Impact Of Financial Management Practices On Profitability Of Business Enterprises (Case Study Of SME Operators In Ilorin Metropolis)
Impact Of Financial Management Practices On Profitability Of Business Enterprises (Case Study Of SME Operators In Ilorin Metropolis)
Abstract
Financial management practices act as tool for the organizations to remain profitable while ensuring that they do not become bankrupt or insolvent. Particularly, this is important to the SME’s sector where any mismatch in financial management practices is probable to negatively impact the performance to a high extent. However, the influence that the financial management practices have on SME’s financial performance has not been well established, as both positive and negative relationships have been obtained. The study sought to determine the effect of financial management practices on the financial performance of 10 small and medium enterprises in Nigeria. The study employed the descriptive research design in conducting the study. The population for this research comprised of all the10 SMEs in Illorin, Nigeria, with the respondents being the managerial employees or owners. Due to the population being well defined, small and manageable, a census approach was employed in order to cover the entire population of 10 SMEs. The study used primary and secondary data, primary data was collected using questionnaires. The data were tabulated, classified and summarized by descriptive measures such as frequency distribution, percentages, inferential statistics and mean and standard deviations. Tables and graphs were used for presentation of analyzed data. All the SMEs were found to have financial management practices incorporated in their operations. The financial management practices had positive Pearson Correlations implying that all the variables had a positive effect on the SMEs’ performance. This means that an increase in these variables will cause an increase in the organization’s returns. However, all the variables were less significant except cash budget management practices meaning they must be combined for them to be able to predict the changes in the performance. The effect of the variables combined had a strong relationship with SMEs’ financial performance based on the regression analysis. The study recommends that the managements should carefully evaluate their companies’ structures before adopting the financial management practices. The study thus concludes that adding and integrating financial management practices is concluded to highly improve how the SMEs will perform overall. The study recommends that the managers in the SMEs should highly prioritize financial management practices during the formulation of the organization strategies. The study also recommends that regulatory bodies should formulate appropriate policies and regulations which will facilitate the implementation of financial management practices in the firms.
Chapter One
Introduction
1.1. Background to the Study
Business Enterprises (SMEs) are seen as a driving force for the promotion of an economy (Khan and Jawaid, 2004) and they contribute immensely to the economic development of any country.
According to OECD (1997), business enterprises play a major role in economic growth and development, creation of employment and income generation. Business enterprises in Nigeria contribute enormously to National Gross Domestic Product (GDP) and employment in the informal sector. It creates employment and leads to the export of locally manufactured goods and services as well as helping the local government authorities to generate tax revenues for socio-economic development.
As in most developing countries, small and medium-scale enterprises form a significant part of the economic growth. Nevertheless, they face a number of problems, including access to finance from formal sources, which is often considered to be the most important problem (MFPED, 2008). Consequently, the growth of the SME sector directly affects the performance of the nation. In all economies they constitute the vast majority of business establishments and they are usually responsible for the majority of employment opportunities created which account for one third to two thirds of the private sector turnover (Ntsika, 2002). It is estimated that SMEs contribute 56% of private sector employment and 36% of the Gross Domestic Product (GDP) worldwide (Arianoff, 2010). In many countries, SMEs have been a major engine of growth in employment and output over decades. In developing countries they are seen as a major „self-help‟ instrument for poverty eradication due to the ease of entry and exit.
The success or failure of small to medium enterprises (SMEs) is contingent on their financial viability and one of the most common problems facing such firms is their ability to secure sufficient cash flow and working capital to remain profitable.
Financial management is one of several functional areas of management which is central to the success of any small business (Meredith, 2006). Financial management is the management of finances of a business in order to achieve the financial objectives of the business. McMahon et al. (2008) defines financial management based on mobilizing and using sources of funds: Financial management is concerned with raising the funds needed to finance the enterprise‟s assets and activities, the allocation of theses scare funds between competing uses, and with ensuring that the funds are used effectively and efficiently in achieving the enterprise‟s goal.
Financial management as used in this study is composed of five (5) constructs and these include; working capital management which is also subdivided into cash management, receivables management and inventory management. Other constructs under financial management include; investment, financing, accounting information systems and financial reporting and analysis. Ross et al (2009) indicated three kinds of decisions the financial manager of a firm must make in business; these include the financing decision, and decisions involving short-term finance and concerned with the net working capital, investment and financial reporting.
Inefficient financial management may damage business efficiency and this will continuously affect the growth of the Small and Medium enterprises. However, efficient financial management is likely to help SMEs to strengthen their business efficiency and, as a result, these difficulties can partly be overcome, also regardless of the business enterprise, if the financial decisions are wrong, profitability of the such enterprises will be adversely affected. Consequently, a business organization’s profitability could be damaged because of inefficient financial management. Business Enterprises have often failed due to lack of knowledge of efficient financial management.
Similarly, Ang (2002) indicated three main financial decisions including the investment decisions, financing decisions and dividend decisions. Meredith (2006) asserts that financial management is concerned with all areas of management, which involve finance not only the sources, and uses of finance in the enterprises but also the financial implications of investment, production, marketing or personnel decisions and the total performance of the enterprise. However, such areas are not currently well embraced by SMEs in Nigeria and urgent attention needs to be paid to. Lack of effective management during SMEs early stages is also a major cause of business failure for small businesses. Owners tend to manage these businesses themselves as a measure of reducing operational costs.
1.2. Statement of Problem
Financial management in SMEs is often different to that found in large firms due to the more dynamic nature of their cash flow cycle, general paucity of working capital, and their ability to raise finance through debt or equity (Welsh and White, 1981). SMEs also lack the financial management and accounting systems available to large firms, as well as the professional staff who manage such systems. Typically the owner-manager is required to perform these tasks, often, but not always, with support from a bookkeeper and an accountant. This is a pattern found throughout the world, both within the advanced economies that comprise the Organisation for Economic Co-operation and Development (OECD) group of nations, and the developing economies (OECD, 2010).
Poor business performance has for long remained unexplained most especially in the third-world countries perspective where the Small and Medium Enterprises occupy the large part of the economy. However, some studies from developed nations see (Nguyen, 2001) cite inefficient financial management practices to contribute immensely to SMEs poor business performance.
Thirdly, research indicates that most small businesses have inadequate financial structures and activities, this problem causes inconsistent SMEs financial records and large discrepancies arise in the ways the business enterpise report their financial positions. For example, many SME in developing countries may have two or three sets of books for different audiences. Auditing such financial records can be labor and time intensive, which raises the cost of loan processing for SMEs, in addition auditing such financial statement can be unreliable.
Finally, previous studies showed a relationship between working capital management and profitability of SMEs and other related constructs, these studies are from the developed nations and had looked mostly at working capital management without looking deeply on the multiplicative effect of various constructs of financial management practices, that is working capital management, financing, investing, financial reporting and accounting information systems and how all these affect profitability and business performance of SMEs.
1.3. Objectives of the Study
Starting and operating a small business includes a possibility of success as well as failure. Because of their small size, a simple management mistake is likely to lead to sure death of a small enterprise hence no opportunity to learn from its past mistakes. This may be attributed to lack of planning, improper financing and poor management has been cited as the main causes of failure of small enterprises.
It is against this realization that the current study aims to investigate the impact of financial management practices on profitability of SMEs.
The specific objectives of this study include:
- Determine effect of working capital management practices on the profitability of SMEs in Nigeria.
- Determine the extent of financial management practices employed by the SMEs and their effect on growth.
- Examine how financial planning practices influence on the profitability of SMEs
- Determine the influence of accounting information systems on the profitability of SMEs in Nigeria.
- Scrutinize the effect of financial reporting and analysis practices on the profitability of SMEs in Nigeria.
- Establish the relationship between financial management practices and business performance of SMEs.
1.4 Research Questions
- What are the various financial management practiced by SMEs in Illorin?
- What is the effect of financial management on SMEs in Illorin?
- What is the relationship between financial management and performance of SMEs?
1.5. Significance of the Study
Most previous researchers have concentrated on examining, investigating and describing the behavior of Business Enterprises in practicing financial management. Their findings are mainly related to exploring and describing the behavior of business enterprises towards financial management practices and characteristics. There has been little research examining the impact of financial management practices on profitability.
The various management of business enterprises who contribute to 80% of the country’s economy will find this research work useful so also are the government of the country.
This research study will also be of immense benefit to all as it will provide indepth knowledge on the various aspect of financial management practices which may be adopted and implemented by management of various business enterprise.
Another group that will find this study useful is researchers, teachers and students of financial management sciences. While the topic: “ impact of financial management practices on profitability of business enterprises” may not be strange to them, its application to the small scale business organizations will definitely arouse their interest, which can be in the area of knowledge or adoption of this research for further study.
1.6. Scope And Limitation of the Study
The scope of this study encompass on the impact of financial management practices on small and medium scale business enterprises using SMEs operator in Ilorin Kwara State as case study.
Ilorin Municipality is one of the vibrant commercial centers in the Ilorin region of Kwara State, Nigeria. Though the numbers of enterprises are growing at an accelerated rate; ineffective financial management practices are presumed to persist in the municipality. This implies that some of the enterprises in Taiwo Oke Municipality are not profitable and this might make it difficult for the enterprises to contract credit facilities from financial institutions because the financial institutions will always want to grant credit facilities to profitable enterprises.
The study is limited by time and resources available to the researcher.
1.7. Definition of Terms
Financial Management:
FM is concerned with raising the funds needed to finance the enterprise’s assets and activities, the allocation of theses scare funds between competing uses, and with ensuring that the funds are used effectively and efficiently in achieving the enterprise’s goal.
Working Capital Management:
Working capital management has many nuances in literature but the common definition deals with efficient management of firm’s investment in current assets and liabilities; such as cash, marketable securities, accounts receivable and inventory.
Capital Budgeting Management:
Capital budgeting is the process of appraising and picking out long-term investments that is in consonance with the goal of increasing the value of owners.
Payback Period:
Talks of the amount of time that the enterprise needs to recoup its initial capital/funds invested.
Business enterprises are categorized predominantly based on ownership, namely; sole proprietorship, partnerships, corporations and limited liability companies including limited liability partnership
Financial Measures Of Performance:
Financial measures of performance can be referred to as the results of a company’s operations in monetary terms. Financial measures of performance are derived from the accounts of a company or can be found in the company’s profit and loss statement or the balance sheet.
Accounting Information System:
An accounting information system (ais) is a system of collecting, storing and processing financial and accounting data that is used by decision makers. An accounting information system is generally a computer-based method for tracking accounting activity in conjunction with information technology resources.
Small And Medium Enterprises:
Small and medium enterprise or small and medium-sized enterprise (SMEs, small and medium-sized scale business enterprise, SMBs and variations thereof) are companies whose personnel numbers fall below certain limits.
Profitability:
The term profitability is referred to as the ability to make profits steadily over a long period of time.
Chapter Five
Summary, Conclusion and Recommendations
5.1 Summary of Findings
The study sought to determine the effect of financial management practices have on the financial performance of 10 small and medium enterprises in Illorin, Nigeria. The study employed the descriptive research design in conducting the study. The population for this research comprised of all the 10 SMEs in Illorin, Nigeria, with the respondents being the managerial employees or owners. The data was tabulated, classified and summarized by descriptive measures such as frequency distribution, percentages, inferential statistics and mean and standard deviations. Multiple regression and Correlation analysis were used in determining the relationship that existed among the study’s variables.
The study also sought to determine the relationship between the study’s variable which was achieved through correlation analysis. Cash budget management had a Pearson Correlation of 0.5730, Risk Management had a Pearson Correlation of 0.1839, Working Capital Management had a Pearson Correlation of 0.6970 and size of the firm had a Pearson Correlation of 0.3348. This means that all the variables had a positive effect on the SMEs’ performance. This means that an increase in these variables will cause an increase in the organization’s returns which is supported by the available theories such as Contingency
Theory and Pecking Order Theory that explain how the financial management practices may be integrated in SMEs to ensure maximum gains.
The effect of the variables combined had a strong relationship with SMEs’ performance as shown by a coefficient of correlation of 0.9213. The coefficient of determination obtained of 0.835 implies that the model obtained accounts for up to 83.58% of the changes in performance of SMEs. The regression model was also significant at 95% confidence level in explaining the relationship that exists between the study variables implying that the model was reliable. This concurs with the study conducted by Rauf, (2016) on financial management practices in Small and Medium Sized Enterprises in SriLanka.
Cash Budget management had a coefficient of 0.086, Risk Management practices a coefficient of 0.197, Working Capital Management coefficient of 0.163 and Size of the firm a coefficient of 0.069. All the variables had a significant effect as they had a p-value less than 0.05. This shows an increase in these variables will result in significant increase in the financial performance of the SMEs. This is similar to Vohra and Dhillon (2014) who investigated the financial management practices on small firm in India and found out positive consequence of financial management practices on firms’ performance which mediate via financial planning capabilities.
The predictive model thus developed was; Y=43.76+ 0.086X1+ 0.197X2+ 0.163X3+ 0.069X4. Where: Y= Financial Performance, X1= Cash budget management Practices, X2= Risk Management Practices, X3= Working Capital Management Practices and X4= Size of the SMEs. Whereby, all the variables have a positive effect on SMEs’ financial performance.
Saah, (2015) also established the same positive on their study on the profitability of SMEs in the Tamale Metropolitan area of Ghana.
5.2 Conclusion
The study concludes that the SMEs have all put in place financial management practices to oversee their financial transactions. However, the adoption extent was concluded to vary with the particular organization due to the differences in the financial structures. Cash budgeting management practices had above average of adoption, which may be due to their utilization in undertaking most financial operations. Cash budget management was further established to have a significant positive effect on the organizations’ financial performance. The positive relationship is due to Proper budgeting acting as a tool to boost the organizations’ financial performance through providing a guideline on how the activities are conducted. The study thus concludes that the cash budget management practices enable planning, borrowing and efficient control of the organization’s expenditures.
While the most adopted risk management practices were Loss reduction/prevention and risk avoidance, whereas the least was risk transfer. The study concludes that through risk management practices, the organizations are able to identify and mitigate potential risks. On the other hand, on working capital management, the most adopted was sufficient cash flow to meet daily needs and the least was receivables management system being fully automated. The study concludes that through working capital management, there is proper management of the entity’s current assets and current liabilities to ensure that the entity has the required liquidity.
The study further concludes that size does play a role in how the SMEs performed. The positive influence is due to; increased economies of scale, reduced cost of production and increased ability to access additional financed from financial institutions. The study thus concludes that organizations with a larger size are more likely to perform better than the smaller ones.
This has seen most organization invest much in acquiring assets which will enable them to expand their operating scales. The same phenomenon was established by Rathnasiri, (2015) who conducted a study on SMEs in Sri Lankan.
Based on the study findings, the study further concludes that there exists a strong positive relationship between the variables with a coefficient of correlation of 0.9213. The predictor variables which are the various financial management practices are concluded to have a positive and significant effect on the SMEs’ financial performance. Hence, adding and integrating financial management practices are concluded to highly improve how the SMEs will perform overall.
The studies conducted internationally have also found similar positive relationship that exists between financial management practices and the financial performance of SMEs. Abanis et al, (2013) conducted a study in Western Uganda aimed at determining the financial performance of SME and found out a positive effect existed. Saah, (2015) on the other hand conducted a study on how SMEs in Tamale region conducted their financial management operations and established accounting, reporting and investing had a positive impact on the financial performance. Similarly, Mazzarol, et al, (2015) conducted a study on the financial management practices of SMEs in Australia and Singapore regions and established organizations that had well organized financial management practices had improved performance.
5.3 Limitations of the Study
The study was faced by certain limitations which hindered the effectiveness of data collection. To begin with, the study was collecting sensitive information on the financial management practices of10 SMEs in Illorin, Nigeria. This is because most organizations avoid disclosing information pertaining to their finances due to securityreasons.
Hence, the respondents were reluctant in providing information as required. However, the researcher covered this by assuring them that the data collected would be solely used for academic purposes.
The study was also limited to three financial management practices in the SMEs. This includes the financial risk management practices, cash budget management practices and working capital management which may not be a comprehensive list of the financial management practices used. Practices such as credit management and profit retention were not covered by the study which may deter full determination of the influence which financial management practices have on financialperformance.
Additionally, the study limited itself to the listed 10 SMEs in Illorin, Nigeria thus excluding other SMEs from the study. As such, this may not be an actual representation of the situation that exists in the other SMEs. This is due to the differences in structure and organizational operations. Hence, the other SMEs may have completely different financial management practices other than these firms.
The available time to carry out this study also posed a limitation as more time would have been paramount in a taking other factors relevant to the study into consideration. Despite this, the researcher ensured comprehensive and well planned data collections, so the findings obtained are accurate and justified.
5.4 Recommendations of the study
This section provides various recommendations and suggestions for further studies.
5.4.1 Managerial Recommendations
Based on the study’s findings, the study makes various recommendations. To begin with, the study established that financial management practices have a significantly positive effect on the financial performance of SMEs. The study thus recommends that the managers in SMEs should highly prioritize financial management practices during the formulation of the organization strategies. This will enhance transparency, accountability and consistency in their financial operations. However, the study recommends that the managements should carefully evaluate their companies’ structures before adopting the financial management practices. This will ensure that the practices adopted are well suited for that particular firm as companies differ in capitalstructures.
5.4.2 Policy Recommendation
The study also recommends that regulatory bodies should formulate appropriate policies and regulations which will facilitate the implementation of financial management practices in firms. This will enhance efficiency and effectiveness in managing SMEs as well as foster consistency in the implementation of financial management practices.
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