicated that current assets were
financed through current liabilities of their firms. The responses had a mean of 2.89.
This shows that majority of the responses were 3 indicating that firms apply moderate
financing and investing policies. This confirms the assertion by Gitman (2009) that
working capital is financed by a combination of long term and short term funds of a
firm.
Long term sources of funds consist of capital (equity from owners) and long term debt
which only provide for a relatively small portion of the working capital requirements.
Finance theory dictates that only the permanent portion of the working capital should be
supported by the long term financing (Gitman, 2009). Thus, the firms appropriately
utilize both current liabilities and long term funds to finance the current assets.
there were almost an equal number of respondents who agreed and those who disagreed
with the statements in support of working capital levels having an influence on
profitability. This implies that both conservative and aggressive financing and investing
policies are not applied by manufacturing firms in Kenya. Thus, it can be argued that the
firms apply moderate financing and investing policies in managing their working capital.
114
Whatever the level of working capital maintained by firms, there is an opportunity cost
that is incurred. It may either be liquidity risk or reduced profit. Neither conservative nor
aggressive financing policy is being applied by the firms and this means that there is
neither too high nor too low use of long term debt and capital (Weinraub & Visscher,
1998). Since the firms use moderate financing and investing policies, it may be
concluded that the business environment is moderately volatile. Firms tend to adopt a
conservative financing approach during the time of high business volatility and an
aggressive financing policy during the time of low volatility (Sathymoorthi & Wally-
Dima, 2008). Since, the firms are maintaining ideal levels of working capital; it can be
argued that the firms apply moderate investing policy. This implies that firms
profitability level is moderate (Nasr & Afza, 2009).
Table 4.47: Working Capital Levels Results

% % % % % Mean
1 The firm maintains a low level of 9.9 8.4 12.7 59.2 9.9 3.51
current assets as a percentage of
total assets
2 The firm maintains a current ratio 7.0 11.3 7.0 59.2 15.5 3.65
of 2:1
3 The firm maintains a high level 18.3 12.7 18.3 40.8 9.9 3.11
of current liabilities in relation to
total liabilities
of current liabilities in relation to
total assets
of current assets in relation to
current liabilities
6 The current assets are financed by 12.7 36.6 11.3 28.2 11.3 2.89
long term funds of the firm
Average 11.28 18.58 12.12 44.80 13.26 3.30
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4.10.1 Reliability Measurement for Working Capital Levels
they met the threshold of more than 0.7. The results of the analysis show cronbachs
alpha of 0.853. This implies that the instrument was sufficiently reliable for measuring
working capital levels. The results of the analysis are as shown in table 4.48 below:
Table 4.48: Reliability Measurement Results of Working Capital Levels

Working Capital Levels 6 0.853
Table 4.49: KMO and Bartletts Test Results for Working Capital Levels
Df 15
Sig. .000
When the 6 composite measures on working capital levels were subjected to principal
component analysis, the results indicated that all of the composite measures had
measures loaded between 0.744 and 0.845. These loadings were higher than 0.4 (David
et al., 2010). Therefore, all the six composite measures of working capital levels were
retained as critical drivers of profitability. The results of the analysis are presented in
table 4.50 below.
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Table 4.50: Component Matrix of Working Capital Levels
Factor Factor
Loading
The firms maintain a high level of current liabilities in relation to total liabilities 0.845
The firms maintain a low level of current assets as a percentage of total assets 0.800
The firm maintains a current ratio of 2:1 0.777
The current assets are financed by long term funds of the firm 0.776
The firm maintains a high level of current assets in relation to current liabilities 0.774
The firms maintain a high level of current liabilities in relation to total assets 0.744
4.10.2 Correlation between Working Capital Levels and Profitability

working capital levels and profitability was determined. Table 4.51 indicates that there is
a positive significant linear relationship between working capital levels and profitability
of manufacturing firms in Kenya. This relationship has been illustrated by correlation
coefficient of 0.538 at 0.01 significant level. This implies that there is a positive and
significant relationship between working capital levels and profitability of
manufacturing firms in Kenya. The results contract the findings by Al-shubiri (2011)
that showed that there is a negative relationship between working capital levels and
profitability. However, the finding conforms to the results of Hussain et al. (2012) that
revealed that low investment in current assets and low current liabilities financing
increases the profitability of the firms. The positive relationship between working capital
levels and profitability implies that the manufacturing firms in Kenya invest heavily in
the productive assets (non current assets) and have low investment in the non productive
assets (current assets). Productive assets have the ability to generate profit unlike the non
productive assets. However, investment in current assets ensures that there is enough
liquid assets.
117
Table 4.51: Correlation between Working Capital Levels and Profitability
Working Capital
Profitability Levels

N 71 71
Working Capital Levels Pearson Correlation .538** 1
N 71 71
**. Correlation is significant at the 0.01 level (2-tailed).
4.10.3 Curve Fit between Working Capital Levels and Profitability

A regression line was superimposed on the scatter plot of profitability versus working
capital levels as shown on figure 4.8. The regression line indicates a positive gradient
which shows that there is a positive relationship between working capital levels and
profitability. The results contradict the study conducted by Al-mwalla (2012) that found
that an aggressive financing policy has a negative impact on profitability and value.
However, the results conform to the study done by (Hussain et al., 2012) that found that
the application of an aggressive financing policy with high level of current liabilities has
a positive influence on profitability. The positive relationship from the results indicates
that manufacturing firms have employed finance managers who are able to maintain
ideal working capital levels. The finance managers are able to balance between the
levels of current assets and current liabilities against the levels of non current assets and
non current liabilities.
118
Figure 4.8: Curve Fit between Working Capital Levels and Profitability

explained by working capital levels. The calculated R value was 0.538. R2 value was
0.2894 which means that 28.94% of the corresponding variation in profitability can be
explained by working capital levels. The rest 71.06% can be explained by other factors
that are not in the model. The results of the analysis are shown in table 4.52.
Table 4.52: Model Summary for Working Capital Levels

.538 .289 .281 4.87459
working capital levels and profitability has an F value = 45.756 which is significant with
p-value = 0.000 < 0.05 meaning that the overall model is significant in the prediction of
profitability in manufacturing firms in Kenya. The study therefore rejected the null
119
hypothesis that working capital levels do not have any influence on profitability of
influence of working capital levels on profitability of manufacturing firms in Kenya.
Table 4.53: ANOVA for Working Capital Levels and Profitability

Regression 972.123 1 972.123 45.756 .000

Residual 1465.988 69 21.246
Total 2438.111 70
p-value = 0.000 < 0.05 and a constant of 8.034 with a p-value = 0.000 < 0.05. Both the
constant and working capital levels contribute significantly to the model. Therefore, the
model can provide the information needed to predict profitability from working capital
levels. The regression equation is presented as follows: Y = 8.034 + 2.145X5 + ; Where
Y = Profitability, X5 is the working capital levels and is the error term
Table 4.54: Prediction of Profitability from Working Capital Levels

Coefficients
B Std. Error T Sig.
(Constant) 8.034 3.023 2.658 .000

Working Capital Levels 2.145 .391 5.486 .000
4.10.4 Conclusion on Working Capital Levels

From the study, it was discovered that the finance managers are very cautious in the use
of working capital items. They apply moderate financing and investment policies.
Aggressive investing and financing have the effect of increasing profitability while
conservative working capital policies have the effect of reducing profitability. However,
120
aggressiveness brings about increased risk. Return Risk trade off theory requires firms
balance between profitability and liquidity. Despite the fact that the firms adopt
moderate working capital policy, the chief finance officers may be doing it
unconsciously. Therefore, the firms should employ finance managers with sound
financial knowledge or train the finance managers on financial matters to ensure that
they understand better utilization of working capital items for the purpose of maximizing
profits for their firms.
4.11 Effects of Working Capital Management on Profitability

4.11.1 Combined Correlation Matrix for the all Variables
Results in table 4.62 (Appendix VII) show that all the variables are positively correlated.
Profitability positively correlates with all the independent variables. Correlation between
the dependent (profitability) and each of the independent variables is here below ranked
in accordance with their strength; Liquidity 0.711, Inventory Control 0.601, Working
Capital Levels 0.538, Accounts Payable Practices 0.403 and Credit Policy 0.346.
Correlation between profitability and liquidity is the strongest and credit policy has the
lowest among all the independent variables. This implies that the relationship between
profitability and liquidity is 0.711 and credit policy is 0.346.
The strength of relationships among independent variables is measured by the

coefficient of correlation. When the relationship between two independent variables is
strong, it is known as multicollinearity. When multicollinearity exists between
independent variables, the results of multiple regression analysis can not be relied upon.
There is no specific value at which we would say multicollinearity exists; it is a matter
of judgement (Curwin & Slater, 2008). Correlation among the independent variables in
this study do not show any sign of multicollinearity. Conventionally, a correlation of
more than 0.8 or less than -0.8 between two independent variables is a sign of
multicollinearity (Waters, 2011; and Garson, 2012). Correlation among all the
independent variables show a correlation of less than 0.8 and more than -0.8 with the
highest correlation being between inventory control and liquidity of 0.685 and the lowest
121
correlation between credit policy and liquidity of 0.281. Credit policy shows the
following correlation with the following independent variables; accounts payable
practices (0.578), inventory control (0.297), Liquidity (0.281) and working capital levels
(0.357). Accounts payable practices have correlation with inventory control (0.491),
liquidity (0.473) and working capital levels (0.581). Inventory control has a correlation
of 0.685 and 0.488 with liquidity and working capital levels respectively. Liquidity has a
correlation of 0.619 with working capital levels. Since correlation among all the
independent variables were less than 0.8 and more than -0.8, the study concluded that
there was no multicollinearity among the independent variables (Water, 2011; and
Garson, 2012). Therefore, the study was justified to apply linear regression analysis.
4.11.2 Test for Multicollinearity

Multicollinearity is an unacceptable high level of inter correlation among the
independent variables, such that effects of independent variables can not be separated
(Garson, 2012). In multiple regression, the variance inflation factor (VIF) is used as an
indicator of multicollinearity. Variance inflation factor (VIF) is a factor by which the
variance of the given partial regression coefficient increases due to given variables
extent of correlation with other predictors in the model (Dennis, 2011). As a rule of
thumb, lower levels of variance inflation factor (VIF) are desirable as higher levels of
VIF are known to affect adversely the results associated with multiple regression
analysis. A simple diagnostic of co linearity is the variance inflation factor for each
regression coefficient.
Garson (2012) asserts that the rule of thumb is that VIF > 4.0 multicollinearity is a
problem and other scholars use more lenient cut off of VIF > 5.0 when multicollinearity
is a problem. However, OBrien (2007) suggests that this rule of thumb should be
assessed in contextual basis taking into account factors that influence the variance of
regression coefficient. He further argued that the VIF value of 10 or even 40 or higher
does not necessarily suggest the need for common treatment of multicollinearity such as
using ridge regressions, elimination of some variables or combine into a single variable.
122
This study adopted a VIF value of 4.0 as the threshold. Credit policy had a VIF of 1.962,
accounts payable practices 2.357, inventory control 2.020, liquidity 2.115 and working
capital levels 1.504. These results indicate that the VIF values of the independent
variables were within the threshold of 4.0. This indicated that that there was no threat of
multicollinearity problem and therefore, the study used linear regression model. The
results of the analysis are shown in table 4.55.
Table 4.55: Co linearity Statistics

Co linearity Statistics
Tolerance VIF
Credit Policy .510 1.962
Accounts Payable Practices .424 2.357
Inventory Control .495 2.020
Liquidity .473 2.115
Working Capital Levels .665 1.504
4.11.3 Combined Effect of the Independent Variables on the Profitability

A combined effect of all the independent variables; credit policy, accounts payable
practices, inventory control practices, liquidity management practices and working
capital levels on profitability were tested. This was done through standard multiple
linear regression analysis. The multiple linear regression analysis determined the amount
of influence that each independent variable had on profitability on a joint model.
The result in table 4.56 shows that R2 was 0.933. This implies that 93.3% of the
variation in profitability is explained by the variation in the independent variables jointly
(credit policy, average payable practices, inventory control practices, liquidity
management practices and working capital levels). The remaining 6.7% can be
explained by other factors that are not in the model. This shows a very good fit of the
multiple data on the regression model. This fitness level is higher than all the levels of
fitness the individual variables had on individual regression models.
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Table 4.56: Model Summary on Combined Effect
.966 .933 .922 3.71343
A. Predictors: Credit Policy, Accounts Payable Practices, Inventory Control Practices,

Liquidity Management Practices, Working Capital Levels
The analysis of variance (ANOVA) in table 4.57 shows a good result for the multiple
linear regression model. It is an indication that working capital management components
influence profitability significantly. It shows the significance of the F statistics of
405.482 The p-value is 0.000 which is less than 0.05. This confirms the models
goodness of fit to explain the variations and validate that the independent variables
affect the dependent variable.
The hypothesis to be tested was:
H0: 1 = 2 = 3 = 4 = 5 = 0
H1: At least one of (1, 2, 3, 4, 5) 0
Therefore, the null hypothesis was rejected that all the partial regression coefficients are
equal to zero and concluded that at least one of the partial regression coefficients is not
equal to zero. The implication to these findings is that all the independent variables;
credit policy, accounts payable practices, inventory control practices, liquidity
management practices and working capital levels have a significant combined effect on
profitability and can be used to predict profitability.
124
Table 4.57: ANOVA for Multiple Regression Analysis
Regression 29764.413 5 5952.883 405.482 .000

Residual 954.233 65 14.681
Total 30718.646 70
A. Predictors: Credit Policy, Accounts Payable Practices, Inventory Control Practices,

Liquidity Management Practices, Working Capital Levels
Table 4.58 on coefficients showed that for liquidity management practices, the
regression coefficient is positive (0.693) indicating that the more ideal level of liquidity,
the higher the profitability of the manufacturing firm and the relationship is statistically
significant (p = 0.000). The regression coefficient on inventory control practices is
positive (0.401) and the relationship is statistically significant (p= .012). Working capital
levels show a positive coefficient (.402) and the relationship is statistically significant (p
= .033). The relationship between credit policy and profitability shows a positive
coefficient (0.061). The relationship is not statistically significant (.151). The coefficient
value for accounts payable practices negative (-0.099) indicating a negative relationship.
Therefore, for every unit change in accounts payable practices it results into 0.099
decrease in profitability. The relationship is not statistically significant as shown by p-
value .162.
This model suggests that once liquidity management practices, inventory control
practices and working capital levels are taken into account, the effect of credit policy
and accounts payable practices disappears. This means that profitability has less to do
with credit policy and accounts payable practices than it does with liquidity management
practices, inventory control practices and working capital levels.
125
The t values confirmed that liquidity, is the most useful predictor of effectiveness of
profitability (t = 4.582), then inventory control (t = 1.958), working capital levels (t =
1.379), credit policy (t = 0.735) and the least is accounts payable practices (t = -0.335).
Table 4.58: Beta Coefficients of the Variables of the Combined Model

Unstandardized Standardized
Coefficients Coefficients
B Std. Error Beta T Sig.
Credit Policy 0.061 0.083 0.811 0.735 0.111
Accounts Payable Practices -0.099 0.292 -0.043 -0.335 0.162
Inventory Control Practices 0.401 0.201 0.217 1.958 0.012
Liquidity Mgt. Practices 0.693 0.151 0.517 4.582 0.000
Working Capital Levels 0.402 0.291 0.114 1.379 0.033
A. Dependent Variable: Profitability
B. Linear Regression through the Origin
4.11.4 Optimal Conceptual Model

The research findings of this study as shown in table 4.58, indicated that there was a
need to modify the model. The model was therefore modified in line with the established
results in table 4.58. The optimal conceptual model has independent variables aligned
according to their degree of influence on the dependent variable, that is, profitability.
According to the findings in table 4.58 liquidity management practices, inventory
control practices and working capital levels had significant influence on profitability in
that order. Their p-values were liquidity management practices (.000), inventory control
practices (0.012) and working capital levels (0.033). However, Credit policy and
accounts payable practices did not significantly influence profitability as indicated in
table 4.58, credit policy (Sig. 0.111) and Accounts payable practices (Sig .162). Credit
policy and accounts payable practices were therefore dropped from the optimal
conceptual model.
126
The regression equation for the relationship can be remodeled as shown below:
Y = 0.693X1 + 0.401X2 + 0.402X3 +
Where: Y = Profitability
X1 = Liquidity Management Practices
X2 = Inventory Control Practices
X3 = Working Capital Levels
The reviewed optimal conceptual model of this study is as shown in figure 4.9. The new
adjusted optimal conceptual model is a realignment arising from the degree of influence
for each variable with a significant influence on profitability; liquidity management
practices, accounts payable practices and working capital levels
Inventory Control Practices Profitability
Working Capital Levels
Figure 4.9: Optimal Conceptual Framework
127
CHAPTER FIVE
SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
5.1 Introduction
The main objective of this study was to determine the effects of manufacturing firms in
Kenya. From the overall objective, the study sought to find out if credit policy, accounts
payable practices, inventory control practices, liquidity management practices and
working capital levels influence profitability of manufacturing firms in Kenya. This
chapter presents the summary of major findings of the study, overall conclusions based
on managerial and theoretical implications of working capital management in
manufacturing firms in Kenya. Finally, the chapter highlights important
recommendations for further research.
5.2 Summary of the Findings

The study was conducted based on the premise that working capital management does
not influence profitability of manufacturing firms in Kenya. The study reviewed both
theoretical and empirical literature on working capital management. From the review of
the related literature, a comprehensive conceptual framework of argument of the
relationship between working capital management and profitability was formulated.
The hypothesized relationship was tested empirically guided by the following specific
objectives; to determine whether credit policy influences profitability of manufacturing
firms, to a determine the degree to which accounts payable practices influence
profitability of manufacturing firms, to examine how inventory control practices
influence profitability of manufacturing firms, to establish whether liquidity
management practices influence profitability of manufacturing firms and to investigate
whether working capital levels influence profitability of manufacturing firms in Kenya.
The hypothesized relationship between the working capital management and
profitability were presented in a conceptual framework.
128
Based on the conceptual framework and objectives of the study, a questionnaire was
prepared and tested both for validity and reliability using Cronbachs Co-efficient alpha
, through a pilot study. The pretested questionnaire was used to collect the primary data
for the independent variables and a record survey sheet for the dependent variable
(profitability) from a stratified sample of 81 firms. Out of 81 firms, (71) 87.7%
responded. The independent variables of the study were tested for multicollinearity and
independence. Durbin Watson test was carried out to test the independence of
variables. Normality tests were carried out on the profitability (dependent variable)
using a histogram of frequencies and Shapiro Wilk test. Statistical package for social
sciences (SPSS) version 20.0 was used as the statistical tool for analysis all through.
Quantitative data was analyzed and described using descriptive and inferential statistics.
Scatter plots were used to examine and see if linear regression relationship existed after
which inferential statistical analysis for every variable was made. Multiple linear
regression analysis was used to test the combined effect of all the independent variables.
5.2.1 Credit Policy and its Effect on Profitability

The results of correlation showed that there was a positive significant linear relationship
between credit policy and profitability. This relationship was illustrated by correlation
coefficient of 0.346 at 0.01 significant levels. R square was 12% and this was relatively
low. This shows that Credit policy explains 12% of the variation in profitability of
manufacturing firms in Kenya. An F statistics of 7.248 indicated that the model was
significant. This was supported by the probability value of 0.016 which was less than
0.05. This indicated that the overall model applied can significantly predict outcome
valuable. These findings led to the rejection of null hypothesis and accepted the
alternative hypothesis that credit policy significantly influences profitability of
5.2.2 Accounts Payable Practices and their Effect on Profitability

The results of correlation showed that there was a positive significant linear relationship
between accounts payable practices and profitability. This relationship was illustrated by
129
correlation coefficient of 0.403 at 0.01 significant levels. R square was 16.2% and this is
relatively low. This shows that accounts payable practices explain 16.2% of the
variation in profitability of manufacturing firms in Kenya. An F statistics of 16.014
indicated that the model was significant. This was supported by the probability value of
0.000 which was less than 0.05 and therefore indicated that the overall model applied
can significantly predict the outcome valuable. The findings implied that the accounts
payable practices influence firms profitability in manufacturing firms in Kenya. These
findings led to the rejection of null hypothesis and accepted the alternative hypothesis
that accounts payable practices significantly influence profitability of manufacturing
firms in Kenya.
5.2.3 Inventory Control Practices and their Effect on Profitability

The results of quantitative analysis showed that there was a positive significant linear
relationship between inventory control practices and profitability. This relationship was
illustrated by correlation coefficient of 0.601 at 0.01 significant levels. R square was
36.1% and this was quite high. This showed that inventory control practices explain
36.1% of the variations in profitability of manufacturing firms in Kenya. An F statistics
of 48.909 indicated that the model was significant. This was supported by the probability
value of 0.000 which was less than 0.05 and therefore indicated that the overall model
applied can significantly predict (profitability) outcome valuable. These findings led to
the rejection of null hypothesis and accepted alternative hypothesis that inventory
control practices significantly affect profitability of manufacturing firms in Kenya.
5.2.4 Liquidity Management Practices and their Effect on Profitability

The results of inferential analysis showed that there was a positive significant linear
relationship between liquidity management practices and profitability. This relationship
was illustrated by correlation coefficient of 0.711 at 0.01 significant levels. R square was
50.6% and this was quite high. This shows that liquidity management practices explain
50.6% of the variation in profitability of manufacturing firms in Kenya. An F statistics
of 90.677 indicated that the model was significant. This was supported by the probability
130
value of 0.000 which was less than 0.05 and therefore indicated that the overall model
applied can significantly predict (profitability) outcome valuable. These findings led to
the rejection of null hypothesis and accepted the alternative hypothesis that liquidity
management practices significantly affects profitability of manufacturing firms in
Kenya.
5.2.5 Working Capital Levels and their Effect on Profitability

The results of quantitative analysis showed that there was a positive significant linear
relationship between working capital levels and profitability. This relationship was
illustrated by correlation coefficient of 0.538 at 0.01 significant levels. R square was
28.9% and this was moderate. This implies that working capital levels explain 28.9% of
the variation in profitability of manufacturing firms in Kenya. An F statistics of 45.756
indicated that the model was significant. This was supported by a probability value of
0.000 which was less than 0.05 and therefore indicated that the overall model applied
can significantly predict profitability. These findings led to the rejection of null
hypothesis and accepted the alternative hypothesis that working capital levels
significantly affect profitability of manufacturing firms in Kenya.
5.2.6 Combined Effect of all Independent Variables on Profitability

The study found that there is a strong combined effect of the study independent variables
(credit policy, accounts payable practices, inventory control practices, liquidity
management practices and working capital levels) on profitability of manufacturing
firms in Kenya. The effect was further found to be statistically significant.
The findings indicated that not all independent variables (credit policy, accounts payable
practices, inventory control practices, liquidity management practices and working
capital levels) made a significant contribution in explaining the dependent variable
(profitability). It was found that only Liquidity management practices and inventory
control practices had a positive and significant influence on profitability of
manufacturing firms. Credit policy and working capital levels did not contribute
131
significantly on profitability and accounts payable practices contributed negatively on
profitability of manufacturing firms although this contribution was insignificant.
5.3 Conclusion
Based on the empirical evidence adduced in this study, a number of logical conclusions
can be made.

The positive and statistically significant relationship between credit policy and
profitability implies that finance managers can maximize profits for their firms by
extending credit to their customers and ensuring that their credit policies are neither too
lenient nor too strict. They should ensure that they extend credit to only customers well
known to the firm and have a good history with the firm. Cash discounts should be
provided to the customers to induce them pay promptly. The credit period extended
should not be too long to ensure recovery of cash early. Further, it can be concluded that
there exists a positive and significant relationship between credit policy and profitability
in manufacturing firms in Kenya. This implies that credit policies were statistically
significant in explaining profitability of manufacturing firms in Kenya

Manufacturing firms in Kenya can reap reasonable benefits in inculcating a good
relationship with their suppliers. It is also evident that accounts payable practices
encourage firms maintain the right amount of credit with their suppliers. Well utilized
accounts payable is a major source of short term financing and the firm does not need to
borrow from the market if it can prudently utilize accounts payables.

The findings of inventory control on profitability of manufacturing firms in Kenya
showed that finance managers of manufacturing firms take precautions to ensure that
their firms maintain ideal levels of inventories of both raw materials and finished goods.
132
This may have led to increased profitability of manufacturing firms in Kenya and
therefore it can be concluded that there exists a positive and significant relationship
between inventory control and profitability.

The results of the study found that firms maintain high levels of liquid cash and this may
have led to reduced profitability. Therefore, it can be concluded that manufacturing
firms in Kenya have the ability to generate cash and pay short term and long term debts
when they fall due. The firms have no threats of becoming bankrupt. However, the firms
can not maximize their profits because the excess cash has no ability to generate profits.
The cash can be converted into productive assets and therefore generate further profits.

The results of the study were that manufacturing firms in Kenya applied moderate
financing and investment policies during the study period. Therefore, it is concluded that
the business environment was moderately volatile and this implies that the firms
profitability level was moderate. It can further be concluded that there exists a positive
relationship between working capital levels and profitability of manufacturing firms in
Kenya. Working capital level was significant in explaining profitability of
5.4 Recommendations of the Study

Based on the study findings, the following recommendations have been made;

Finance managers of manufacturing firms should regularly review their credit policies to
ensure that they are ideal. Ideal credit policies ensure that both sales and profit increase
and at the same time minimize the risk of bad debts. They should design credit policies
that are capable of helping their firms collect proceeds from debtors as good working
133
capital management urges for quick cash collection from credit sales for quick re-
investment in the short term securities in order to boost profitability.

Kenya Association of Manufacturers should advise member firms to ensure
improvement in the relationship between their firms and their suppliers. Firms pay
promptly their credit purchases so that the companies names are not damaged. This
ensures good reputation and goodwill. Early payment ensures that manufacturing firms
enjoy good relationship with their suppliers and also enjoy cash discounts for early
payment. Cash discounts help to increase profit and good relationship with suppliers
ensures availability of supplies and therefore improved working capital.

Firms should install and maintain good inventory control systems such as Economic
Order Quantity (EOQ) and Just in Time (JIT). This ensures that firms are maintaining
ideal levels of inventory that have an effect of increasing profitability of the firms. The
management should ensure that the staff is qualified to perform duties assigned. Ideal
inventories levels should be maintained. The staff should also maintain accurate
inventory records. All these have an impact on the profitability level of the firms.

The finance managers should establish optimal cash targets, lower and upper cash limits
in their firms. This ensures that firms hold neither too low nor too high cash levels. They
should invest excess cash in productive assets. This ensures that firms do not hold
excessive cash at the expense of increased fixed assets that are able of improving
profitability.

The Board of Directors of the manufacturing firms should employ finance managers
with sound financial knowledge or retrain their finance managers on financial matters to
134
ensure that they understand better utilization of working capital items for the purpose of
maximizing profits for their firms. The retrained finance managers will help the firms
maintain ideal levels of working capital and hence increased profitability of the firms.
5.5 Areas for Further Research

This study was not able exhaust all working capital management components that have
effects on profitability in manufacturing firms. Therefore, effects of prepayments,
accrued expenses, government regulations and policy, economic environment and
culture on profitability of manufacturing firms need be established in future studies.
5.6 Policy Implication

The Government of Kenya through the Ministry of Industrialization should create an
authority to oversee the development and success of manufacturing sector so as to be in
line with the economic pillar of Vision 2030. Kenya Association of Manufacturers
(KAM) and policy makers should advocate for qualified personnel to be employed as
chief finance officers in the member firms. This will ensure that chief finance officers
are members of the Institute of Certified Public Accountants of Kenya (ICPAK) and are
regulate by ICPAK to attain a number of continuous professional development credit
hours per year.
135
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APPENDIX 1 QUESTIONNAIRE
Introduction
I am a student at Jomo Kenyatta University of Agriculture and Technology pursuing a
PHD Degree in Business Administration (Finance Option). My Research Project is on
the effects of working capital management on profitability of manufacturing firms in
Kenya. This questionnaire is aimed at collecting information on the given topic. The
information provided will be held confidential and used for the purpose of enabling the
researcher accomplish an academic requirement.
Instructions
Please respond each question by putting a tick ()
PART - A
Background Information
1. When did your company commence its operations?
1-10 Years ago ( )
11-20 Years ago ( )
21-30 Years ago ( )
31- 40 Years ago ( )
41-50 Years ago ( )
Over 50 Years ago ( )
2. What is the length of time your company has been a member of Kenya Association of
Manufacturers?
1-5 Years ( )
6-10 Years ( )
11-15 Years ( )
16-20 Years ( )
21-25 Years ( )
Over 25 Years ( )
150
3. Under what classification is your company placed by Kenya Association of
Manufacturers (KAM)?
Building, Mining and Construction ( )
Chemical and Allied Sector ( )
Energy, Electrical and Electronics Sector ( )
Foods and Beverages Sector ( )
Leather and Footwear Sector ( )
Metal and Allied Sector ( )
Motor Vehicles Assemblers and Accessories Sector ( )
Paper and Board Sector ( )
Pharmaceutical and Metal Equipment Sector ( )
Plastic and Rubber Sector ( )
Textile and Apparels Sector ( )
Timber, Wood and Furniture Sector ( )
4. What is your organizational form?

Listed Company ( )
Other limited companies ( )
Partnership ( )
Sole Proprietorship ( )
Co-operative Society ( )
Other, please specify ..
5. How many workers are currently employed by your company employed?

Between 1 and 10 workers ( )
Over 500 workers ( )
151
6. What types of products does your company deal with?
Raw Materials ( )
Parts ( )
Semi-Assembled components ( )
Finished Goods ( )
Dont know ( )
7. What formal organization structure does your company have?

Simple form ( )
Functional ( )
Divisional ( )
Matrix ( )
Other, please specify..
PART B
Credit Policy
The following statements relate to credit policy, credit standards, credit terms and
collection efforts by your company. Indicate how agreeable you are with the statements
by placing a tick () against correct option. Strongly agree (SA), Agree (A), Neutral
(N), Disagree (D), Strongly Disagree (SD)
s
Statement Response
SA A N D SD
1 The firm extend s credit facilities to its customers
2 The firm considers production cycle when setting
credit standards
3 The length of time allowed to your customers has an
influence on sales
4 The firm frequently reviews levels of accounts
receivables
152
5 The firm frequently reviews the levels of bad debts
6 The firm investigates the credit worthiness of
customers who want credit facilities
7 The firm regularly writes to customers reminding
them to pay their debts
8 The firm Sometimes writes off bad debts from
customers who do not pay
9 The firm sometimes take legal action against
customers who refuse to pay
10 The firm has set credit terms that stipulate credit
period extension
11 The firm allows cash discounts to customers to induce
them pay promptly
12 The firm stipulates the amount of discount allowed to
a customer on payment within a specified time
13 The discount given to your customers depend on the
credit period allowed
14 The firm considers production cycle when setting
collection period
15 The average length of time between credit sales and
cash collection from the customers is longer than 30
days
16 The firm has set a lenient credit policy
17 The overall firms credit policy has an ability to
increase sales
PART - C
Accounts Payable Practices
153
For the following statements you are requested to indicate whether you Agree (A),
Disagree (D), Strongly Agree (SA), Strongly Disagree (SD) or Neutral (N) about
accounts payable practices in your firm
Statement Response
SA A N D SD
1 The firm receives credit facilities from its suppliers
2 The firm receives cash discounts from its suppliers
upon payment within a stipulated period of time
3 The firm is sometimes charged an interest by its
suppliers for late payment
4 The firms past debts have ever been waived by its
suppliers
5 The firm is sometimes unable to pay its suppliers on
time
6 The payment period allowed by your suppliers to
your firm is reasonable
PART - D
Inventory Control Practices
For the following questions you are requested to indicate whether you Agree (A),
Disagree (D), Strongly Agree (SA), Strongly Disagree (SD) or Neutral about inventory
control practices in your firm
Statement Response
SA A N D S
D
1 The firm has a defined level of inventories for raw
materials
154
2 The firm has determined optimal batch sizes
3 The firm reviews inventory levels periodically
4 The firm keeps accurate inventory records
5 The firm has installed an inventory control system
PART - E
Disagree (D), Strongly Agree (A), Strongly Disagree (SD) or Neutral about Liquidity
Management Practices in your firm
Statement Response
SA A N D SD
1 Current assets are maintained at a higher level than
the current liabilities
2 Inventories constitute a large position of the total
current assets
3 Cash and marketable securities are maintained at a
higher level than the current liabilities
4 Liquidity ratios are maintained at optimal level
5 The firm always prepares a cash budget
6 The firm has been aided by Cash flow prediction in
financial planning
7 The firm has an optimum cash balance policy
8 The firm regularly assesses the optimum and
minimum levels of liquidity
PART - F
Working Capital Levels
155
Disagree (D), Strongly Agree (SA), Strongly Disagree (SD) or Neutral (N) about
investment and financing policies in your firm
Statement Response
SA A N D SD
1 The firm maintains a low level of current
assets as a percentage of total assets
2 The firm maintains a high level of current
assets in relation to current liabilities
3 The firm always maintains current ratio of 2:1
liabilities in relation to total liabilities
liabilities against total assets
6 Current assets are financed by long term funds
of the company
156
APPENDIX 11 RECORD SURVEY SHEET
The record survey sheet was filled in by the researcher himself. All information required
in the matrix came from the annual reports of the manufacturing firms for the period
2008 to 2012
2008 2009 2010 2011 2012
KSHS KSHS KSHS KSHS KSHS
Million Million Million Million Million
Sales
Cost of Sales
Gross Profit
Profit before Tax & Int.
Current Assets
Current Liabilities
Working Capital
Non Current Assets
Total Assets
Accounts Payable
Accounts Receivable
Inventories
Cash and Bank Balances
Return on Assets (ROA) =
Profit BIT / Total Assets
APPENDIX III LETTER TO THE COMPANY CHIEF FINANCE OFFICER
Through the Company CEO
157
P. O. Box 1522-20300; Tel: 0722-285776;
Email address: ndirangukj@yahoo.com
Nyahururu
Dear Respondent,
Im a student of Jomo Kenyatta University of Agriculture and Technology. Im pursuing
a doctor of philosophy degree in business administration, finance option. Im
researching on effects of working capital management on profitability of manufacturing
firms in Kenya. My target population is 413 manufacturing firms in Nairobi industrial
area and its surroundings which are registered with Kenya Association of Manufacturers
(KAM).
I will use a questionnaire and record survey sheet to elicit information which will be
useful in the above mentioned research as part of doctor of philosophy degree in
business administration. Your company has been selected as one of the organizations
where the researcher will collect the data required for the study. You are requested to fill
in the attached questionnaire. The information supplied will be used strictly for
academic purposes only and will be treated with utmost confidentiality.
Your co-operation will be highly appreciated.

Thank you.
Yours Faithfully,

APPENDIX IV CREDIT POLICY RESULTS
Table 4.59: Credit Policy Results

158
Statement 1 2 3 4 5 Mean
% % % % % Likert
1 The firm extends credit facilities to 0 5.6 5.6 43.7 45.1 4.28
their customers
2 The firm considers production 1.4 7.0 8.5 46.5 36.6 3.73
cycle when setting credit standards
3 The credit period customers are 1.4 5.6 9.9 35.2 47.9 4.23
allowed has an influence on sales
4 The firm frequently reviews levels 0 1.4 2.8 49.3 46.5 4.41
of accounts receivables
5 The firm reviews the level of bad 1.4 1.4 9.9 47.9 39.4 4.23
debts
6 The firm investigates the 0 9.9 5.6 45.1 39.4 4.14
creditworthiness of customers
7 The firm regularly writes to 5.6 11.3 18.3 31.0 33.8 3.76
customers reminding them to pay
their debts
8 The firm sometimes writes off bad 4.2 16.9 22.5 45.1 11.3 3.42
debts from customers who do not
pay
9 The firm sometimes take legal 5.6 9.9 12.7 53.5 18.3 3.69
action against customers who
refuse to pay
10 The firm has set credit terms that 18.2 9.9 8.5 43.7 19.7 3.37
stipulate credit period extension
11 The firm allows cash discounts to 2.8 4.2 22.5 40.8 29.7 3.90
customers to induce them pay
promptly
12 The firm stipulates the amount of 2.8 8.5 19.7 47.9 21.1 3.76
discount allowed to customers
159
13 The discount allowed to your 2.8 7.0 23.9 43.8 22.5 3.76
customers depend on the credit
period allowed
14 The firm considers the production 4.2 7.0 15.5 45.1 28.2 3.86
cycle when setting the credit
collection period
15 The period between credit sales 4.2 21.1 14.1 29.6 31.0 3.62
and cash collection is longer than
30 days
16 The firm has set lenient credit 8.4 15.5 19.7 43.7 12.7 3.37
policy
17 The firms overall credit policy 1.4 4.2 12.7 39.4 42.3 4.17
has an ability to increase sales
Average 3.60 8.44 12.68 43.07 32.21 3.91
160
APPENDIX V COMPONENT MATRIX OF CREDIT POLICY
Table 4.60: Component Matrix of Credit Policy

Factors Factor
Loading
The firm stipulates the amount of discount allowed to a customer 0.873
The firm allows cash discounts to customers to induce them pay promptly 0.854
The firm has set credit terms that stipulate credit period extension 0.804
The firm considers production cycle when setting credit standards 0.802
The period between credit sales and cash collection is longer than 30 days 0.784
The firm frequently reviews levels of accounts receivables 0.769
The firm writes off bad debts from customers who do not pay 0.753
The firm reviews the levels of bad debts 0.750
The firms overall credit policy has an ability to increase sales 0.701
The firm extends credit facilities to their customers 0.658
The firm has set lenient credit policy 0.629
The length of time customers are allowed has an influence on sales 0.602
The firm considers the production cycle when setting the collection period 0.598
The firm investigates the creditworthiness of customers 0.538
The firm takes legal action against customers who refuse to pay 0.347*
The discount allowed by your firm depends on credit period allowed 0.335*
The firm regularly writes to customers to remind them pay their debts 0.292*
* Items dropped
161
APPENDIX VI LIQUIDITY MANAGEMENT PRACTICES RESULTS
Table 4.61: Liquidity Management Practices Results

% % % % % Mean
1 The current assets are 0 2.8 7.0 47.9 42.3 4.30
maintained at a higher level
than the current liabilities
2 The inventories constitute a 0 11.3 5.6 53.5 29.6 4.01
large portion of the total
current assets
3 The cash and marketable 0 8.5 23.9 49.3 18.3 3.77
securities are maintained at a
higher level than the current
liabilities
4 The liquidity ratios are 1.4 7.0 12.7 56.3 22.5 3.92
maintained at optimal levels
5 The firm always prepares 2.8 8.5 0 53.5 35.2 4.10
cash budgets
6 The firm is aided by cash 0 1.4 12.7 57.7 28.2 4.13
flow projections in financial
planning
7 The firm has an optimum 1.4 11.3 12.7 50.7 23.9 3.84
cash balance policy
8 The firm regularly assesses 1.4 4.2 11.3 64.8 18.3 3.94
the optimum and minimum
levels of liquidity
Average 0.88 6.88 10.74 54.21 27.29 4.00
162
APPENDIX VII CORRELATION MATRIX OF ALL VARIABLES
Table 4.62: Correlation Matrix of all Variables

Accounts Working
Firm Credit Payable Inventor Capital
Profitability Policy Practices y Control Liquidity Levels
Firm Pearson
1
Profitabilit Correlation
y Sig. (2-tailed)
N 71
Credit Pearson
.346** 1
Policy Correlation
N 71 71
Accounts Pearson
.403** .578** 1
Payable Correlation
Practices Sig. (2-tailed) .000 .000
N 71 71 71
Inventory Pearson
.601** .297* .491** 1
Control Correlation
Sig. (2-tailed) .000 .012 .000
N 71 71 71 71
Liquidity Pearson
.711** .281* .473** .685** 1
Correlation
Sig. (2-tailed) .000 .018 .000 .000
N 71 71 71 71 71
163
Working Pearson
.538** .357** .581** .488** .619** 1
Capital Correlation
Levels Sig. (2-tailed) .000 .002 .000 .000 .000
N 71 71 71 71 71 71
** Correlation is significant at the 0.01 level (2-tailed)
*Correlation is significant at the 0.05 level (2-tailed)
APPENDIX VIII LIST OF MANUFACTURING FIRMS UNDER KAM
Food & Beverages

1. Africa Spirit Limited 31. Europack Industries Ltd 61. Miritini Kenya Ltd.
2.Agriner Agricultural 32. Excel Chemicals Ltd 62. Nairobi Bottles Ltd
Development Ltd.
3. Al-Mahra Industries Ltd 33. Farmers Choice Ltd 63. Nairobi Flour ills Ltd.
4. Alpha Fine Foods Ltd 34. Frigoken Ltd 64. NAS Airport Services
Ltd.
5. Alphine Coolers Ltd 35. Giloil Company Ltd 65. Nestle Kenya Ltd
164
6.Aquamist Ltd 36. Global Beverages Ltd 66. Patco Industries Ltd.
7. Bidco Oil Refineries Ltd 37. Global Fresh Ltd 67. Pearl Industries Ltd.
8. Bio Food Products Ltd 38. Gonas Best Ltd 68. Pembe Flour Mills Ltd.
9. Blue Nile Wire Products 39. Green Forest Food Ltd 69. Premier Flour Mills
Ltd Ltd.
10.B. A.T. Kenya Ltd 40. Highland Canners Ltd 70. Premier Food Industries
Ltd.
11. Broadway Bakery Ltd 41. Homeoil 71. Proctor & Allan (E.A
12. Brookside dairy Ltd 42. Insta Products (EPZ) 72. Promasidor (Kenya)
Ltd Ltd.
13. C. Dormans Ltd 43. Jambo Biscuits (K) Ltd 73. Rafiki Millers Ltd
14. C. Czarnikow Sugar 44. Kapa Oil Refineries Ltd 74. Razco Ltd
(EA) Ltd
15. Cadbury Kenya Ltd 45. Karirana Estate Ltd 75. Re-Suns Spices Ltd
16. Candy Kenya Ltd 46. Kenafric Industries Ltd 76.Sigma Supplies Ltd.
17. Carlton Products (EA) 47. Kenblest Ltd 77.Softa Bottling Co. Ltd.
Ltd
18. Chirag Kenya Ltd 48. Kenchik Ltd 78. Spice World Ltd.
19. Coca Cola East Africa 49. Kenya Nut Company 79.Spin Knit Dairy Ltd
Ltd Ltd
20. Corn Products Kenya 50. Kenya Sweets Ltd 80. Super Bakery Ltd
Ltd
21. Crown Foods Ltd 51. Kenya Tea 81. Trufoods Ltd
Development Agency
22. Deepa Industries Ltd 52. Kevian Kenya Ltd 82. Unga Group Ltd
23. Del Monte Kenya Ltd 53. Koba Waters Ltd 83. Usafi Services Ltd
24. E & A Industries Ltd 54. Kwality Candles & 84. Uzuri Foods Ltd
Sweets Ltd
25. East African Breweries 55. Lari Dairies Alliance 85. Valuepak Foods Ltd
Ltd Ltd
165
26. East African Seed Co. 56. London Distillers (K) 86.W.E Tilley (Muthaiga)
Ltd Ltd
27. East African Sea Foods 57. Maji Foods Industries 87.Wanji Food Industries
Ltd Ltd Ltd
28. Eastern Produce Kenya 58. Mastermind Tobacco 88.Wrigley Company (EA)
Ltd (Kakuzi) (K) Ltd. Ltd
29. Edible Oil Products Ltd 59. Melvin Marsh
International
30. Erdemann Co. (K) Ltd 60. Mini Bakeries (Nbi) Ltd
Plastic & Rubber

1. ACME Containers Ltd 19. Kenpoy Manufacturers 37. Raffia Bags (K) Ltd
Ltd
2. Afro Plastics (K) Ltd 20. King Plastic Industries 38. Rubber Products Ltd.
Ltd
3. Betatrad (K) Ltd 21. Kingsway Tyres & 39. Safepak Ltd.
Automart Ltd
4. Blowplast Ltd 22. L.G Harris & Co. Ltd 40. Sameer Africa Ltd
5. Bobmil Indutries Ltd 23. Laneeb Plastics Industries 41. Sanpac Africa Ltd.
6. Comlast Industries Ltd 24. Metroplastics Kenya Ltd. 42. Signode Packaging
System Ltd
7. Dune Packagings Ltd 25. Nairobi Plastics Ltd 43. Silpack Industries
Ltd.
8. Dynaplas Limited 26. Ombi Rubber Roller Ltd. 44. Singh Retread Ltd.
9. Elgitrend (Kenya) Ltd 27. Packaging Industries Ltd. 45. Solvochem East
Africa Ltd
10. Elgonkenya Ltd 28. Packaging Masters Ltd. 46. Springbox Kenya Ltd
11. Eslon Plastics of 29. Plastic Electricons 47. Styroplast Ltd.
Kenya
12. Five star Industries Ltd 30. Plastic & Rubber 48. Sumaria Industries
166
Indusries Ltd Ltd
13. General Plastics Ltd 31. Polyblend Ltd 49. Super
Manuafacturers Ltd
14. Haco Industries Kenya 32. Polyflex Industries Ltd. 50. Techpak Industries
Ltd Ltd
15. Hi-Plast Ltd 33. Polythene Industries Ltd 51.Threadsettrs Tyres
Ltd
16. Jamlam Industries Ltd 34. Premier Industries Ltd. 52. Uni-Plastics Ltd
17.Kamba Manufacturing 35. Prosel Ltd. 53. Wonderpac Industries
(1986) Ltd Ltd
18. Keci Rubber Industries 36. Qplast Industries Ltd.
Ltd
Leather & Foot Wear

1. Alpharama Ltd 3. Budget Shoes Ltd 5. Dogbones Ltd
2. Bata Shoes Co (K) Ltd 4. C & P Shoes Ltd 6.Leather Industries of
Kenya Ltd
Pharmaceutical & Medical Equipment

1. African Cotton 8. Dawa Ltd 15.Novelty Manufacturing
Industries Ltd Oasis Ltd.
2. Alpha medical 9. Elys Chemicals 16. Oss.Chemie (K)
Manufacturers Ltd Industries Ltd
3. Beta Health care 10. Gesto Pharmaceuticals 17. Pharm Access Africa
International Ltd Ltd Ltd.
4. Biodeal Laboratories Ltd 11. KAM Industries Ltd 18. Pharmaceutical
Manufacturing Co. (K)
Ltd.
5. Biopharma Ltd 12. Laboratory & Allied 19. Regal Pharmaceuticals
Ltd Ltd.
167
6. Bulk Medicals Ltd 13. Manhar Brothers (K)
Ltd
7. Cosmos Ltd 14. Medivet Product Ltd.
Paper & Board

1. Adpak International Ltd 19. Elite Offset Ltd 37. Paperbags Ltd.
2. Allpack Industries Ltd 20. Ellams Products Ltd 38. Pressmaster Ltd.
3. Associated Paper & 21. Graphics & Allied Ltd 39. Printing Services Ltd.
Stationery Ltd.
4. Autolitho Ltd 22. Icons Printers Ltd 40.Printpak Multi
Packaging Ltd.
5. Bag and Envelops 23. Interlabels Africa Ltd 41. Printwell Industries
Converters Ltd Ltd.
6. Bags & Bailers 24. International Paper & 42. Prudential Printers Ltd.
Manufacturers Ltd Boards Supplies Ltd
7. Brand Printers Ltd 25. Jomo Kenyatta 43. Ramco Printing Works
Foundation Ltd.
8. Carton Manufacturers 26. Kartasi Industries Ltd 44. Stallion Stationery
Ltd Manufacturers
9. Cempack Limited 27.Kenafric Diaries 45. Standard Group Ltd
Manufactures Ltd
10. Chandaria Industries 28. Kenya Litho Ltd 46. Statpack Industries Ltd
Ltd
11. Colour Labels Ltd 29. Kenya Stationers Ltd 47. Taws Ltd
12. Colour Packaging Ltd 30. Kim-Fay East Africa 48. Tetra Pak Ltd
Ltd
13. Colourprint Ltd 31. Kul Graphics Ltd 49. The Regal Press Kenya
Ltd
14. Creative Print House 32. Lables Converters Ltd 50. Twiga Stationeries &
Printers
168
15. D. L. Patel Press 33. Modern 51. Uchumi Quick Supplies
(Kenya) Ltd Lithographic(K) Ltd. Ltd
16. Dodhia Packaging Ltd 34. Mufindi Paper Ltd 52. United Bags
Manufactures
17. East Africa Packaging 35. Nation Group Ltd.
Industries Ltd
18. East African Paper 36. Paper House of Kenya
Converters Ltd Ltd.
Timber & Furniture

1. Economic Housing 6. Newline Ltd. 11. Shamco Industries Ltd.
Group Ltd
2. Eldema (Kenya) Ltd 7. Panesars Kenya Ltd. 12. Timsales Ltd
3. Fine woodworks Ltd 8. PG Bison Ltd 13. Woodmakers Kenya
Ltd
4. Furniture International 9. Rosewood Office 14. Woodtex Kenya Ltd
Ltd Systems Ltd.
5. Kenya Wood Ltd 10. Shah Timber Mart Ltd
Metal & Allied

1. Alloy Steel Casting Ltd 16. General Aluminum 31. Rolmil Kenya Ltd.
Fabricator
2. Apex Steel Limited 17. Gopitech (Kenya) Ltd 32. Sandstorm Africa
Rolling Mill Division Limited
3. ASL Ltd. 18. Heavy engineering Ltd 33. Sheffied Steel Systems
Ltd.
4. ASP Company Ltd 19. Insteel Ltd 34. Specialised
Engineering Co. (EA) Ltd
5. Athi River Steel Plant Ltd 20. J.F mccloy Ltd 35. Steel Structures Ltd
6. Booth Extrusions Ltd 21. Kens Metal Industries 36. Steelmakers Ltd
169
Ltd
7. City Engineering Works 22. Khetshi Dharamishi & 37. Steelwool (Africa) Ltd
Ltd Co. Ltd
8. Chrystal Industries Ltd 23. Mabati Rolling Mills 38. Steel Structures Ltd
Ltd
9. Crystal Industries Ltd 24. Manufacturers & 39. Steelmakers Ltd
Supplier (K) Ltd.
10. Davis & Shirtliff Ltd 25. Mecol Limited 40. Steelwool (Africa) Ltd
11. Devki Steel Mills Ltd 26. Metal Crown Ltd. 41. Tononoka Steels Ltd
12. East Africa Spectre Ltd 27. Nails & Steel Products 42. Viking Industries Ltd
Ltd.
13. East African Foundry 28. Nampak Kenya Ltd. 43. Warren Enterprises Ltd
Works (K) Ltd
14. Elite Tools Ltd 29. Napro Industries Ltd 44. Welding Alloys Ltd
15. Friendship Container 30. Orbit Engineering Ltd. 45. Wire Products Ltd
Manufacturers Ltd
Building & Construction
1. Athi River Mining Ltd 5. E. A. Portland Cement 9. Orbit Enterprises Ltd
Co. Ltd
2. Bamburi Cement Ltd 6. Karsan Murji & 10. Saj Ceramics Ltd.
Company Ltd
3. Bamburi Special 7. Kenya Builders &
Products Ltd Concrete Ltd
4. Central Glass Industries 8. Manson Hart Kenya Ltd
Ltd
Chemicals & Allied

1. Anffi Kenya Ltd 22. Faaso Exporters Ltd. 43. Proctor & Gamble
(E.A) Ltd
2. Basco Products (K) Ltd 23. Galaxy Paints & 44. PZ Cussons &
170
Coating C. Ltd Company
3. Bayer East Africa Ltd 24. Grand Paints Ltd 45. Reckitt Benkiser (E.A)
Ltd.
4. Beiersdorf East Africa 25. Henkel Kenya Ltd 46. Revolution Chemicals
Ltd Ltd.
5. Blue Ring Products Ltd 26. Interconsumer Products 47. Rumorth EA Ltd.
Ltd
6. BOC Kenya Ltd 27. Johnson Diversey East 48. Sara Lee Kenya Ltd
Africa Ltd
7. Buyline Industries Ltd 28. Kel Chemicals Limited 49. Sarok Ltd.
8. Carbacid (CO2) Ltd 29. Kemia International Ltd 50. Seweco Paints Ltd.
9. Chemicals and Solvents 30. Ken Nat Ink & 51. Shreeji Chemicals
(EA) Ltd Chemicals Ltd Limited
10. Chrysal Africa Ltd 31. Kridha Ltd 52. Soilex Chemicals Ltd.
11. Coates Brothers (EA) 32. Magadi Soda Company 53. Strategic Industries Ltd
Ltd Ltd
12. Colgate Palmolive (EA) 33. Maroo Polymers Ltd. 54. Supa Brite Ltd
Ltd
13. Continental Products 34. Match Masters Ltd. 55. Super Foam Ltd
Ltd
14. Cooper K Brands Ltd 35. Metroxide Africa Ltd. 56. Syngenta East Africa
Ltd
15. Crown Berger Kenya 36. Murphy Chemicals E. 57. Synresins Ltd
Ltd A.Ltd
16. Crown Gases Ltd 37. Odex Chemicals Ltd. 58. Tri-Clover Industries
Ltd
17. Decase Chemicals Ltd 38. Oasis Limited 59. Twiga Chemical
Industries Ltd
18. Deluxe Inks Ltd 39. Orbit Chemicals 60. Uniliver Kenya Ltd
Industries Ltd.
171
19. Desbro Kenya Ltd 40. Osho Chemicals 61. Vitafoam Products Ltd
Industries
20. Elex Products Ltd 41. Pan African Paper Mills
(E.A) Ltd
21. European Perfumes & 42. Polychem East Africa
Cosmetics Co. Ltd Ltd.
Textiles & Apparels

1. Africa Apparels EPZ Ltd 10. Fulchand Manek & 19. Silver Star
Bros Ltd Manufacturers Ltd
2. Ajit Clothing Factory Ltd 11. Image Apparels Ltd 20. Spinners & Spinners
Ltd
3. Alltex EPZ Ltd 12. Kema E.A Ltd 21. Straight-line Enterprises
Ltd
4. Alpha Knits Ltd 13. Kikoy Co. Ltd 22. Sunflag Textile &
Knitwear
5. Amedo Centre Kenya 14. Le-Stud Ltd 23. Teita Estate Ltd
Ltd
6. Apex Apparels (EPZ) 15. Midco Textiles (EA) 24. Thika Cloth Mills Ltd
Ltd Ltd
7. Bogan Industries Ltd 16. Mirrage Fashionwear 25. United Aryan (EPZ) Ltd
EPZ
8. Dharamshi & Co. Ltd 17. Ngecha Industries Ltd. 26. Vaja Manufacturers Ltd
9. Establishments Ltd 18. Protex Kenya (EPZ) 27. Yoohan Kenya EPZ
Ltd. Ltd.
Motor Vehicles & Accessories

1. Associated Battery 8. General Motors East 15. Pipe Manufacturers Ltd
Manufacturers (EA) Ltd Africa Ltd
2. Auto Ancilliaries Ltd 9. Impala Glass Industries 16. Sohansons Ltd
172
Ltd
3. Auto Springs 10. Kenya Grange Vehicle 17. Theevan Enterprises
Manufacturers Ltd Industries Ltd Ltd
4. Automotive & Industrial 11. Labh Singh Harman 18. Toyota East Africa Ltd
Battery Manufacturers (K) Singh Ltd
Ltd.
5. Banbros Ltd 12. Mann Manufacturing 19. Unifilters Kenya Ltd
Co Ltd
6. Bhachu Industries Ltd 13. Megh Cushion 20. Varsani Brakelinings
Industries Ltd. Ltd
7. Chui Auto Spring 14. Mutsimoto Motor
Industries Ltd Kenya Ltd
Electrical & Electronics

1. Assa Abloy East Africa 7. Eveready East Africa 13. Metsec Ltd.
Ltd Ltd
2. Aucma Digital 8. Holman Brothers (E.A) 14.Modulec Engineering
Technology Africa Ltd. Ltd Systems Ltd.
3. Avery (East Africa) Ltd 9. Iberaafrica Power ( EA) 15. Mustek East Africa Ltd.
Ltd
4. Baumann Engineering 10. International Energy 16.nationwideelectrical
Ltd Technik Industries
5. Centurion Systems Ltd 11. Ken West Cables Ltd 17. Optimum Lubricants Ltd
6. East African Cables Ltd 12. Metrex International 18. PCTL Automation Ltd.
Ltd
173

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Effects of Working Capital Management on Profitability of Manufacturing Firms

James Ndirangu Kungu

A Thesis submitted in partial fulfillment for the Award of Doctor of Philosophy

Aggressive Investment Policy: It is a working capital management policy that

Working Capital Management: It is the management of current assets and

1.1.1 Global Perspective

1.1.2 Regional Perspective

1.1.3 Local Perspective

Table 1.1: Key Contributors to Export / Foreign Exchange Earnings in 2012

Table 1.2: Key Contributors to GDP between 2008 and 2012

1.1.4 Aspect of Profitability and Manufacturing Firms in Kenya

The inefficient management of working capital impairs profitability and interrupts

Working capital management is important to manufacturing firms because it comprises

The foregoing notwithstanding, vast majority of companies either maintain excessive or

1.3 Objective of the Study

1.3.2 Specific Objectives of the Study

1.4 Hypo Kenya, Republic of theses of the Study

1.5 Significance of the Study

A). Kenya Association of Manufacturers

B). Chief Finance Officers

C). Researchers, Policy Makers, Professionals and Managers

1.6 Scope of the Study

1.7 Limitations of the Study

2.1 The Concept of Working Capital Management

The management of working capital is important to the financial health of businesses of

Improving Working Capital Management (WCM) is reasonably important for companies

2.2 Conceptual Framework

Aggressive Investment Policy

Independent Variables Dependent Variable

2.3 Review of Related Literature

To remain profitable, businesses must ensure proper management of their receivables

2.3.1.1 Credit Standards

2.3.1.2 Credit Terms

2.3.1.3 Collection Efforts

2.3.1.4 Creditworthiness of Customers

H01: Credit policy does not influence profitability of manufacturing firms in

2.3.1.1.1 Loss Given Default Model of Credit Policy

2.3.2 Accounts Payable Practices

2.3.2.2 Delays in Payments

2.3.2.3 Payment Period

H02: Accounts payable practices do not influence profitability of

2.3.2.1.1 Transaction Cost Theory

2.3.3 Inventory Control Practices

2.3.3.1 Inventory Level

2.3.3.2 Inventory Control System

H03: Inventory control practices do not influence profitability of

2.3.3.1.1 Economic Order Quantity Model of Inventory Management

Where D = Demand in units per year

2.3.4.1 Current Ratio

2.3.4.2 Quick Ratio

2.3.4.3 Cash Management

H04: Liquidity management practices do not influence profitability of

2.3.4.1.1 Baumols Cash Management Model

2.3.4.1.2 Miller-Orr Cash Management Model

2.3.5 Working Capital Levels

2.3.5.1 Aggressive Investment Policy

The degree of aggressiveness of working capital investment policy is measured by ratio

2.3.5.2 Conservative Investment Policy

2.3.5.3 Aggressive Financing Policy