EFFECTS OF WORKING CAPITAL MANAGEMENT ON THE PERFORMANCE OF

SMALL AND MEDIUM ENTERPRISES IN MOMBASA COUNTY

ABDILLAHI HAMZA SHURUT

A RESEARCH PROPOSAL SUBMITTED TO THE DEPARTMENT OF BUSINESS IN

THE SCHOOL OF BUSINESS IN PARTIAL FULFILLMENT OF THE REQUIREMENT
FOR THE AWARD OF A DEGREE IN BACHELOR OF BUSINESS INFORMATION
TECHNOLOGY AT JOMO KENYATTA UNIVERSITY OF AGRICULTURE AND
TECHNOLOGY

NOVEMBER 2019
 DECLARATION

I hereby declare that this research proposal is my original work and has not been presented for
award of degree in Jomo Kenyatta University of Agriculture and Technology or any other
University.

Signed: ……………………………………… Date: ………………………………

ABDILLAHI HAMZA SHURUT

HDB212-C005-0410/2016

This proposal has been submitted for examination with my knowledge as University research
supervisor

Signed: ………………………………….. Date: …………………………………….

MR. TIMOTHY KARIUKI

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 DEDICATION

I dedicate this proposal to our family, friends, and everyone that played a part in the development
of this project. I also like to dedicate this to all individual and groups in need of the services this
project provides.

Above all I thank God.

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 ACKNOWLEDGEMENT

I give glory and honor to Almighty God for his goodness, steadfast love and giving me energy to
undertake this task. I also give thanks to our supervisor for his unwavering support. His
dedication and commitment has helped me in a great way. I acknowledge the endless efforts of
Mr. Timothy Kariuki who has helped me get where I am in this technology growing world by
giving me the skills I require and also my who gave me hope and support both financially and
psychologically to pursue this course to completion of this proposal.

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TABLE OF CONTENTS

DECLARATION ......................................................................................................................... II

DEDICATION ............................................................................................................................ III

ACKNOWLEDGEMENT ......................................................................................................... IV

LIST OF APPENDICES ......................................................................................................... VIII

LIST OF TABLES ...................................................................................................................... IX

LIST OF FIGURES ...................................................................................................................... X

LIST OF ABBREVIATIONS .................................................................................................... XI

DEFINITION OF TERMS .......................................................................................................XII

ABSTRACT.............................................................................................................................. XIII

CHAPTER ONE ............................................................................................................................1

INTRODUCTION .........................................................................................................................1

1.1 BACKGROUND OF THE STUDY ............................................................................................... 1

1.2 STATEMENT OF THE PROBLEM ............................................................................................. 5

1.3 OBJECTIVES OF THE STUDY .................................................................................................. 6

1.3.1 General Objective .................................................................................................................6

1.3.2 Specific Objectives ................................................................................................................6

1.4 RESEARCH QUESTIONS ....................................................................................................... 6

1.5 SIGNIFICANCE OF THE STUDY ............................................................................................... 6

1.6 SCOPE OF THE STUDY ............................................................................................................ 7

CHAPTER TWO ...........................................................................................................................8

LITERATURE REVIEW .............................................................................................................8

2.1 INTRODUCTION ...................................................................................................................... 8

2.2 THEORETICAL REVIEW ......................................................................................................... 8

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2.2.1 Financing Theory ..................................................................................................................8

2.2.2 Risk-Return Trade-off Theory ............................................................................................9

2.2.3 Fisher Separation Theorem ...............................................................................................11

2.3 CONCEPTUAL FRAMEWORK ............................................................................................... 11

2.4 REVIEW OF VARIABLES ....................................................................................................... 12

2.4.1 Inventory .............................................................................................................................12

2.4.2 Accounts receivable ............................................................................................................13

2.4.3 Accounts payable ................................................................................................................14

2.4.4 Performance of SMEs.........................................................................................................15

2.5 EMPIRICAL REVIEW ............................................................................................................ 16

2.6 CRITIQUE OF EXISTING LITERATURE................................................................................. 17

2.7 RESEARCH GAPS ................................................................................................................. 19

2.8 SUMMARY ............................................................................................................................ 19

CHAPTER THREE .....................................................................................................................21

RESEARCH METHODOLOGY ...............................................................................................21

3.1 INTRODUCTION .................................................................................................................... 21

3.2 RESEARCH DESIGN .............................................................................................................. 21

3.3 TARGET POPULATION ......................................................................................................... 21

3.4 SAMPLING FRAME. .............................................................................................................. 22

3.5 SAMPLING AND SAMPLING TECHNIQUE. ............................................................................ 22

3.6 DATA COLLECTION METHODS ........................................................................................... 23

3.7 DATA COLLECTION PROCEDURE ........................................................................................ 24

3.8 PILOT TESTING .................................................................................................................... 24

3.8.1 Validity.................................................................................................................................24

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3.8.2 Reliability.............................................................................................................................24

3.9 DATA ANALYSIS AND PRESENTATION. ................................................................................ 25

REFERENCES ............................................................................................................................26

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 LIST OF APPENDICES

APPENDIX I: INTRODUCTION LETTER……..…………………………………………...31

APPENDIX II: QUESTIONNAIRE……………..…………………….………………………32

APPENDIX III: WORKPLAN……..……………………………………………..……….......40

APPENDIX IV: BUDGET…………………………………………………………………..…41

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 LIST OF TABLES

Table 3.1 Population Study and Sample....................................................................................22

Table 3.2 Sample size...................................................................................................................23

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 LIST OF FIGURES

Figure 2.4 Conceptual Framework......................................................................................12

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 LIST OF ABBREVIATIONS

ACP Accounts Payable

ACR Accounts Receivable

EOQ Economic Order Quantity

ROA Return on Assets

ROE Return on Equity

ROI Return on Investment

ROS Return on Sales

SMEs Small and Medium Enterprises

WCM Working Capital Management

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 DEFINITION OF TERMS

Account Payables Payables management entails the decision to balance the benefits of trade
Management credit against the cost associated with the credit which include the cost of
late payment penalties and foregoing cash discounts (Van-Horne &
Wachowicz, 2004).

Account This is the maintaining of a given level of receivables that will attain the
Receivable twin objectives of profitability and liquidity (Dunn, 2009).
Management
Financial This is a measure of the outcomes of a firm's operations and policies in
Performance monetary terms (Kassim, 2011).

Inventory A set of controls and policies that monitors the levels of inventory and
Management determine when to replenish, quantity to order and levels to be maintained
(Chandra, 2008)

Small & Medium These are enterprises that employ between 11 and 100 workers (GoK,
Enterprises 2010)

Working Capital These are current assets and liabilities that can be liquidated within a year
(Gunay & Kesimli, 2011).

Working Capital Management of the short-term investments and financing of a company

Management which include current assets and current liabilities (Ross, Westerfield, &
Jordan, 2010)

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 ABSTRACT

Working Capital Management is considered to be a very important element in a business and the
proper management of working capital leads to profitable business venture. Working Capital
Management is a business practice involving inventory management, account payables and
accounts receivables. Working capital management plays an important role in improving the
performance of business entities. This paper will analyze whether SMEs in Kenya carry out
working capital management and the effect of Working Capital Management (WCM) on the
financial performance of SME’s in Mombasa County. The findings of this study will enable
SMEs to realize the importance of working capital management and its influence of the
profitability of their SMEs. The review of theoretical framework has been done in line with the
research variables and a conceptual framework has been developed in line with the research
objectives. The theories to be used includes financing theory, risk return trade off theory and
fisher separation theorem. The study will employ a descriptive research design which will be
useful in establishing the relationship of working capital management practices and financial
performance. Descriptive study is concerned with finding out the what, where and how of a
phenomenon. The research will be conducted in Mombasa County and the sample design which
will be used on conducting the research will be a sample survey of respondents including
wholesalers and retailers. The sampling frame for the study comprises of 200 SMEs located in
Mombasa. The major source of data to be used will be through questionnaire. Piloting of the
study will be carried out to ascertain the validity and reliability of the instruments. Collected data
shall be analyzed using Statistical Package for Social Sciences (SPSS). Data analysis will include
the use of descriptive and inferential statistics. Descriptive statistics involves the use of
frequency tables, pie charts, graphs and percentages while inferential statistics involves the use of
multiple regression analysis. Data will be presented in tables.

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 CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Small and Medium Enterprises are important to almost all economies in the world, especially to those
in developing countries and within that broad category and to those with major employment and
income distribution challenges. Working capital management is also important because of its effects on
the firm’s profitability and risk, and consequently its value. For instance high inventory levels reduces
the cost of possible interruptions in the production process or of loss of business due to the scarcity of
products, reduces supply costs, and protects against price fluctuations, among other advantages.
Consequently, granting trade credit favours the firm’s sales in various ways. However, firms that invest
heavily in inventory and trade credit can suffer reduced profitability. Thus, the greater the investment in
current assets, the lower the risk, but also the lower the profitability obtained. Decisions about how
much to invest in the customer and inventory accounts, and how much credit to accept from suppliers,
are reflected in the firm’s cash conversion cycle, which represents the average number of days between
the date when the firm must start paying its suppliers and the date when it begins to collect payments
from its customers.

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Ovia (2001) cited in James (2011) stated that, available empirical studies have shown that, the small
and medium scale enterprises generate at least 60% of the United States of America (USA) Gross
Domestic Product (GDP), that the SMEs constitute the major breakthrough in several emerging sectors,
most breakthroughs in (IT) in the U.S.A were propelled by SMEs. For instance Microsoft Disk
Operating System (MS Dos) that enabled about 80% of the world PCS to operate was developed in
1980 by Bill Gates and Paul Allen when their company was a small scale enterprise. Das and Dey
(2005) also stated that, in India, Information Technology (IT) industry exported about 6 billion
software’s and related services in year 2000 that, empirical evidences shows that SMEs contribute 40%
of India’s gross domestic product. In Ghana, Abor and Quartey (2010) stated that empirical evidences
have shown that SMEs provides 85% of the manufacturing employment and contributes 70% of
Ghana’s GDP and accounts for 92% of business in Ghana.

Researches by other scholars have also produced evidences indicating the effects which working capital
management has on performances of SMEs with regard to profit, turnover, return on equity, firm size
and return on assets. For instance, Hayajneh and Yassine (2011) investigated the relationship between
working capital management efficiency and profitability through applying on 53 Jordian manufacturing
firms listed on the Aman Stock Exchange (AEM) from 2000 to 2006. The study found positive
association between size of sales and growth of sales and profitability. Lotfinia, Mousavi and Jari
(2012), Sampling of Tehran Stock Exchange (TSE) 80 firms from 2005- 2009 with available annual
data and tested their hypothesis with the use of stepwise regression analysis. The research results
showed that there is positive relationship between working capital management and firm size.

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Management of current asset and liabilities is particularly important in the case of small and medium
companies and that, most of these companies’ assets are in the form of current assets while current
liabilities are one of the main sources of external financing in view of their difficulties in obtaining
funding in the long term capital market and the financing constraint that they face. Nigerian firms as
others the world over, utilize working capital for smooth operation. They plan for and manage their
inventories, cash, receivables and payables, to ensure that requirements in these items are met. Raw
materials are needed for production; finished goods inventory to meet customer demand and sales and
profit objectives of firms. Cash is necessary to meet the liquidity needs of Nigerian firms. Considering
the low per-capital income and disposable income of Nigerian consumers, Nigerian firms offer trade
credit to customers, creating accounts receivables. These firms also take advantage of trade credit from
other firms, creating accounts payables.

The small scale enterprises (SMEs) play an important role in the Kenyan Economy. According to the
Economic Survey 2006, the sector contributed over 50 percent of new jobs created in the year 2005.
Despite their significance, Kenya National Bureau of Statistics, 2007 indicate that three out of five
businesses fail within the first few months of operation as cited by Bowen et al (2009) due to several
challenges.

Because of their small size, a simple management mistake is likely to lead to closure of a small
enterprise as there is no chance for management to learn from its past mistakes. Lack of planning,
improper financing and poor management have been cited as the main causes of failure of small
enterprises. Lack of credit has also been identified as one of the most serious constraints facing SMEs
thus hindering their development. In addition to these, education is also one of the factors that impact
positively on growth of firms.

3
As with many developing countries, there is limited research and scholarly studies about the SME
sector in Kenya. The 1999 National Baseline Survey conducted by Central Bureau of Statistics, ICEG
and K-Rep Holdings provided comprehensive picture of SMEs in Kenya. Mead (1998) observes that
the health of the economy as a whole has a strong relationship with the health and nature of small scale
enterprise sector. Given this scenario, an understanding of the dynamics of SMEs is necessary not only
for the development of support programs for SMEs, but also for the growth of the economy as a whole.
Given the importance of these small businesses to the Kenyan economy and the informal way in which
they are managed, there is need to conduct an enquiry to investigate effect of working capital
management on the performance, especially of SMEs in Mombasa county.

Most researchers have focused their analysis on larger firms although some few have offered studies on
SME’s in service, manufacturing, finance and agricultural industry. For instance Mathuva (2010)
focused on the influence of working capital management on corporate profitability of firms listed at the
Nairobi Securities Exchange. Gakure, Cheluget, Onyango and Keraro (2012) on the other hand
analysed the relationship between working capital management and performance of 15 manufacturing
firms listed at the Nairobi Securities Exchange for a period of five years from 2006 to 2010. Omesa,
Maniagi, Musiega and Makori (2013) examined the relationships between Working Capital
Management and Corporate Performance of 20 manufacturing firms listed on the Nairobi securities
exchange for 5 years from 2007-2011 was selected. Finally, Nyabwanga, Ojera, Lumumba, Odondo &
Otieno (2012). However, these studies provide no evidence on the relationship between working capital
management and performance of SMEs in Mombasa County during the period 2018-2019.

In this context, the objective of the current work is to assess the impact of working capital management
practices on performance for a panel made up of 200 accountants and book keepers in SMEs located in
Mombasa County during the period 2018-2019.

4
Performance is the end result of the whole organization’s systems in relation to its objective. Ittner and
Larcker (2000) suggested that financial data have limitations as a measure of company performance.
The two note that other measures, such as quality, may be better at forecasting, but can be difficult to
implement. This study focuses on financial measures of profitability, liquidity and growth. Profitability
can be measured by ratios such as Return on Investment (ROI), Return on Equity (ROE), and Return on
Assets (ROA) while the Optimal Growth is measured by total shareholder return creation and
profitability perspective (Handschuh et al., 2011)

This work contributes to the literature in two ways. First, no previous evidence exists for the case of
SMEs in Mombasa County. The second contribution is that, unlike the previous studies the study aims
at analysing the impact of working capital management on the performance of SMEs in trade industry
trading in the area of study.

1.2 Statement of the Problem

Small and Medium Enterprises are major pillars of economic development in Kenya and other
developing countries. According to the Economic Survey of Kenya (2006), the sector contributed over
50 percent of new jobs created in the year 2005. However the National Bureau of statistics 2007
reported that three out of five of these businesses fail due to lack of planning, financing and poor
management, lack of credit and the level of education of entrepreneurs (Bowen Michael et al, 2009,
Oketch, 2000, King and McGrath, 2002). Although the problem of finance has been identified as one of
the major constraints to performance of SMEs, existing literature does not specify the impact of
working capital management which is one of the major aspects of finance, on the performance of
SMEs. This study aims at analysing the impact of working capital management on the performance on
SMEs in Mombasa County.

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1.3 Objectives of the Study

1.3.1 General Objective

The general objective of this study is to establish the effects of working capital management on the
performance of the Small and Medium Enterprises in Mombasa County.

1.3.2 Specific Objectives

1. To examine the effect of accounts payables on the performance of SMEs in Mombasa County.
2. To analyze the effect of accounts receivables on the performance of SMEs in Mombasa County.
3. To determine the effect of inventory management practices on SMEs performance in Mombasa
County.

1.4 Research Questions

1. What is the effect of Accounts payables practices on financial performance of SMEs in

Mombasa County?
2. What is the effect of Accounts receivables practices on financial performance of SMEs in
Mombasa County?
3. What is the effect of Inventory management practices on financial performance of SMEs in
Mombasa County?

1.5 Significance of the Study

The findings of this study can benefit the managers in the SME’s sector. The research can also give an
insight on the factors that will be affecting the working capital of the SME’s and how to handle them;
these include account payables, account receivables and the inventory management. The findings can
also help the future researchers when conducting a research on the same field they can use the findings
of the research as a reference.

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1.6 Scope of the Study

The main purpose for the research is to investigate and highlight factors affecting working capital
management on financial performances of SMEs in Mombasa County. The study proposal will take a
period of three months to complete that is from November 2019 -January 2020. The study will target
the owners of small and medium enterprises at Mombasa County.

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 CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter focuses on the theoretical literature, conceptual frame work, critique of existing literature,
summary and research gaps. The aspects dealt with in the literature are variables which are later
mentioned in the conceptual framework and the findings that other writers had established on the same,
this information greatly contributes to the achievement of the objectives of this research study.

2.2 Theoretical Review

2.2.1 Financing Theory

Finance theory according to (Agha, 2014), falls under three main categories: capital budgeting, capital
structure and working capital management. The two categories of capital budgeting and capital
structure decision are mostly related with financing and managing long- term investments. Financial
decision about working capital however, are mostly related with financial and managing short-term
investments that undertake both current assets and current liabilities simultaneously (Mwalla, 2012)
therefore, working capital management in most cases is referred to as short-term financial management.
With SMEs appearing to have more problems with under investments due to constrained access to
capital markets and over dependency on banks financing, they can counter this by having shorter
CCCs. This will help them cover possible gaps between receipt and payment. Furthermore, good
working capital management enhances a firm flexibility and competitive advantage (Fraenkel, 2010).

8
For these SMEs, working capital can act as a major internal source of capital. With these firms having
relatively limited access to capital market, short-term borrowing is used to overcome this obstacle. A
firm can also use accounts payable to finance its operations by obtaining goods on credit from suppliers
and building good rapport which will enable them to postpone payments of the outstanding depts. with
suppliers and use the amount to find its expansion or growth. If an Enterprise, therefore, has a shorter
inventory cycle, a longer payable cycle, and a shorter received cycle, it can free up funds from day-to-
day operations and invest them into growth projects, so it relies less on external sources of funding,
maintain optimal levels of working capital enables a firm to meet its obligations as and when they fall
due. This therefore, builds the credit worthiness of a firm thereby increasing its borrowing capabilities
and decreasing its default risk, thus increasing the firm value (Ahmad, 2012).

2.2.2 Risk-Return Trade-off Theory

The risk return trade-off is the principle that potential return increases with an increase in risk. Low
levels of uncertainty or risk are associated with low potential returns, while high levels of uncertainty
or risk are associated with high potential returns. According to risk returned trade off, invested money
can render high profits only if the investor is willing to accept the possibility of losses. The appropriate
risk return trade off depend on a variety of factors including risk tolerance, years to retirement and the
potential to replace lost funds. Time can also play an essential role in determining a portfolio with the
appropriate levels of risk and reward. For example, the ability to invest in equities over the long term
provides the potential to recover from the risk bear markets and participate in bull markets, while a
short term frame makes equity a higher risk proposition (Afza, 2011).

9
Working capital decisions provide a classic example of the nature of risk-return in financial decision
making. Increasing a company’s net working capital, and current assets less current liabilities, reduces
the risk of a company not being able to pay its bills on time. This at the same time reduces the overall
profitability of the firm. Working capital management involves the risk-return trade-off: not taking
additional risk unless compensated with additional returns This theory is in line with independent
variables one and three (cash and accounts payable) since lack of meeting financial obligation on the
part of firms threaten their relationship with creditor and paying off all creditors will affect the cash
position negatively as it tends to reduce profit. Therefore managers have to strike a balance between
these two positions.

For investors, the risk return trade-off is one of the essential components of each investments decision
is well as in the assessment of portfolios is a whole. At the foundation of this assessment, the
consideration of the risk as well the reward of an investment can determine whether taking action
makes sense or not. At the portfolio level, the risk return trade off can include assessments on the
concentration or the diversity of holdings and whether the mix presents too much risk or a lower than
desired potential for returns .The management of working capital involves risk and return trade off
(Mwalla, 2012).It is not possible to accurately estimate the working capital needs and so a firm must
decide the current production levels to be carried out. Given a firms’ technology and production policy,
sales and demand conditions and operating efficiency, its current assets holdings will depend upon its
working capital policy which may follow a conservative or aggressive policy and these policies involve
risk and return trade-offs (shubiri,2011).

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2.2.3 Fisher Separation Theorem

According to Hochstein (2001) in Erik (2012), the idea of the Fisher separation theorem is ‘given
perfect and complete capital markets, the production decision (investment) is seen as governed solely
by an objective market criterion (maximizing wealth), with no regard to the individuals subjective
preferences that enter into the consumption decision’. What this means, is that companies should avoid
confusion between an investment and financing the investment. Fisher’s separation theory is associated
with working capital because a company should separate how; much it invest in working capital versus
how they will finance working capital. (Gitman, 2008) presented the discussion of this theory on the
difference between the investment and financing of working capital by defining terms such as gross
working capital and net working capital. He also introduced the working capital in the balance sheet,
gave an in depth into the financing of working capital and company investment in general. This theory
is line with any of the variable as it encompasses investment in accounts receivable, cash, accounts
payable, inventory and financial intervention.

2.3 Conceptual Framework

A conceptual framework assists the reader easily to connect the relationship of the various variables in
a study. The diagram shows the summary of the variables affecting Working Capital Management
which are inventory, account payables and account receivables.

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 Independent Variables Dependent Variable

INVENTORY
- Economic Order Quantity
- Inventory budget
- Inventory Management Policy

ACCOUNTS RECEIVABLE PERFORMANCE

- Monitoring accounts receivables - Return on Assets
- Receivable management policies - Return on Equity
- Receivable collection policy - Profitability

ACCOUNTS PAYABLE
- Credit policies
- Monitoring credit payments
- Optimum accounts payable management

Figure 2.1 Conceptual framework

2.4 Review of Variables

2.4.1 Inventory

Inventory is the stock procured with the aim of selling at a profit and represents the largest cost to a
manufacturing firm. Inventory consists of between 20% and 30% of the total investment in a
manufacturing firm. Efficient management of inventory is therefore important in order to facilitate the
firm’s operations. Kwame (2007) established that most firms prepare inventory budgets and also review
their inventory levels. Enhancing the inventory management enables firms to avoid tying excess capital
in idle stock at the expense of other viable ventures.

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2.4.2 Accounts receivable

Accounts receivable refers to the unpaid claims from a firm’s customers at a given time, usually due
within a relatively short period (up to one year), and indicates the firm’s supply of trade credit.
Accounts receivable consist of the credit a business grants its customers when selling goods or services
as per the trade policy and volume supplied.

The main objective of offering trade credits is the increase of profitability because of attracting more
customers and more sales. A firm also dominates over its competitors in that it constantly increases
sales hence an increase in its value.

According to Emery et al. (2004), accounts receivables are large investments in firm's asset, which are,
like capital budgeting projects, measured in terms of their net present values. Sales are stimulated in
case of credit sales, as the customer is able to assess the product before paying for it though they also
have opportunity costs. The debtors’ risk, economic value and futurity are important characteristic that
explain the need for a proper receivables management. Berrry and Jarvi (2006) state that in setting up a
policy for determining optimal amount of accounts receivable the various costs of maintaining
receivables are of importance. A trade-off between the securing of sales and profits and the amount of
opportunity cost and administrative costs of the increasing account receivables; and the level of risk the
firm is prepared to take when extending credit to a customer, is important because this customer could
default when payment is due.

The management of receivables revolves around three aspects namely credit policy, credit analysis and
the control of receivables. Credit policy is a trade-off between the increased sales due to the credit
terms extended and the cost of maintaining the debtors and bad debts. This involves the determination
of the credit period and any discounts therein. Credit analysis is the process of determining the risks
involved in advancing credit to a given party by analysing their credit worth. Controlling of receivables
on the other hand involves following up debtors, formulation of the best credit collection policy and its
execution.

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The efficient management of accounts receivable depends to a greater extend on the credit policy and
collection procedure. A credit policy specifies requirements to value the worthiness of customers and a
collection procedure provides guidelines for collecting unpaid invoices that will minimize delays in
outstanding receivables.

During global financial crisis, characterized by high liquidity risk faced by the banks, trade credits may
increase, operating as a substitute for bank credits, or decrease - acting as their complement. Bastos and
Pindado (2012) for example, suggest that credit constraints during a financial crisis cause firms holding
high levels of accounts receivable to postpone payments to suppliers, which act in the same manner
with their suppliers. This gives rise to a trade credit contagion in the supply chain characterized by a
cascading effect. The current financial crisis provides economists with a unique opportunity to study
the role of alternative financial sources during periods of breakdown of institutional financing.

2.4.3 Accounts payable

The most significant source of short-term finance is trade credit. It is relatively easy to obtain; varies
with the amount granted; informal and unstructured source of finance. It does not also require any
negotiations and form of agreement or restrictions which is common in other sources of finance.
Management of accounts payables involves the balancing of the benefits of trade credit against the
costs of foregoing cash discounts, late payment penalties, opportunity cost associated with deterioration
in credit standing and chance of increase in the price that can be imposed by the seller on the buyer.
The ultimate effect of managing accounts payables efficiently is to maintain cash outflow which
ensures a firm’s liquidity is not adversely affected and consequently the firms profitability also will not
be affected (Uremadu et al., 2012).

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2.4.4 Performance of SMEs

Performance is the state of yielding a financial gain. A firm’s financial performance , in the view of the
stake holder is measured by how better off the stakeholder is at the end of a period , than he was at the
beginning and this can be determined using ratios derived from financial statements ;mainly the balance
sheet and income statement, or using data on stock market prices These ratios give an indication of
whether the firm is achieving the owners objectives of making them wealthier and can be used to
compare a firm’s ratios with other firms or to find trends of performance over time. An adequate
performance measure ought to give an account of all the consequences of investments, on the wealth of
shareholders. The main objective of shareholders in investing in a business, is to increase their wealth.
Thus the measurement of business performance must give an indication of how wealthier the
shareholder has become as a result of the investment over a specified period of time.

ROA is used as a vital measure of profitability. The ROA provides information about how much profits
are generated, on average, by each unit of the assets of the firm In addition they noted that ROA can be
measured using the equation, ROA = Net Profit after tax /total equity. This suggest that ROA is an
indicator of how efficiently a firm is being operated with the assets available to the firm. ROE should
be the starting point for any systematic analysis of firm performance ROE relates the earnings left over
for equity investors after debt service costs have been factored into the equity invested in the firm. The
equation used to measure ROE can be represented as;

ROE = Net Profit after Interests before tax / Total equity

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2.5 Empirical Review

(Ahmad, 2012) carried a study in a Malaysia which sought to investigate the impact of capital structure
on company’s performance by analysing the relationship between return on asset, return on equity,
short-term debt and long-term debt. The study established that short term debt and long term debt had a
significant relationship with ROA. It was also established that ROE had significant relationship with
short term debt, long term debt and total debt. Kotut (2013) does not clearly bring out the effects of
poor receivable management practices on the impairment of the receivable. However, he links the
impairment of the receivables to poor performance and liquidity levels of most companies in Kenya.
This study will therefore seek to critically bring out the link between accounts receivable practices and
impairment of receivables.

Moreover, most studies analyse receivable management practices from the working capital perspective;
mostly as a part of working capital management, from various points of view (Gill, 2010) and
(Mathuva, 2010). For example, talks about the response of accounts receivable to changes in the cost of
inventories, profitability, risk and liquidity while other authors explore the impact of an optimal
receivables management, i.e. the optimal way of managing accounts receivables that leads to profit
maximization.

(Makori, 2013) examined the relationships between Working capital management and corporate
performance of 20 manufacturing firms listed on the Nairobi Securities Exchange for 5 years from
2007-2011. However, these studies do not provide any evidence of the relationship between cash
management practices and performance of SMEs. In this context, the objective of the current work is to
assess the impact of working capital management practices on performance for a panel made up of 200
accountants and book keepers in SMES located in Mombasa County during the period 2018-2019.

16
2.6 Critique of Existing Literature

(Gill, 2010) carried out their research on American manufacturing companies. They argued that the
results of the findings similar to those they included in their research. The sample size they used was
also small. They further argued that future research should investigate generalization of the findings
beyond the American manufacturing companies. (Baveld, 2012) Studied the impact of working capital
Management on the profitability of public listed firms in the Netherlands. 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 extending the sample size so that an
industry- wise analysis can help to uncover the factors that explain the better performances for some
industries and how these best practices could be extended to other industries.

(Muchina, 2011) Studied the influence of working capital management on firms’ profitability of small
and medium enterprises sector. They argued that despite significantly role played by SMEs, their
financial management environment is not well understood especially in the area of WCM. However, in
their study they attempted to analyse the relationship between WCM 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, 2007) in their study on WCM and profitability concluded that if firms properly manage their
accounts receivables, payables and inventories, it will ultimately lead to increase profitability of the
firms. They suggested that further research be conducted on the same topic with different companies.
(Ikram, 2011) studied working capital management on profitability in the cement industry. The results
of the study were based on only one sub sector in 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.

17
(Mathuva, 2010) examined the influence of working capital management components on corporate
profitability using a sample of 30 firms listed on the Nairobi Stock Exchange (NSE) for the periods
1993 to 2008. The key findings of his study were that: i) there exists a highly significant negative
relationship between the time it takes firms to collect cash from their clients (accounts collection
period) and profitability, ii) there exists a highly significant positive relationship between the period
taken to convert inventory to sales (the inventory conversion period) and profitability, and iii) there
exists a highly significant positive relationship between the time it takes the firm to pay its creditors
(average payment period) and profitability.

Khan et al (2011) carried out a study to investigate the hypothesis that working capital management has
effect on profitability and there exist a trade-off between risk and return. They used a sample of 92
Pakistani firms from the textile sector for the period 2001 to 2008. Descriptive Statistics, Correlation
and Regression Analysis were used for investigation. The findings of the study concluded that there
exist a moderate risk-return trade off in between profitability and liquidity hypothesis. Moreover,
working capital management has a significant impact on profitability with respect to the textile sector
of Pakistan. Further there exists a positive relationship between size and profitability. This study was
limited to the textile industry with a sample of 92 companies, which may not be fully generalized to the
entire economy of Pakistan.

(Gakure, 2012) examined the relationship between WCM and performance of manufacturing firms
listed at the Nairobi Securities Exchange (NSE). The study used secondary data from a sample of 18
firms at the NSE. A regression model was determined to establish the relationship between the
dependent variable and the independent variables. Pearson’s correlation and regression analysis were
used for the analysis. The results indicated that there is a strong negative relationship between firm’s
performance and liquidity of the firm.

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2.7 Research Gaps

A few empirical studies have been done to access the relationship between WCM practices and
financial performance in Kenya. This research main aim is to fill the gap by investigating the factors
that affect working capital management so as to ensure that business organizations are able to run well
with enough capital. This study seek to fill this literature gap by looking at how factors affecting
working capital management on the financial performance of SMEs in Mombasa County.

2.8 Summary

Working capital is very essential for day to day running of a firm and thus should be well managed.
The other part is ensure that cash collection and disbursement are as efficient as possible. On the other
hand debtor management is also a crucial factor to consider; for effective debtor management an
effective Credit policy should be set because it guides management about how to control debtors and
how to balance between liberal and strict credit. If company does not restrict debtors on the period and
terms of payment, debtors may become ignorant and delay in paying the debt and thus affecting
working capital negatively.

Inventory also being one of the variables that determines proper working capital management should be
adequate in the firm for proper working capital management. Similarly, business owners must make a
trade-off in the management of the inventories of raw materials they carry, this reduce holding cost and
minimizes shortages.

19
The empirical studies show that WCM has an impact on the financial performance of firms and is of
particular importance to small firms. However, the researchers defer on the kind of impact that WCM
has on financial performance of firms. Some researchers (Nyabwanga, 2012) have found a positive
relationship while others have found a negative relationship (Falope, 2009). For other researchers
(Mathuva, 2010) different components of WCM have different impact on the financial performance of
firms. Therefore this study attempted to cover the gap which exists in defining the kind of relationship
between WCM and financial performance of firms. The study therefore concentrates on SMEs in
Mombasa County since only a few studies have been carried out in regards to the effect of WCM on the
performance of SMEs in Mombasa County.

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 CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

This chapter presents the research methods that the researcher will adapt to facilitate execution of the
study to satisfy study objectives. These steps include; research design, population of interest, sample
and sampling techniques, data collection instruments, procedures and data analysis.

3.2 Research Design

The research design is a master plan specify the methods and procedures for collecting and analysing
the needed information (Zikmund, 2010). It is a framework that plans the actions for the research
proposal, as well as to guide us in solving problems. It is the arrangement of conditions for the
collection and analysis of data in a way that aims to combine relevance and purpose of the research.
Descriptive research design shall be used in this study. The descriptive research design formulates the
problem for more precise investigation and in this case is to investigate the factors that affect Working
Capital Management of SMEs by exploring and creating a detailed description of the phenomenon.

3.3 Target Population

Population is the total number of items in a specific geographical area. Population is defined as the sum
of all the elements about which the researcher intends to make assumptions. The target population of
the study will include 200 registered small and medium enterprises at Mombasa County. For
researcher's convenience, these SMEs were divided into 2 categories which include: the retailers and
wholesalers. This information is further tabulated in Table 3.1 below;

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Category Target population Percentage (%)

Retailers 100 50

Wholesalers 100 50

Total 200 100

Table 3.1 Target Population

3.4 Sampling Frame.

Sampling frame is the list of all possible units that data can be collected. In line with this, the sampling
frame of the study will include 66 respondents who are; the retailers and wholesalers.

3.5 Sampling and Sampling Technique.

A sample is a representative of the entire population. The researcher used sample survey, this involves
complete enumeration of the whole population of 66 as the sample size following the thumb rule which
emphasizes that one should obtain as big sample as possible.

If a sample is taken from a population, a formula must be used to take into account confidence levels
and margins of error. When taking statistical samples, sometimes a lot is known about the population,
sometimes a little and sometimes nothing at all. For example, one might know that a population is
normally distributed (e.g., for heights, weights or IQs), one may know that there is a bimodal
distribution (as often happens with class grades in mathematics classes) or one may have no idea about
how a population is going to behave (such as polling college students to get their opinions about quality
of student life). Slovene’s formula is used when nothing about the behaviour of a population is known
at all.

22
A sample is a subset where every item in population has the same probability of being in the sample
(Susan, 2010). The sample size for the study will be calculated using Slovene’s formulae as follows:

n = N / (1 + Ne^2)
Where: n = Number of samples
N = Total population, 100
e = Error tolerance, 0.10 (10%)
n = 200/ (1 + 200 (0.10^2))
= 66

Therefore, the sample size for the study will comprise of 66 respondents.

Category Target population Sample size Percentage (%)

Retailers 100 33 50

Wholesalers 100 33 50

Total 200 66 100

Table 3.1 Sample size

3.6 Data Collection Methods

The study will be using both secondary and primary data. The researcher also will use questionnaire to
collect first-hand information, questionnaires will be convenient in this research as it enables
respondents to feel free to give details of even sensitive information. A questionnaire is well thought-
out tool designed to elicit information that can be obtained through written responses from the study
subjects. The questionnaires will be given to the respondents and be given enough time to fill the
questions. Both open and closed ended questions to be used and the questions which base on the three
objectives.
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3.7 Data Collection Procedure

The researcher will request for an introductory letter from Jomo Kenyatta University of Agriculture and
Technology which will be attached to the questionnaires explaining the purpose of the study. The
researcher will use drop and pick method in administering the questionnaire. The researcher will collect
the questionnaires from the respondents after a period of two weeks.

3.8 Pilot Testing

The pilot study will be used to test the validity and reliability of the data collection tool. It will enable
the researcher to rephrase, omit or add some questions.

3.8.1 Validity

To ensure the validity of data collection tool, the study will employ content validity. Content validity
focuses on the extent to which the content of the instrument corresponds to the substance of the
theoretical concept it is designed to measure. In addition, the supervisors will assess the validity of the
content of the data collection tool.

3.8.2 Reliability

(Cooper, 2011) defined reliability as a measure of how consistent the results from a test are. The
research instruments used in a study are only said to be reliable if they can measure a variable
accurately and consistently and obtain the same results under the same conditions over a period of time.
To test the reliability of the instrument, Cronbach’s alpha coefficient will be computed for each of the
study variables. The aim of this test will be to ascertain the internal consistency of the items. Items are
considered reliability if they yield a reliability of 0.70 and above according to (Fraenkel, 2010).

24
3.9 Data Analysis and presentation.

Data Analysis is the processing of data to make meaningful information (Susan, 2010). Data processing
involves translating the answers on a questionnaire into a form that can be manipulated to produce
statistics. The data collected will be edited for comprehensiveness and accuracy. Data will be analysed
using descriptive statistics to get percentages and frequencies. The Data will then be presented using
charts, tables and graphs, Conclusions and recommendations will then be made.

This study will use descriptive and inferential statistics in the analysis of data. Once data will be
collected, data will be crosschecked and verified for errors, completeness and consistency. It will then
be coded, entered and analysed descriptively using Statistical Package for Social Sciences. Pearson
correlation will be used to analyse the relationship between each independent variable and dependent
variable. Multiple linear regression analysis model will be computed to determine the statistical
relationship between the independent variable and the dependent variables. Thus, multiple regression
model that will be used in the study will be:

Y = β0 + β1X1 + β2X2 + β3X3 + ε

Where,
β0, β1, β2, β3, and β4 are the regression co-efficient
Y – Financial performance of SMEs
X1 – Account Payables
X2 – Inventory Management
X3 – Accounts Receivables
β0 - Intercept constant
β1, β2, β3, β4 = Beta coefficients.
ε = Error variable for regression.

Analysed data will be presented descriptively using tables, bar graph and pie charts.

25
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 APPENDIX I: LETTER OF INTRODUCTION

Hamza Shurut,
Jomo Kenyatta University of Agriculture and Technology
P.O Box 81310-80100,
Mombasa,

Dear respondent,

RE: REQUEST FOR PARTICIPATION IN A RESEARCH STUDY

I am a student from JKUAT, carrying out research on factors affecting working capital management on
financial performances of SMEs. This is partial fulfilment of the requirement for the award of the
degree in Bachelor of Business and Information Technology (BBIT) degree program at the Jomo
Kenyatta University of Agriculture and Technology.

The result of this study will provide the management with the necessary information on the factors
affecting working capital management on financial performances of SMEs. This is an academic
research and confidentiality is strictly emphasized, your name will not appear anywhere in the report.
Kindly spare some time to complete the questionnaire attached. Your cooperation and assistance will
be highly appreciated. Thank you in advance.

Yours faithfully,

Hamza Shurut

Researcher

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 APPENDIX II: QUESTIONNAIRE

Instructions:

1. Do not write your name or any other personal identification information anywhere in this
questionnaire.
2. Tick where appropriate in the spaces provided and give descriptive answers where requested.
3. Please answer all the questions.

SECTION I: BACKGROUND INFORMATION (Please tick one)

1. Select type of business:

 Sole proprietorship
 Partnership
 Limited Liability Company
2. How many employees does the firm have?
0 to 4
5 to 49
50 to 99
100 to 150
Over 150
3. Kindly select the nature of business and specify the business carried out

Wholesale

Retailing

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4. What is the annual Gross turnover?
Ksh 0 to Ksh 5,000,000
Ksh 5,000,001 to Ksh. 25,000,000
Ksh 25,000,001 to Ksh 50,000,000
Ksh 50,000,001 to Ksh 75,000,000
Ksh 75,000,001 to Ksh 100,000,000
Over Ksh 100,000,000
5. How many years has the company been in business?
 0-3
 4-6
 7-10
 Over 10
6. Does your enterprise have any written policy statement regarding working capital management
strategy?
 Yes
 No

7. If yes, kindly indicate the areas it covers

 Inventory
 Debtors
 Creditors
 All of the above
8. What accounting system does the firm use?
 Computerized
 Manual
 A combination of computerized and manual

33
 9. Rank each single area of working capital management in terms of the number of problems faced.
Use the following scale:
1=Least problems

2=Few Problems

3=Many problems

4=Most problems

Area of Working Capital Ranking

Inventory
Debtors
Creditors

10. Of the above areas of working capital, which area would the firm need training?
Kindly tick all that are appropriate.

 Inventory management
 Debtors management
 Creditors management

34
SECTION II: ACCOUNT RECEIVABLES
Please indicate the extent to which you agree or disagree with regards on credit control:

Factors Never Hardly Sometimes Mostly Always

(1) ever (3) (4) (5)
(2)

Does the firm offer some sales on credit?

& Does the firm offer cash discounts?

Does the firm suffer bad debts

Is legal action taken to recover them?

Does the enterprise analyze and report on

debtors aging?

Does the firm monitor receivables?

Does the firm factor debtors?

Is there a credit collection policy?

35
 SECTION III: INVENTORY MANAGEMENT
Please indicate the extent to which you agree or disagree with the following in regards to inventory
management:

Factors Never Hardly Sometimes Mostly Always

(1) ever (3) (4) (5)
(2)

Does the firm have adequate stock to meet demand

at all times?
Are there times when the firm is under stocked?

Are there times when the firm is over stocked?

Does it use economic order quantity each time it

orders stock?
Are there controls over security and authorization of
stock?
Does the firm maintain up to date stock records?

Does the firm offer quantity discounts?

36
SECTION IV: ACCOUNT PAYABLES
Please indicate the extent to which you agree or disagree with regards on credit control:

Factors Never Hardly Sometimes Mostly Always

(1) ever (3) (4) (5)
(2)

Does the firm obtain services on

credit?
Does the firm’s suppliers offer cash
discounts?
Are all creditors paid in time?
Does the firm exploit trade credit as
much as possible?

37
 Rank the ease of access of the following sources of funds on the following scale:
1= easiest to access

2= moderately easy to access

3= easy to access

4= slightly difficult to access

5= very difficult to access

6= most difficult to access

Source of funds Ranking

Bank loans
Overdraft
Bills discounting
Letter of credit
Working capital loan

38
 Section V: WORKING CAPITAL
Please indicate the extent to which you agree or disagree with regards on credit control:

Factors Never Hardly Sometimes Mostly Always

(1) ever (3) (4) (5)
(2)

Our SME maintains a low level of

current assets as a percentage of total
assets
Our SME always maintains current
ratio of 2:1
Our SME maintains current ratio of
2: 1
Does the firm exploit trade credit as
much as possible?

Thank you for your cooperation!

39
 APPENDIX III: RESEARCH WORK PLAN

AUG 2019 SEP 2019 OCT 2019 NOV 2019

ACTIVITY

Introduction

Literature review

Research methodology

Proposal Submission

Proposal Presentation

40
 APPENDIX IV: FINANCIAL BUDGET

Item Cost (kshs.)

Transport 5000

Typing and Printing 5000

Internet Services and Airtime 4000

Stationery 4000

Photocopy 2500

Binding 2500

Other Miscellaneous expenses 5000

Total 28000

41