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IMPACT OF FINANCIAL MANAGEMENT PRACTICES ON PROFITABILITY OF BUSINESS ENTERPRISES: CASE STUDY OF SME OPERATORS IN ILORIN METROPOLIS

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:

1.   Determine effect of working capital management practices on the profitability of SMEs in Nigeria.

2.   Determine the extent of financial management practices employed by the SMEs and their effect on growth.

3.   Examine how financial planning practices influence on the profitability of SMEs.

4.   Determine the influence of accounting information systems on the profitability of SMEs in Nigeria.

5.   Scrutinize the effect of financial reporting and analysis practices on the profitability of SMEs in Nigeria.

6.   Establish the relationship between financial management practices and business performance of SMEs.

1.4  STATEMENT OF HYPOTHESIS

The following hypotheses were tested for the research study:

Hypothesis One

Financial management practices positively influences Business and financial performance.

Hypothesis Two

Working Capital Management as a financial management practice has a positive relationship to profitability of business enterprises.

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.

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