RELATIONSHIP BETWEEN FINANCIAL REPORTING AND ANALYSIS
PRACTICES AND FINANCIAL PERFORMANCE OF SMALL AND MEDIUM
ENTERPRISES IN KENYA
BY
CLEMENT MUINDE
A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILMENT OF THE
REQUIREMENTS FOR THE DEGREE OF MASTER IN BUSINESS
ADMINISTRATION, UNIVERSITY OF NAIROBI
NOVEMBER, 2013
DECLARATION
I declare that this is my own original work and to the best of my knowledge it has not
been submitted for a degree award in any other University or institution of higher
learning.
Signature…………..…………………………
Date…………………………..
D61/72331/2011
This research project has been submitted for moderation with my approval as University
Supervisor
Signature…………..…………………………
DR. JOSIAH ADUDA
Chairman Department of Finance and Accounting
ii Date…………………………..
DEDICATION
This work is dedicated to all my family members for their support, encouragement,
patience and understanding while I was not available to you the times you needed me
most.
iii ACKNOWLEDGEMENT
Many thanks to the Almighty God for seeing me through the entire period. In God I live
and move and have my being.
Thanks to my family for their encouragement and support during this entire period.
Many thanks too to my Supervisor for his patience during this entire research period. You
gave me the chance to see my best side.
In addition, thanks to my colleagues and friends for helping me with typesetting and
proofreading of the document. This final document is as a result of your participation and
input. iv ABSTRACT
Small and Medium-sized Enterprises (SMEs) play an important role in any economy
through generation of employment, contributing to the growth of Gross Domestic
Production (GDP), embarking on innovations and stimulating of other economic
activities. The objective of the study was to establish the financial reporting and analysis
practices adopted by small and medium enterprises in Kenya and to establish the
relationship between financial reporting and analysis practices and financial performance
of small and medium enterprise in Kenya.
The study adopted a descriptive cross-sectional research design. The target population
comprised of the top 100 SMEs in Kenya for the year 2012. The researcher used simple
random sampling to select 50 respondents. Primary data is information gathered directly
from respondents and for this study the researcher used questionnaires. Quantitative data
collected was analyzed by the use of descriptive statistics using SPSS and presented
through percentages, means, standard deviations and frequencies. The information was
displayed by use of bar charts, graphs and pie charts and in prose-form.
The study found that there is a strong positive relationship between financial reporting,
financial analysis, financial management and management accounting and financial
performance of SMEs. There is need for management of Small and medium enterprise in
Kenya to enhance their financial reporting practices, financial analysis practices ,financial
management practices and management accounting practices as it was found that
financial reporting and analysis practices affects the financial performance of small and
medium enterprises in Kenya .
v TABLE OF CONTENT
DECLARATION............................................................................................................... ii DEDICATION.................................................................................................................. iii ACKNOWLEDGEMENT ............................................................................................... iv ABSTRACT ....................................................................................................................... v TABLE OF CONTENT.................................................................................................... v LIST OF TABLES ........................................................................................................... ix LIST OF ABBREVIATIONS .......................................................................................... x CHAPTER ONE ............................................................................................................... 1 INTRODUCTION............................................................................................................. 1 1.1 Background of the Study ........................................................................................... 1 1.1.1 Financial Reporting and Analysis Practices ....................................................... 2 1.1.2 Financial Performance of Small and Medium-sized Enterprises ....................... 3 1.1.3 Financial Reporting and Analysis Practices and Financial performance of Small
and Medium-sized Enterprises .................................................................................... 4 1.1.4 Small and Medium-sized Enterprises in Kenya ................................................ 6 1.2 Research Problem...................................................................................................... 7 1.3 Research Objectives .................................................................................................. 9 1.4 Value of the study ..................................................................................................... 9 CHAPTER TWO ............................................................................................................ 10 LITERATURE REVIEW .............................................................................................. 10 2.1 Introduction ............................................................................................................. 10 2.2 Theoretical Review ................................................................................................. 10 2.2.1 The Theory of the Firm .................................................................................... 10 2.2.2 The Theory of Entrepreneurship....................................................................... 12 vi 2.2.3 Financial Sustainability Theory ........................................................................ 14 2.3 Empirical Review .................................................................................................... 14 2.4 Financial Reporting And Analysis Practices........................................................... 19 2.5 Financial Reporting and Analysis Practices and Business Performance ................ 21 2.6 Research Gaps ......................................................................................................... 23 CHAPTER THREE ........................................................................................................ 24 RESEARCH METHODOLOGY .................................................................................. 24 3.1 Introduction ............................................................................................................. 24 3.2 Research Design ...................................................................................................... 24 3.3 Target Population .................................................................................................... 24 3.4 Sample Size ............................................................................................................. 25 3.5 Data collection......................................................................................................... 26 3.6 Data Processing and Analysis ................................................................................. 26 3.7 Validity and Reliability ........................................................................................... 28 CHAPTER FOUR........................................................................................................... 30 DATA ANALYSIS AND INTERPRETATION ........................................................... 30 4.1 Introduction ............................................................................................................. 30 4.2 Analysis and Interpretation ..................................................................................... 30 4.2.1 General Information ......................................................................................... 30 4.2.2 Financial Reporting and Analysis Practices ..................................................... 31 4.2.3 Regression Analysis ......................................................................................... 37 4.3 Summary and Interpretation of Findings ................................................................ 39 CHAPTER FIVE ............................................................................................................ 42 SUMMARY, CONCLUSIONS AND RECOMMENDATIONS ................................ 42 5.1 Summary ................................................................................................................. 42 vii 5.2 Conclusion............................................................................................................... 43 5.3 Policy Recommendations ........................................................................................ 45 5.4 Limitations of the study........................................................................................... 46 5.5 Areas for Further Research ..................................................................................... 46 REFERENCES ................................................................................................................ 48 APPENDICES ................................................................................................................. 53 Appendix I : Questionnaire ........................................................................................... 53 Appendix II: 2012 Kenya Top 100 companies ............................................................. 56 viii LIST OF TABLES
Table 4.1: Category which the SMEs belong to ............................................................... 30
Table 4.2: Financial reporting and analysis practice on financial performance of SMEs 31
Table 4.3: Effects of financial management practices on financial performance of SMEs
in Kenya ............................................................................................................................ 33
Table 4.4: Effects of financial analysis on financial performance of SMEs in Kenya ..... 34
Table 4.5: Effects of investment analysis on financial performance of SMEs in Kenya . 35
Table 4.6: Effects of Inventory Management Practices on performance of SMEs in Kenya
........................................................................................................................................... 36
Table 4.7: Model Summary .............................................................................................. 38
ix LIST OF ABBREVIATIONS
GDP
Gross Domestic Product
SMEs
Small and Medium-sized Enterprises
SPSS
Statistical Package for Social Science
MFI
Micro-Finance Institution
x CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Small and Medium-sized Enterprises (SMEs) play an important role in any economy
through generation of employment, contributing to the growth of Gross Domestic
Production (GDP), embarking on innovations and stimulating of other economic
activities (Gamage, 2000). Therefore, for the developing countries, it is important to
accelerate the growth of SMEs in order to gain sustainable development. The numbers of
SMEs in Kenya tend to increase continuously. In the context of SMEs, accounting
information is important as it can help firms manage their short-term problems in critical
areas like costing, expenditure and cash flow by providing information to support
monitoring and control (Mitchell et al., 2000, Son et al. 2006).
Thus, financial reporting system is necessary to ensure that the SMEs’ economic
resources are used effectively and efficiently in pursuit of its goals. It also follows that
there is a particular need in growing SMEs for the skills of financial analysis which will
allow financial statements to be read and understood, whether they contain historical or
forecast information (McMahon, 1995). Therefore, through this research an attempt is
made to ascertain the comprehensiveness of financial reporting and analysis practices
adopted by SMEs in Kenya and evaluate whether these financial reporting and analysis
practices have an impact on the financial performance of these organizations.
1 1.1.1 Financial Reporting and Analysis Practices
Gitman (2007) defines financial management as the area of business management
devoted to a judicious use of capital and a careful selection of sources of capital, in order
to enable an organisation to move in the direction of reaching its goals. This definition
points to certain essential aspects of financial management namely prudent or rational use
of capital resource and achieving the goal of the firm.
According to Oduware (2011), financial management entails planning for the future of a
business enterprise to ensure a positive cash flow. Brinckmann et al. (2011) and
Management Study Guide (2012) define financial management as managerial activities
that concern the acquisition of financial resources and the assurance of their effective and
efficient use. Financial management involves planning, organising, directing and
controlling the financial activities such as the procurement and the utilisation of funds of
the enterprise.
According to Firer et al. (2004) and Gitman (2007), financial management decisions
include: Investment decision (capital budgeting decision). Investment decision refers to
the process of planning and managing a firm’s long-term investments. Capital budgeting
is used to evaluate whether investments in fixed assets such as new machinery, new
plants, new products, and research development projects are worth pursuing. Capital
budgeting techniques include non-discounted cash flow techniques (payback period and
the accounting rate of return) and the discounted cash flow techniques (net present value,
internal rate of return, profitability index and discounted payback period). Working
2 capital management involves managing the short-term assets and liabilities of a firm.
Working capital management ensures that a firm has sufficient cash flow in order to meet
its short-term debt obligations and operating expenses. Financial decision (capital
structure); This relates to the raising of finance from various sources depending on the
type of source, period of financing, cost of financing and the returns. Capital structure
refers to the way a company finances its assets through some combination of equity, debt,
or hybrid securities. Dividend decision; This involves the decision with regards to the net
profit distribution (dividend payment to shareholders and retained earnings).
1.1.2 Financial Performance of Small and Medium-sized Enterprises
According to Firer et al. (2004), the goal of financial management is to maximize the
wealth of the owners of the firm. The goal of the firm is to maximize its value to its
shareholders. Value is represented by the market price of the company’s common stock,
which, in turn, is a reflection of the firm’s investment, financing, and dividend decisions.
The market price of a firm’s stock represents the focal judgment of all market participants
as to what the value is of the particular firm. It takes into account present and prospective
future earnings per share, the timing, duration, and risk of these earnings, and any other
factors that bear upon the market price of stock. The market price serves as a
performance index or report card of the firm’s progress.
Osteryoung et al. (1997) argues that it is important to note that firms have stated or
unstated objectives. Corporate finance theory assumes that the objective of the firm is to
maximise shareholder’s wealth. This is, however, usually not the case with SMEs who
often do not participate in the capital markets. Small business enterprises often exhibit
3 differences in their objectives for running their businesses well away from the traditional
shareholder wealth maximization concept. The objectives of small businesses include just
having a job, enjoying a particular lifestyle associated with getting involved in a
particular business, providing income to the owner-manager, and growing the business in
terms of earnings through sales.
According to Kuratko et al. (1997), Woodlift et al. (1999) and Newby et al. (2003), the
goal of SME owners can be measured quantitatively (financial) and qualitatively (nonfinancial). Financial return includes to earn as much profit as possible, to have as much
disposable income as possible, to achieve financial security, to build family wealth for
the future. Effective financial management strategy is crucial to the growth of a small
business.
1.1.3 Financial Reporting and Analysis Practices and Financial
performance of Small and Medium-sized Enterprises
Literature on financial management of small firms identifies the components of financial
management practices crucial to the performance of small firms as financial planning and
control, financial analysis, accounting information, management accounting, capital
budgeting and working capital management (Osman 2007; Azhar et al. 2010 ).
According to Maseko and Manyani (2011), accounting systems provide a source of
information to owners and managers of small businesses operating in any industry for use
in the measurement of financial performance. It is crucial therefore that the accounting
practices of small businesses supply complete and relevant financial information needed
4 to improve economic decisions made by entrepreneurs. Ismail and Zin (2009) note that
business strategy is one of the main components that contributes towards growth among
small firms. Padachi (2010) points out that the main factors that contribute to success or
failure of small business are categorized as internal and external factors.
The external factors include financing (such as the availability of attractive financing),
economic
conditions,
competition,
government
regulations,
technology
and
environmental factors. The internal factors are managerial skills, workforce and the
accounting systems. This is consistent with the views of Ismail and Zin (2009) and
Nandan (2010) that in the context of small business, accounting information is important
as it can help the firms manage their short-term problems in critical areas like costing,
expenditure and cash flow, by providing information to support monitoring and control.
Ismail and King (2005), Son et al. (2006), and Shahwan and Al-Ain (2008) point out that
accounting information is also useful for firms operating in a dynamic and competitive
environment as it can help them integrate operational initiatives within long-term
strategic plans. Sarapaivanich (2003) find that SMEs lack of access to capital and high
interest rates charges are partially the result of incomplete accounting records, and the
inefficient use of accounting information. Poor record keeping and accounting
information make it difficult for financial institutions to evaluate potential risks and
returns making them unwilling to lend to SMEs.
Peel and Bridge (1998) note that capital budgeting and planning positively impact on the
performance of small businesses. SMEs engaged in detailed strategic planning are more
likely to use formal capital budgeting techniques, including the net present value method,
5 which is consistent with maximization of firm value. Perceived profitability and success
in achieving organisational objectives are positively associated with planning detail,
suggesting that strategic planning is a key component in improving performance.
Planning is very important because of the constantly changing and volatile business
environment. Sarapaivanich (2003) notes that due to inaccessibility to the capital
markets, the allocation of capital in small firms is very important. Capital assets involve a
large amount of money. The result of capital budgeting decisions continues to impact on
the firm for many years.
Effective capital budgeting can improve asset acquisitions. Frankly (2000) points out that
the appraisal of new and existing capital investment projects is fundamental to the
success of the small firm. In a perfect market, the value of the firm is maximized when
the projects with the highest net present value are selected. In addition, planning and
control positively impact on the performance of SMEs. Through planning, goals are set.
It is important to compare a firm’s actual performance with the goal through the control
process (Veskaisri et al. 2007).
1.1.4 Small and Medium-sized Enterprises in Kenya
Medium enterprises constitute a category difficult to demarcate vis-à-vis the "small" and
"big" business categories. The SME industry in Kenya is characterized by the
employment of between 50 to 200 employees and capital assets of a substantial amount
of about Ksh. 2 million (excluding property). There is no standard definition of SME in
Kenya. Lenders definitions vary, but typically they define SMEs as businesses with 6 to
6 50 employees or with annual revenues less than 50 million Kenyan shillings. Regardless
of the quantitative definition, it is agreed by virtually all stakeholders in this market that
SMEs in Kenya are the “missing middle”. Their size and credit demand have outgrown
the capacity of microfinance institutions, which offer small, short loans via group-lending
methodologies, while the opacity of the SME risk profile combined with the lenders’ lack
of sophisticated risk assessment techniques makes many of them appear undesirable as
credit customers for business banking.
SME growth is often closely associated with firm overall success and survival. Growth
has been used as a simple measure of success in business. Growth is the most appropriate
indicator of the performance for surviving small firms. Moreover, growth is an important
precondition for the achievement of other financial goals of business. From the point of
view of an SME, growth is usually a critical precondition for its longevity. Young firms
that grow have twice the probability of survival as young non-growing firms. It has been
also found that strong growth may reduce the firm’s profitability temporarily, but
increase it in the long run (Scott, 1994).
1.2 Research Problem
The small and medium-sized enterprise (SME) sector has an important role to play in
developing economies not only in economic development, but also in poverty alleviation
and job creation. The sector faces a number of constraints especially in accessing finance,
markets, training and technology. The sector faces both problems and opportunities that
affect their financial performance. However, research carried earlier on small-scale
enterprises reveal that the performance of a number of them is less than satisfactory.
Research conducted in Nairobi by Nyambura (1992) established that finance, manpower
7 and marketing were among the most highly ranked problems facing small enterprises in
the manufacturing sector. In a study carried out in Machakos, Mbuvi (1983) established
that family size which is a component of culture affected the business performance. Large
families were found to withdraw large sums of money from the business to support their
families with food, clothing, education and other needs leaving little to finance business
operations.
D’Amboise and Gasse (1980) studied the use of financial statement analysis by small
manufacturers in Quebec, Canada. DeThomas and Fredenberger (1985) found that 81
percent of the small enterprises regularly obtained summary financial information.
Thomas and Evanson (1987) studied 398 small pharmacies (in Michigan, North Carolina,
Nebraska, Rhode Island and Washington) to examine the extent to which financial ratios
were used in a specific line of small retail business and tested for a relationship between
use of financial ratios and business success.
Various local studies have been conducted by Wasonga (2008) who did a study on
challenges influencing small and medium enterprises (SMES) in Kenya: the Fina Bank
experience. Muua (2009) researched on the significance of training for skills required to
be effective in export marketing by Small and micro enterprises (SMES) exporting
locally manufactured products in Kenya and finally, Mulinge (2009) did a survey on
marketing practices adopted by SMES dealing with clothing and footwear: a case of
Makueni District. There is limited information available on the relationship between
financial reporting and analysis practices and financial performance of small and medium
enterprise in Kenya. Therefore, this study seeks to fill the existing research gap by
answering the following research question, does there exist a relationship between
8 financial reporting and analysis practices and financial performance of small and medium
enterprise in Kenya?
1.3 Research Objectives
i.
To establish the financial reporting and analysis practices adopted by small and
medium enterprises in Kenya
ii.
To establish the relationship between financial reporting and analysis practices
and financial performance of small and medium enterprise in Kenya
1.4 Value of the study
SMEs usually referred to as Jua Kali sector in Kenya are actually the engine of economic
growth. This sector provides employment opportunities, produces goods and services,
and makes use of locally available resources including recycling of wastes thereby
contributing in conserving the environment. Generally the users of SME financial reports
might include banks and other creditors, the owners or shareholders and “others”
(business advisors, tax authorities, trade contacts), (Sian & Roberts, 2009). The key
beneficiaries of this study will be banks, micro-finance institutions, Government, and
Non-governmental organizations that provide lending to the SMEs. All these need to
structure a better way of rating the financial risks that face the SMEs they fund in order to
get better loan repayment guarantees. The government will also benefit in form of
increased taxes, GDP, and economic growth. The findings from this study will go a long
way into establishing specific effects of financial reporting and analysis practices on
SMEs. This information will be used to inform any efforts to train SME entrepreneurs.
9 CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
In this chapter the researcher looks at past studies carried out by other researchers which
are related to the topic under research. The researcher looks at both theoretical and
empirical studies on the relationship between financial reporting and analysis practices
and financial performance of small and medium enterprise in Kenya. The researcher then
identifies the research gaps.
2.2 Theoretical Review
2.2.1 The Theory of the Firm
The Theory of the Firm consists of a number of economic theories that describe the
nature of the firm, including its existence, its behaviour and its relationships with the
market (Williamson, 1964). Economists have examined a wide range of traditional and
modern models in order to discover whether any of them can justly claim to be the
Theory of the Firm. For example, Curwen sought a theory that is sufficiently general to
explain the behaviour of all firms within the economy, irrespective of the size or the
degree of competition that they face (Curwen, 1983,). Whilst there have been limitations
in trying to achieve such a general theory that is applicable to all aspects of the firm,
many economic models have emphasized the assumption of profit maximization.
10 For nearly a quarter of a century, the assumption that the firm maximizes profits has been
the focal point of neoclassical economic theory and perhaps the most important of the
assumptions, that make up the Theory of the Firm, is the assumption that firms maximise
profits by setting output where marginal costs equal marginal revenue (Anderson and
Ross, 2005). In order to achieve the intended objective of profit maximization, several
factors of production are required by business entities. Economists have generally
classified these factors of production into four specific areas, i.e. Land, Labour,
Entrepreneurship and Capital. Each of these factors plays a critical role in determining
the profitability of the firm.
Although capital may refer to the acquisition of funds that are required for a business, it
also refers to the proper management and financial skills needed to manage the funds
required to ensure that a business operates efficiently. Hence, there can be a strong
correlation between the management of funds of a business and the maximization of
profits.
In order to successfully establish and grow any business entity, especially the small
business entity, there are many crucial financial decisions that must be made. Many of
these decisions relate to sourcing of capital and ensuring that such capital is utilized in a
manner that results in the optimal growth and profitability of the entity. In order to
achieve this objective, there is a necessity for the entity to possess financial management
and accounting skills.
11 2.2.2 The Theory of Entrepreneurship
Individuals or firms use the term ‘entrepreneurship’ in economic theory almost
exclusively to refer to the innovative or market equilibrating activities that are performed
in conditions of uncertainty. Although the concept of entrepreneurship is found
throughout economic literature, many economic theories fail to give it a coherent place in
their models (Adaman and Devine, 2000).
During the twentieth century, many economists have attempted to clarify the process of
entrepreneurship to aid our understanding of the market process. These economists have
emphasized different aspects of entrepreneurship and contributed to an enhanced
understanding of entrepreneurship (Wood, 2005). Kirzner, in Competition and
Entrepreneurship, argued that entrepreneurs act as economic agents to rectify
disequilibrium in the economy until the economy reaches equilibrium (Kirzner, 1973).
Kirzner’s
Theory
of
Entrepreneurship
emphasizes
the
equilibrating
role
of
entrepreneurship by stating that profit opportunities exist when the market is not in
equilibrium. These profit opportunities are discovered and acted upon by entrepreneurs,
thereby causing the market to return to equilibrium.
This theory has been used to emphasise the importance of entrepreneurship and could
become a universally accepted model that is utilized by economists and industry experts.
However, one of the weaknesses and difficulties of the theory is the assumption that all
entrepreneurs have similar access to information and resources and that information and
resources relating to entrepreneurial opportunities are readily available to all
12 entrepreneurs (Holcombe, 2003, p25). Holcombe argues that by seeking information and
searching through promising ideas, it is possible to create an environment where
entrepreneurial insights are more likely to be developed, thereby creating a direct link
between knowledge and entrepreneurship.
Therefore, it might appear that the production and dissemination of knowledge and
information will produce more entrepreneurs that will equilibrate the economy
(Holcombe, 2003, p28). This includes information relating to the financial management
and accounting for resources needed by entrepreneurs. For example, it may be possible
that disequilibrium in the economy can be identified by the proper financial record
keeping and that such financial records can be used in order to seize opportunities for
profits, thereby allowing the economy to return to equilibrium. There is consensus
amongst SME owners, bankers and development officials on four continents that SMEs
lack the know-how to provide standardized, transparent, credible financial information to
potential financial sources (www.fmi-inc.net/sme/overview.html). An improvement in
financial management and accounting skills may enhance the ability of SMEs to obtain
funding so that they are better equipped to seize opportunities for profits.
The importance and need for financial management and accounting skills is widely
recognised in large businesses. Most of these companies spend enormous resources to
ensure that they have the necessary financial skills at a strategic and operational level.
Larger institutions rely on these skills in order to achieve their operational goals and to
achieve a return for their shareholders. They also rely on these skills to ensure that they
13 comply with legislation and regulatory requirements, such as compliance with taxation
laws.
2.2.3 Financial Sustainability Theory
Long-term survival and sustainability is critical for an MFI in being able to reach its
target clientele and cover administrative and other costs. While social goals of reaching
the poorest and poverty alleviation are valid, sustainable standing on one’s own feet is as
true for low income households receiving microfinance, as for the microfinance itself.
Sustainability for microfinance has internal and external implications. Internal in terms of
deposit and savings mobilization, financial performance, staff motivation, loan
administrative costs etc while external in terms of availability of funds for loan
disbursement, grant for community organizing etc ( Morduch, 2002)
2.3 Empirical Review
D’Amboise and Gasse (1980) studied the use of financial statement analysis by small
manufacturers in Quebec, Canada and found that small manufacturers in shoe and plastic
industries formally undertook the analyses based on financial statements and the findings
revealed that manufacturing firms managerial decisions were largely based on the
financial reports prepared. The research conducted by DeThomas and Fredenberger
(1985) found that 81 percent of the small enterprises regularly obtained summary
financial information. Ninety-one percent of the summary information was in the form of
traditional financial statements (balance sheets, profit and loss statements, fund
statements), the remainder being bank reconciliation and operating summaries whereas
no business was regularly receiving cash-flow information. The study further found that
14 61 percent of respondents felt the financial statements provided the information they
required for planning and decision-making. Nevertheless, only 11 percent of respondents
reported that they had used financial statement information formally as part of managerial
evaluation, planning and decision-making, 2 percent of businesses utilized financial ratio
analysis, and few made even simple historical comparisons.
Thomas and Evanson (1987) studied 398 small pharmacies (in Michigan, North Carolina,
Nebraska, Rhode Island and Washington) to examine the extent to which financial ratios
were used in a specific line of small retail business and tested for a relationship between
use of financial ratios and business success. The study used regression analysis to
examine the relationship between financial ratio usage and SMEs profitability. However,
they could not demonstrate any significant relationship between earnings-to-sales and the
number of financial ratios used by the owner in operational decision-making.
D’Amboise and Gasse (1980) studied the utilization of formal management techniques in
25 small shoe manufacturers and 26 small plastic manufacturers in Quebec, Canada and
found that 88 percent of the businesses used a cost accounting system. Regarding
accounting standards, DeThomas and Fredenberger (1985), in a survey of over 360 small
enterprises in Georgia, found that the standards of financial record keeping were very
high. In addition to cheque and deposit receipts, around 92 percent of respondents had
some form of record keeping. Regarding the use of financial information, DeThomas and
Fredenberger’s (1985) study indicated that 96 percent of the respondents had financial
15 statements prepared, the responsibility for evaluating and using the information was
within the business itself and only four percent relied on an outside accountant services.
In the survey of 69 small enterprises across the USA, Farhoodman and Hryck (1985)
reported on the most important applications of computers, and it was found out that
accounting was rated as the highest percentage. Similarly, Palmer (1994) interviewed 36
small independent retail owner-managers and found that 33 percent of the sample
businesses used computerized accounting systems. Reviewing previous research results
shows accounting and financial management applications dominated the use of
computers in small and medium enterprises in the North America in 1980’s and 1990’s.
Williams (1986) evaluated the adequacy of accounting records for 10,570 failed and
surviving small enterprises operating throughout Australia. The findings are compatible
with Peacock’s (1986, 1987,1988) findings in that a significant proportion of ownermanagers kept inadequate accounting records. Holmes (1987) conducted a survey of
accounting information requirements of 928 small enterprises operating in Sydney,
Melbourne and Brisbane. Fifty-seven percent of respondents indicated they used the
journal/ledger (double entry) systems. This finding is rather in contrast to Peacock’s
(1987) findings of types of records maintained by failed enterprises, where only 2.1
percent of respondents were found to use double entry systems.
In the study conducted by Cooley and Pullen (1979), cash management was seen as the
process of planning and controlling cash flows. It consisted of three basic components:
cash forecasting practices, cash surplus investment practices and cash control practices.
16 Cooley and Pullen (1979) examined cash management practices of 122 small businesses
engaged in petroleum marketing and reported that 73 percent of respondents had
experienced a cash surplus. In a divergent view to Grablowsky and Rowell’s (1978) and
Cooley and Pullen’s (1979) survey, Murphy’s (1979) study indicated that active cash
management in small enterprises in the UK was unusual, and that there was little
inclination to invest surplus cash on a short-term basis. Regarding accounts receivable
management practices, Grablowsky (1976) and Rablowsky and Lowell (1980) found
generally low standards. Approximately 95 percent of businesses that sold on credit
tended to sell to anyone who wished to buy. Only 30 percent of respondents subscribed to
a regular credit reporting service. Most had no credit checking procedures and guidelines,
and only 52 percent enforced a late-payment charge. Thirty-four percent of businesses
had no formal procedure for aging accounts receivable. Bad debts averaged 1.75 percent
of sales, with a high of 10 percent in some concerns. Murphy (1978) revealed a very high
level of awareness and utilization of credit control systems in the UK, even in the
smallest businesses.
The previous studies done on inventory management practices, D’Amboise and Gasse
(1980) studied the utilization of management techniques in small shoe and plastic
manufacturing industries in Canada and found 64 percent of shoe and 65.4 percent of
plastic businesses employed formal inventory control systems. While Grablowsky and
Rowell (1980) found that most of the respondents had in excess of 30 percent of their
capital invested in inventory, the general standard of inventory management was poor.
Only six percent of businesses in their survey used a quantitative technique such as
17 economic order quantity for optimizing inventory and 54 percent had systems which were
unable to provide information on inventory turnover, reorder points, ordering costs or
carrying costs. Related to the methods used to determine inventory level, Grablowsky
(1984) compared methods used by a sample of 94 small enterprises with those used by
large enterprises and found that large enterprises used methods to determine inventory
levels far more than small enterprises.
Brigham (1995) suggested that capital budgeting might be more important to a smaller
firm than its larger counterparts because of the lack of access to the public markets for
funding. Capital budgeting has attracted researchers over the past several decades.
McMahon et al. (1993) claimed the earliest study of capital budgeting of SMEs was
reported by Soldofsky (1964). During 1961, Soldofsky interviewed 126 owners of small
manufacturing businesses in Iowa and the results were published in 1964. Regarding
capital project selection techniques, there were several surveys conducted by previous
researchers such as Soldofsky (1964), Luoma (1967), Taylor Nelson Investment Services
(1970), Hankinson (1979), Grablowsky and Burns (1980), Proctor and Canada (1992),
and Block (1997). Soldofsky’s (1964) study results shows around 58 percent of
respondents used payback period methods whereas only 4.1 percent employed accounting
rate of return technique.
Block’s (1997) survey of 232 small businesses in the USA indicated payback method
remains the dominant method of investment selection for small businesses, whereas large
corporations widely incorporate discounted cash flow models in financial analysis of
18 capital investment proposals (Proctor and Canada, 1992). This is not evidence of a lack of
sophistication as much as it is a reflection of financial pressures put on the small business
owner by financial institutions. Payback period was used to evaluate capital projects by
51 percent of respondents, while 30 percent reported use of some variation of accounting
rate of return. Only 10 percent reported use of discount cash flow methods such as net
present value (5 percent) and internal rate of return (2 percent). This finding is consistent
with the Soldofsky (1964), Louma (1967), Corner (1967), and Grablowsky and Burns
(1980) findings of a tendency in using simple and complicated methods of capital
investment project evaluation.
In Kenya, Nyagari (1977) did a study on inflation accounting and present company
financial reporting in Kenya, the study revealed that the companies were using inflation
accounting practices which positively influenced their financial performance. Njiraini
(1983) did a study on the exchange rate as a tool of financial reporting implications of
depreciating exchange rates, the study revealed that companies were using exchange rate
as a tool of financial reporting which reduce the depreciating exchange rates and Omolo
(2007) conducted a study on financial reporting in public primary schools in kenya and
the audit expectation gap with reference to public primary schools in Nairobi. The study
revealed that public primary schools were using different financial reporting practices
which aimed at reducing the expectation gap.
2.4 Financial Reporting And Analysis Practices
Holmes and Nicholls (1989) summarize that management accounting information is
associated with success and failure in SMEs depending upon how they are produced and
19 utilized in their companies. However, Horngren (1995) argues that cost accounting or
management accounting concepts and techniques are neutral instruments. It is not the
cause of poor management but primarily symptoms since it may be used wisely or
stupidly by managers of the firms.
Drury and Tayles (1995) concludes that the same rules and procedures established for
external reporting (financial accounting) are likely also to be applied to internal reporting
(management accounting). Though external and internal reporting tend to employ the
same rules, it does not mean that management accounting is subservient to financial
accounting. The reason that most companies adopt the identical practices for both
reporting systems is that firms prefer their internal profit to be reported consistently with
external financial accounting requirements in order that they will be comparable with
outsiders’ assessments of overall company performance. In the other words, companies
would like to be ensured that internal accounting system do not have any conflicts with
external financial accounting requirements.
The other issue in management accounting practices is budgeting. Szychta (2002) in his
study of manufacturing and service enterprises in Poland, found that these enterprises
prepare annual operating financial budgets for the whole enterprises. Also a complete or
nearly complete master budget is prepared by a much smaller proportion of enterprises.
The rest of them prepare sales, production and cost budgets. Unlike Polish companies,
Japanese firms are less extensive in use of financial budgeting (Yoshikawa, et al., 1989).
The key issues in internal reporting are addressed in monthly and annual reports.
20 However, the inadequately related budgeting and reporting system indicated that many
companies failed to use accounting information systematically for clearly defined and
useful purposes (Haldma and Laats, 2002).
For performance measurement and evaluation, most companies based the measurement
on different functions and product groups, to somewhat lesser extent on client groups and
sales regions (Haldma and Laats, 2002). Net profit, rather than controllable profit, is
widely used to evaluate the performance of divisional managers (Drury and Tayles, 1995)
since it could be apparently measured in monetary value and, sometimes, it is not
possible to allocate and designate which costs are controllable or uncontrollable for a
particular manager.
2.5 Financial Reporting and Analysis Practices and Business
Performance
There have been a number of empirical studies conducted in other countries investigating
the types of financial reports produced by SMEs, the frequency of their preparation, and
their perceived usefulness for management purposes. Comprehensive reviews of this
empirical evidence, and the findings of comparable research conducted internationally,
up to the early 1990s are provided by McMahon & Holmes (1989.1990).
The studies attempted to extend the limited prior research with a similar objective,
especially that of McMahon & Davies (1991a, 1991b, 1992a, 1992b, 1994). The broad
concern is the extent to which, if at all, improved financial practices appear to pay-off in
21 terms of enhanced business performances in the SMEs investigated. Moores & Mula
(1993) study the role of managerial control systems, including financial reporting, in
survival and successful growth of nearly 300 Australian family businesses. Moores &
Mula’s (1993) results clearly indicate increasing emphasis on financial reporting as
businesses grow in employment terms and progress through the earlier stages (including a
growth stage) of a business life-cycle model.
The research reported by McMahon & Davies (1994) is part of a two-year investigation
of the essential growth characteristics of a non-random convenience sample of just over
100 growing SMEs from a variety of industries situated in North-East England. On the
basis of their investigation of correlates with the historical financial practices of these
SMEs, McMahon & Davies (1994) believe comprehensive historical financial reporting
is more likely to be undertaken by SMEs which (inter alia) are larger in size. McMahon
& Davies (1994) believe financial ratio analysis based on historical financial statements
is more likely to be undertaken by SMEs which (inter alia) are larger in size and
undertake more comprehensive financial reporting. According to the findings for the
growing SMEs in the McMahon & Davies (1994) study, there do not appear to be any
substantial associations between undertaking more comprehensive financial reporting and
use of financial ratio analysis on the one hand and achieved rates of growth and financial
performance on the other.
22 2.6 Research Gaps
Information about the performance of an enterprise in particular its profitability, is
required in order to assess potential changes in the economic resources that its likely to
control in the future. Information about variability of performance is important in this
respect. Information about performance is useful in predicting the capacity of the
enterprise to generate cash flows from its existing resource base. It is also useful in
forming judgment about the effectiveness with which the enterprise might employ
additional resources (Rees, 1995).
The high rate of failure among small firms, due mainly to inefficient management
underscores the need to develop sound managerial skills. The small businessman who
learns how to collect, analyze and interpret information and how its relevant to specific
problems will increase his firm’s chances for survival, growth and profitability (Petrof et
al 1972). Findings from studies done earlier and government reports on the state of affairs
of small scale enterprises reveals that the sector faces numerous problems and constrains
that affect their performance. While much research has been done on the small business,
little has been done specifically on financial analysis and reporting practices of SMEs in
Kenya. The overall problem therefore is that relatively little is known about the
relationship between financial reporting and analysis practices and financial performance
of small and medium enterprise in Kenya.
23 CHAPTER THREE
RESEARCH METHODOLOGY
3.1 Introduction
This chapter sets out various stages and phases that will be followed in completing the
study. It involves a blueprint for the collection, measurement and analysis of data.
Specifically the following sub-sections were included; research design, target population,
data collection instruments, data collection procedures and finally data analysis.
3.2 Research Design
Creswell (2003) defines a research design as the scheme, outline or plan that is used to
generate answers to research problems. Further Dooley (2007) notes that a research
design is the structure of the research, it is the ‘‘glue’’ that holds all the elements in a
research project together. The study adopted a descriptive cross-sectional research design,
which according to Kothari (2004), is used when the problem has been defined
specifically and where the researcher has certain issues to be described by the
respondents about the problem. Survey designs have also been found to be accurate in
descriptive studies and generalizations of results (Ngechu, 2004). Cross-sectional survey
designs survey a single group of respondents at a single point in time.
3.3 Target Population
According to Ngechu (2004), a study population is a well-defined or specified set of
people, group of things, households, firms, services, elements or events which are being
24 investigated. Thus the population should fit a certain specification, which the researcher
is studying and the population should be homogenous. Keya (1989) states that for
individuals or things or elements that fit a researcher specification, the population can be
divided into sets, population or strata and which are mutually exclusive.
The target population comprised of the top 100 SMEs in Kenya for the year 2012. These
are determined objectively on the basis of the following financial parameters; revenue
growth, earnings growth, returns on equity, retention ratio, current ratio, debt equity ratio
and interest cover ratio. This population was chosen since the people in the management
are the ones involved in the day to day financial reporting and analysis in the
organization and thus are well conversant with the relationship between financial
reporting and analysis practices and financial performance of small and medium
enterprise in Kenya. Mugenda and Mugenda, (2003), explain that the target population
should have some observable characteristics, to which the researcher intends to
generalize the results of the study.
3.4 Sample Size
Ngechu (2004) underscores the importance of selecting a representative sample through
making a sampling frame. From the population frame the required number of subjects,
respondents, elements or firms were selected in order to make a sample. Stratified
proportionate random sampling technique was used to select the sample. According to
Deming (1990), stratified proportionate random sampling technique produce estimates of
overall population parameters with greater precision and ensures a more representative
sample is derived from a relatively homogeneous population. Stratification aims to
25 reduce standard error by providing some control over variance. From each stratum of the
study, the researcher used simple random sampling to select 50 respondents. According
to Cooper and Schindler (2003), random sampling frequently minimizes the sampling
error in the population. This in turn increases the precision of any estimation methods
used.
3.5 Data collection
According to Ngechu (2004), there are many methods of data collection. The choice of a
tool and instrument depends mainly on the attributes of the subjects, research topic,
problem question, objectives, design, expected data and results. This is because each tool
and instrument collects specific data. Donald (2006) notes that there are two major
sources of data used by respondents; primary and secondary data.
Primary data is information gathered directly from respondents and for this study the
researcher used questionnaires. The questionnaire was used to collect mainly quantitative
data although some qualitative data was collected from the open ended questions.
Secondary data involves the collection and analysis of published material and
information from other sources such as annual reports and published data. Thus in this
study the researcher employs the use of survey questionnaire for data collection.
3.6 Data Processing and Analysis
The researcher perused the completed questionnaires and document analysis recording
sheets. Quantitative data collected will be analyzed by the use of descriptive statistics
using SPSS and presented through percentages, means, standard deviations and
26 frequencies. The information was displayed by use of bar charts, graphs and pie charts
and in prose-form. This was done by tallying up responses, computing percentages of
variations in response as well as describing and interpreting the data in line with the study
objectives and assumptions through use of SPSS. Content analysis was used to test data
that is qualitative in nature or aspect of the data collected from the open ended questions.
According to Baulcomb, (2003), content analysis uses a set of categorization for making
valid and replicable inferences from data to their context. All the variables in the study
was measured using data collected from the questionnaire.
The following regression model was used in this study;
Y = β0 + β1FR + β2 FA+ β3FM + β4MA + ε
Where
Y
=
Financial performance of SMEs which was measured by return on assets
and net profits of the firm; it was also measured using lirket scale in
the questionnaire.
FR
=
Financial Reporting; was measured by the comprehensiveness of financial
reporting practices used by small and medium enterprise, this was
measured using various statements on likert scale on financial reporting.
FA
=
Financial analysis, was measured by the comprehensiveness of financial
analysis practices used by small and medium enterprise; this was
measured using various statements on likert scale on financial accounting.
FM
=
Financial Management, this was measured by the comprehensiveness of
financial management practices used by small and medium enterprise; this
27 was measured using various statements on likert scale on financial
Management.
MA
=
Management accounting, this was measured by the comprehensive of
management accounting practices used by small and medium
enterprise, this was measured using various statements on likert scale on
management accounting.
ε
=
error term
3.7 Validity and Reliability
The researcher carried out a pilot study to pretest and validate the questionnaire.
According to Cooper and Schindler (2003), the pilot group can range from 15 to 100
subjects depending on the method to be tested but it does not need to be statistically
selected. This was in line with a quantitative research design methodology employed in
this research project.
According to Somekh, and Cathy (2005) validity is the degree by which the sample of
test items represents the content the test is designed to measure. Content validity which is
employed by this study is a measure of the degree to which data collected using a
particular instrument represents a specific domain or content of a particular concept.
Mugenda and Mugenda (1999) contend that the usual procedure in assessing the content
validity of a measure is to use a professional or expert in a particular field.
To establish the validity of the research instruments the researcher will seek the opinions
of experts in the field of study especially the lecturers in the department of finance and
accounting. This facilitates the necessary revision and modification of the research
28 instrument thereby enhancing validity. According to Walliman (2001), reliability refers to
the consistency of measurement and is frequently assessed using the test–retest reliability
method. Reliability is increased by including many similar items on a measure, by testing
a diverse sample of individuals and by using uniform testing procedures.
The researcher selected a pilot group of 10 individuals from the target population in
Small and Medium enterprise to test the reliability of the research instrument. This was
achieved by first stratifying the individuals according to level of management. The
researcher will also put in consideration gender equity of individuals respondents.
29 CHAPTER FOUR
DATA ANALYSIS AND INTERPRETATION
4.1 Introduction
This chapter presents the findings on the study to determine the relationship between
financial reporting and analysis practices and financial performance of small and medium
enterprises in Kenya. The study targeted a sample size of 50 respondents from which 48
filled in and returned the questionnaires making a response rate of 96%. This response
rate was satisfactory to make conclusions for the study. The response rate was
representative. Descriptive and inferential statistics have been used to discuss the findings
of the study.
4.2 Analysis and Interpretation
4.2.1 General Information
Table 4.1: Category which the SMEs belong to
Frequency
percentage
Manufacturing
12
25.0
Agriculture
14
29.2
Transport and logistics
10
20.8
Telecommunication
4
8.3
Building and construction
3
6.3
Energy and Petroleum service
5
10.4
Total
48
100
30 The study requested the respondents to indicate the sector to which the SME belonged.
From the findings, 29.2% of the respondents indicated that their SMEs belonged to
agricultural sector, 25% of the respondents indicated that their SMES belonged to
manufacturing sectors, 20.8% of the respondents indicated that their SMEs belonged to
transport and logistics sector, 10.4% of the respondents indicated that their SMES
belonged to energy and petroleum service, 8.3% of the respondents indicated that their
SMEs belonged to telecommunications, whereas 6.3% of the respondents indicated that
their SMEs belonged to Building and construction. This is an indication that most of the
sectors were engaged in this study.
4.2.2 Financial Reporting and Analysis Practices
Table 4.2: Financial reporting and analysis practice on financial performance of
SMEs
Disagree
Strongly disagree
Mean
5
5
3
0
1.50 0.30
10
0
0
0
1.21 0.34
16
5
3
0
1.73 0.21
2
9
28
9
3.92 0.23
30
5
2
0
1.96 0.25
Std deviation
Moderate
The manager/ owner is involved in 35
Agree
Strongly agree
Financial reporting and analysis
preparing financial statements
The business prepares the income 38
statement
The business prepares the cash flow 24
statement
The
business
follows
accounting 0
principles
The business prepares the balance sheet
11
31 The business performs financial analysis 14
30
4
0
0
1.79 0.27
The financial statements are prepared 0
2
3
38
5
3.96 0.33
5
6
30
3
3.48 0.24
30
0
0
0
1.63 0.29
15
28
3
1
1
1.85 0.25
The accountant is in charge of preparing 35
10
3
0
0
1.33 0.31
semi-annually
The
business
regards
the
current 4
financial reporting as adequate
The financial statements are prepared 18
annually
The business uses profitability ratios
financial statements
The study sought to determine the respondent’s level of agreement with the above
statements relating to effects of financial reporting and analysis practice on financial
performance of SMEs in Kenya. From the findings, the study established that majority of
the respondents strongly agreed that, the business prepares the income statement as
shown by a mean of 1.21, the accountant is in charge of preparing financial statements as
shown by a mean of 1.33, the manager/owner is involved in preparing financial
statements as shown by mean of 1.50, the financial statements are prepared annually as
shown by mean of 1.63, the business prepares the cash flow statement as shown by a
mean of 1.73, the business performs financial analysis as shown by a mean of 1.79, the
business uses profitability ratios shown by a mean of 1.85, the business prepares the
balance sheet as shown by a mean of 1.96, the study also noted that majority of the
respondents disagreed that the business regards the current financial reporting as
adequate as shown by a mean of 3.48, the business follows accounting principles as
shown by a mean of 3.92 and that the financial statements are prepared semi-annually as
shown by a mean of 3.96.
32 Table 4.3: Effects of financial management practices on financial performance of
SMEs in Kenya
Strongly Agreed
Agree
Moderate
Disagree
Strongly Disagree
Mean
Std Deviation
Financial management practices
The owner/manager is in charge of recording 11
32
5
0
0
1.88
0.28
transactions
The business accounting system is informal
0
0
3
10
35
4.67
0.31
The business accounting system is formal
10
35
3
0
0
1.85
0.31
3
6
25
12
3.88
0.20
28
3
0
0
1.67
0.25
30
6
1
0
1.94
0.25
The accounting department is properly staffed 2
and operates efficiently
The accountant is in charge of recording 15
transactions
The business uses computer assisted software in 11
recording transactions
The study sought to determine the respondent’s level of agreement with the above
statements relating statements relating to effects of financial management practices on
financial performance of SMEs in Kenya. From the findings the study established that
majority of the respondents agreed that the accountant is in charge of recording
transactions as shown by a mean of 1.67, the business accounting system is formal as
shown by a mean of 1.85, the owner/manager is in charge of recording transactions as
shown by a mean of 1.88, the business uses computer assisted software in recording
transactions as shown by a mean of 1.94, the study also noted that majority of the
respondents disagreed that the accounting department is properly staffed and operates
efficiently as shown by a mean of 3.88, and also that the business accounting system is
33 informal as shown by a mean of 4.67, that management accounting information is
associated with success and failure in SMEs depending upon how they are produced and
utilized in their companies.
Table 4.4: Effects of financial analysis on financial performance of SMEs in Kenya
Strongly agreed
agree
Moderate
Disagree
Strongly disagree
Mean
Std deviation
Financial analysis
The financial analysis is done using ratios
11
36
1
0
0
1.79
0.32
The business uses liquidity ratios
14
32
2
0
0
1.75
0.29
The business uses efficiency ratios
15
32
1
0
0
1.71
0.29
The business uses leverage ratios
12
33
3
0
0
1.81
0.29
0
0
4
34
10
4.13
0.30
1
2
4
35
6
3.90
0.30
2
45
1
0
0
1.98
0.41
12
33
3
0
0
1.81
0.29
4
0
1
35
8
3.90
0.30
The business uses internally generated cash
sources only
The business has easy access to bank loans
The business uses internally generated cash
and borrowed funds
The business sets the capital structure
based on the theory
The business uses borrowed funds only
The study sought to determine the respondent’s level of agreement with the above
statements relating to effects of financial analysis on financial performance of SMEs in
Kenya. From the findings the study established that majority of the respondents agreed
that: the business uses efficiency ratios as shown by mean of 1.71, the business uses
liquidity ratios as shown by a mean of 1.75, the financial analysis is done using ratios as
shown by mean of 1.79, the business sets the capital structure based on the theory, the
34 business uses leverage ratios as shown by mean of 1.81 in each case, the business uses
internally generated cash and borrowed funds as shown by a mean of 1.89 the study also
established that majority of the respondents disagreed that the business has easy access
to bank loans. The business uses borrowed funds only as shown by mean of 3.90 and
finally that the business uses internally generated cash sources only as shown by mean of
4.13.
Table 4.5: Effects of investment analysis on financial performance of SMEs in
Kenya
agree
Moderate
Disagree
Strongly disagree
Mean
5
12
10
15
6
3.10 0.09
The business invests in non-current assets
24
23
1
0
0
1.52 0.26
The business utilizes fully the non-currents
2
6
0
35
5
3.73 0.30
The business uses net present value to assess
10
35
3
0
0
1.85 0.31
15
28
5
0
0
1.79 0.25
0
0
8
30
10
4.04 0.26
10
38
0
0
0
1.79 0.34
The business has cash for investment in long
Std deviation
Strongly agreed
Investment analysis
term projects
the investment
The business uses Payback period to assess the
investment
The business invests without evaluating the
investment
The business reviews the investment projects
after a certain period
The study sought to determine the respondent’s level of agreement with the above
statements which relating to effects of investment analysis on financial performance of
35 SMEs in Kenya. From the findings the study established that; majority of the respondents
agreed that the business invests in non-current assets as shown by a mean of 1.52, the
business reviews the investment projects after a certain period, the business uses payback
period to assess the investment as shown by as a mean 1.79 in each case, the business
uses net present value to assess the investment as shown by mean of 1.85, the study also
established that majority of the respondents disagreed that the business has cash for
investment in long term projects as shown by mean of 3.10, the business utilizes fully the
non-currents as shown by mean of 3.73, and that the business invests without evaluating
the investment as shown by a mean 4.04.
Table 4.6: Effects of Inventory Management Practices on performance of SMEs in
Kenya
agree
Moderate
Disagree
Strongly disagree
Mean
There is physical safeguards of inventory 15
30
3
0
0
1.75 0.27
33
5
0
0
1.90 0.29
Std deviation
Strongly agreed
Inventory Management Practices
against theft
Inventory levels are determined based on 10
owner's experience
There is use of standard costs
14
30
4
0
0
1.79 0.27
There is periodic review of overhead rates
18
30
0
0
0
1.63 0.29
Periodic summaries of inventory usage are 12
34
2
0
0
1.79 0.30
prepared and used
There is proper authorization for purchases
12
35
1
0
0
1.77 0.31
There is periodic inventory counts
14
34
0
0
0
1.71 0.31
The business computes inventory turnover 13
30
5
0
0
1.83 0.26
ratios
36 The business uses Economic Order Quantity 20
28
0
0
0
1.58 0.28
34
4
0
0
1.88 0.30
30
4
0
0
1.79 0.27
34
0
0
0
1.71 0.31
model in inventory management
Inventory levels are determined based on 10
historical data
Inventory levels are determined based on the 14
theory of inventory
The
business
uses
computer
assisted 14
software in recording inventory
The study sought to determine the respondent’s level of agreement with the above
statements relating to the effects of Inventory Management Practices on performance of
SMEs in Kenya. From the findings the study established that majority of the respondents
agreed; that the business uses computer assisted software in recording inventory, there is
periodic inventory counts as shown by mean of 1.71 in each case, there is physical
safeguards of inventory against theft as shown by mean of 1.75, there is proper
authorization for purchases as shown by mean of 1.77, inventory levels are determined
based on the theory of inventory, periodic summaries of inventory usage are prepared and
used, there is use of standard costs as shown by a mean of 1.79 in each case, the business
computes inventory turnover ratios as shown by a mean of 1.83, inventory levels are
determined based on historical data as shown by mean of 1.88, and finally that inventory
levels are determined based on owner's experience as shown by a mean of 1.90.
4.2.3 Regression Analysis
In this study, a multiple regression analysis was conducted to test the influence among
predictor variables. The research used statistical package for social sciences (SPSS V 20)
to code, enter and compute the measurements of the multiple regressions. Likert
37 questions were used to determine the relationship between financial reporting and
analysis practices and financial performance of small and medium enterprise in Kenya.
The lirket questions were quantified through SPSS and run for the multiple regression
analysis on the relationship between financial reporting and analysis practices and
financial performance of small and medium enterprises in Kenya.
Table 4.7: Model Summary
Model
R
1
.972a
R Square
Adjusted R Square
.945
Std. Error of the Estimate
.891
.88133
Adjusted R2 is called the coefficient of determination and it shows how change in the
independent variable results to changes in the dependent variable. From the data, the
value of adjusted R2 is 0.891. This implies that, there was a variation of 89.1% of
financial performance of SMEs dues to changes in financial reporting, financial analysis,
financial management and management accounting at 95% confidence interval. This is an
indication that 89.1% financial performance of SMEs could be accounted for by changes
in financial reporting, financial analysis, financial management and management
accounting. The study also found that there is a strong positive relationship between
financial reporting, financial analysis, financial management and management accounting
and financial performance of SMEs as shown by correlation coefficient of 0.972.
38 Coefficients
Model
1
Unstandardized
Standardized
Coefficients
Coefficients
t
Sig.
3.133
.052
B
Std. Error
Beta
(Constant)
.639
.396
Financial Reporting
.400
.884
.823
4.792
.017
Financial analysis
.138
.193
1.00
6.448
.008
Financial Management
.173
.085
.545
2.984
.058
Management accounting
.614
.394
.671
4.098
.000
The established regression equation was;
Y = 0.639 + 0.400X1 + 0.138 X2 + 0.173X3 + 0.614X4
From the above regression model it was revealed that holding financial reporting ,
financial analysis, financial management and management accounting to constant zero
financial performance would stand at 0.639, a unit increase in financial reporting would
lead to increase in financial performance by 0.400 units , a unit increase in financial
analysis would lead to increase in financial performance of SMEs by 0.138 units, a unit
increase in financial management would lead to increase in financial performance of
SMEs by a factor of 0.173, a unit increase in management accounting would lead to
increase in amount of financial performance of SMEs by 0.614 units.
4.3 Summary and Interpretation of Findings
The study found that there was great variation on financial performance of SMEs dues to
changes in financial reporting, financial analysis, financial management and management
accounting. This is an indication that changes in financial performance of SMEs could be
accounted for by changes in financial reporting, financial analysis, financial management
39 and management accounting. The study also found that there is a strong positive
relationship between financial reporting, financial analysis, financial management and
management accounting and financial performance of SMEs.
The findings concur with the findings of D’Amboise and Gasse (1980) who found that
those manufacturing firms’ managerial decisions were largely based on the financial
reports prepared. DeThomas and Fredenberger (1985) found that 81 percent of the small
enterprises regularly obtained summary financial information. Ninety-one percent of the
summary information was in the form of traditional financial statements (balance sheets,
profit and loss statements, fund statements), the remainder being bank reconciliation and
operating summaries whereas no business was regularly receiving cash-flow information.
The study further found that 61 percent of respondents felt the financial statements
provided the information they required for planning and decision-making. Nevertheless,
only 11 percent of respondents reported that they had used financial statement
information formally as part of managerial evaluation, planning and decision-making, 2
percent of businesses utilized financial ratio analysis, and few made even simple
historical comparisons.
The findings of the study concur with the findings of Farhoodman and Hryck (1985)
reported on the most important applications of computers, and it was found out that
accounting was rated as the highest percentage. Palmer (1994) showed accounting and
financial management applications dominated the use of computers in small and medium
enterprises in the North America in 1980’s and 1990’s.
40 However the findings of the study did not concur with findings of Thomas and Evanson
(1987), who studied 398 small pharmacies to examine the extent to which financial ratios
were used in a specific line of small retail business and tested for a relationship between
use of financial ratios and business success. The study could not demonstrate any
significant relationship between earnings-to-sales and the number of financial ratios used
by the owner in operational decision-making.
41 CHAPTER FIVE
SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
5.1 Summary
The study established that most of Small scale business prepared the income statement,
had
accountants who were in charge of preparing financial statements, the manager/
owner were involved in preparing financial statements, the financial statements were
prepared annually, majority of SMEs prepared cash flow statement, further the study
established that SMES performed financial analysis, used profitability ratios, prepared the
balance sheet, the study also noted that the business regards the current financial
reporting as inadequate, accounting principles weren’t followed to latter, the study further
revealed that; the accountants in every SMEs were in charge of recording transactions, a
significant number of SMEs
had
a formal system accounting, in most cases the
owners/manager were in charge of recording transactions, a significant number of
business used computer assisted software in recording transactions, the study also noted
that the accounting department was not properly staffed and equipped.
The study determined that a significant number of the SMEs used efficiency ratios,
liquidity ratios, leverage ratios, their financial analysis was normally done using ratios,
most of SMEs set their capital structure based on the theory, they used internally
generated cash and borrowed funds, the study further revealed that a significant number
of SMEs didn’t have easy access to bank loans. The study revealed that majority of the
SMEs invested in both non-current and long term assets, they conducted a review on
the investment projects after a certain period, they used Payback period to assess the
42 investment, SMEs evaluated investments proposals before approving them, they used net
present value to assess the investment, the study also established that a significant
number
of
SMEs
didn’t
have
sufficient
cash
funding
lo
ng term investment projects, non-currents weren’t fully utilized. Regarding management
practices the study established that a significant number of SMEs had adopted the use of
computer software’s in recording inventory. There were periodic inventory counts,
physical measures had been taken to ensure safety of inventory against theft, SMEs had
put in place a proper authorization for purchases, Inventory levels were determined based
on the theory of inventory, Periodic summaries of inventory usage were prepared and
used, most SMEs computed inventory turnover ratios, and that Inventory levels were
determined based on historical data.
5.2 Conclusion
The study revealed that financial reporting and analysis practices adopted by small and
medium enterprises in Kenya were financial reporting, financial analysis, financial
management and management accounting which significantly influence the financial
performance of Small and Medium Enterprise in Kenya.
The study revealed that a unit increase in financial reporting would lead to increase in
financial performance. The study also found that a unit increase in financial analysis
would lead to increase in financial performance of SMEs. The study found that a unit
increase in financial management would lead to increase in financial performance of
SMEs. It was found that a unit increase in management accounting would lead to increase
43 in the amount of financial performance of SMEs.
The study revealed that there was great variation on financial performance of SMEs dues
to changes in financial reporting, financial analysis, financial management and
management accounting, this is an indication that changes in financial performance of
SMEs could be accounted for by changes in financial reporting, financial analysis,
financial management and management accounting. The study found that there is a
strong positive relationship between financial reporting, financial analysis, financial
management and management accounting and financial performance of SMEs.
From the analysis and summary the study concludes as follows: that most of Small scale
business prepared the income statement, had accountants who were in charge of
preparing financial statements, the manager/owners of some SMEs were engaged in
preparing financial statements, the financial statements were prepared annually, majority
of SMEs prepared cash flow statement, further the study concludes that SMEs performed
financial analysis, used profitability ratios, prepared the balance sheet.
The study further concludes that the accountants in every SMEs were in charge of
recording transactions, a significant number of SMEs had a formal system accounting, a
significant number of business used computer assisted software in recording transactions,
in most accounting departments they the staff lacked some of vital equipped, the study
concludes a significant number of SMEs didn’t have sufficient cash to fund long term
investment projects, non-currents weren’t fully utilized, and that a significant number
of SMEs didn’t have easy access to bank loans.
44 5.3 Policy Recommendations
There is need for SMEs to streamline their financial reporting practices as it was revealed
that financial reporting practices significantly influence the financial performance of
SMEs in Kenya.
There is need for management of Small and medium enterprise in Kenya to enhance their
financial reporting practices it was found that a unit increase in financial reporting would
lead to increase in the financial performance.
The study also recommends that there is need for the management of Small and Medium
Enterprise in Kenya to enhance their financial analysis practices as it was revealed by the
study that a unit increase in financial analysis would lead to increase in financial
performance of SMEs.
There is need for management of Small and Medium Enterprise to streamline their
financial management practices as it was found that a unit increase in financial
management would lead to increase in financial performance of SMEs.
Management accounting practices is of great importance to the financial performance of
small and medium enterprise in Kenya, thus there is need for management of SMEs to
streamline their financial management accounting practices as it was found that a unit
increase in management accounting practices would lead to increase in amount of
financial performance of SMEs.
45 5.4 Limitations of the study
In attaining its objective the study was limited to 50 Small and medium enterprise in
Kenya that were in the list of top 100 SMEs in Kenya year 2012 from which only one
respondent was picked from each.
The study was also limited to the degree of precision of the data obtained from the
respective respondents.
The study was also limited to establish the financial reporting and analysis practices
adopted by small and medium enterprises in Kenya and to establish the relationship
between financial reporting and analysis practices and financial performance of small and
medium enterprise in Kenya
The method used is descriptive research design whereby the variables cannot be
controlled by the researcher. The study intended to use questionnaire as the instrument
for collecting data. This is because time for the data collection was limited to two weeks.
5.5 Areas for Further Research
The study sought to determine the relationship between financial reporting and analysis
practices and financial performance of small and medium enterprises in Kenya. The study
recommends that an in-depth study should be done to determine the challenges facing
SMEs in adoption of financial reporting and analysis practices
The study recommends that an in-depth study should be done to determine the challenges
of operational budgeting small and medium enterprise in Kenya.
46 The study also recommends a study to be carried out on factors influencing the success of
financial reporting and analysis practices among SMEs in Kenya.
The study furthers that an in-depth study should be conducted on the importance of
budgeting to financial reporting in organizations.
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52 APPENDICES
Appendix I : Questionnaire
1. In which sector does your SME belong?
Manufacturing
( )
Agricultural
( )
Transport and logistics
( )
Telecommunication
( )
Building and construction
( )
Energy and Petroleum
( )
Service
( )
Section 2: Financial Reporting and Analysis Practices
2. What is your level of agreement on the following statements relating to effects of
financial
reporting and analysis practice on financial performance of SMEs in
kenya?(1-strongly agree, 2-agree, 3-neutral, 4-disagree, 5-strongly disagree)
Financial reporting and analysis
1
The manager/ owner is involved in preparing financial statements
The business prepares the income statement
The business prepares the cash flow statement
The business follows accounting principles
The business prepares the balance sheet
The business performs financial analysis
The financial statements are prepared semi-annually
The business prepares the statement of changes in equity
The business regards the current financial reporting as adequate
The financial statements are prepared annually
The business uses profitability ratios
The accountant is in charge of preparing financial statements
53 2
3
4
5
3. What is your level of agreement on the following statements relating to effects of
financial management practices on financial performance of SMEs in kenya?(1strongly agree, 2-agree, 3-neutral, 4-disagree, 5-strongly disagree)
Financial management practices
1
2
3
4
5
The owner/manager is in charge of recording transactions
The business accounting system is informal
The business accounting system is formal
The accounting department is properly staffed and operates
efficiently
The accountant is in charge of recording transactions
The business uses computer assisted software in recording
transactions
4. What is your level of agreement on the following statements relating to effects of
financial analysis on financial performance of SMEs in kenya?(1-strongly agree, 2agree, 3-neutral, 4-disagree, 5-strongly disagree)
Financial analysis
1
2
3
4
The financial analysis is done using ratios
The business uses liquidity ratios
The business uses efficiency ratios
The business uses leverage ratios
The business uses internally generated cash sources only
The business has easy access to bank loans
The business uses internally generated cash and borrowed funds
The business sets the capital structure based on the theory
The business uses borrowed funds only
5. What is your level of agreement on the following statements relating to effects of
investment analysis on financial performance of SMEs in kenya?(1-strongly agree, 2agree, 3-neutral, 4-disagree, 5-strongly disagree)
54 5
Investment analysis
1
2
3
4
5
The business has cash for investment in long term projects
The business invests in non-current assets
The business utilizes fully the non-currents
The business uses net present value to assess the investment
The business uses Payback period to assess the investment
The business invests without evaluating the investment
The business reviews the investment projects after a certain period
6. What is your level of agreement on the following statements relating to effects of
Inventory Management Practices on performance of SMEs in kenya?(1-strongly
agree, 2-agree, 3-neutral, 4-disagree, 5-strongly disagree)
Inventory Management Practices
1
There is physical safeguards of inventory against theft
Inventory levels are determined based on owner's experience
There is use of standard costs
There is periodic review of overhead rates
Periodic summaries of inventory usage are prepared and used
There is proper authorization for purchases
There is periodic inventory counts
The business computes inventory turnover ratios
The business uses Economic Order Quantity model in inventory
management
Inventory levels are determined based on historical data
Inventory levels are determined based on the theory of inventory
The business uses computer assisted software in recording
inventory
55 2
3
4
5
Appendix II: 2012 Kenya Top 100 companies
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
ATLAS PLUMBERS AND BUILDERS
TROPIKAL BRANDS AFRIKA
KEPPEL INVESTMENTS LTD
SHIAN TRAVEL
RUPRA CONSTRUCTION CO.
POWERPOINT SYSTEMS (E.A) LTD
CHEMICAL AND SCHOOL SUPPLIES
SATGURU TRAVEL AND TOURS
RADAR LTD
KENTONS LTD
AVTECH SYSTEMS LTD
SAI PHARMACEUTICALS LTD
KUNAL HARDWARE AND STEEL
CONINX INDUSTRIES LTD
R & R PLASTIC LTD
CAPITAL COLOURS C . D LTD
ASL CREDIT LTD
KANDIA FRESH PRODUCE SUPPLIERS LTD
FURNITURE ELEGANCE LTD
MURANGA FORWARDERS LTD
BBC AUTO SPARES LTD
DIGITAL DEN LTD
XRX TECHNOLOGIES LTD
NAIROBI GARMENTS ENTERPRISE LTD
CHARLESTON TRAVEL LTD
SPICE WORLD LTD
MASTER POWER SYSTEMS LTD
SOFTWARE TECHNOLOGIES LTD
KENBRO INDUSTRIES LTD
SKYLARK CREATIVE PRODUCTS LTD
GANATRA PLANT & EQUIPMENT LTD
SECURITY WORLD TECHNOLOGY LTD
SPECIALIZED ALUMINIUM RENOVATORS
LIMITED
WINES OF THE WORLD LTD
VIRGIN TOURS LTD
ARAMEX KENYA LTD
CANON ALUMINIUM FAB LTD
PANESAR'S KENYA LTD
TYRE MASTERS LTD
LANTECH AFRICA LTD
WARREN ENTERPRISE LTD
AFRICA TEA BROKERS LTD
56 43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
MERIDIAN HOLDINGS LTD
DUNE PACKAGING LTD
THE PHOENIX LTD
FAIRVIEW HOTEL LTD
SPECICOM TECHNOLOGIES LTD
PUNSANI ELECTRICALS & INDUSTRIAL
BISELEX (K) LTD
VICTORIA FURNITURES LTD
GINA DIN CORPORATE COMM
AMAR HARDWARE LTD
MELVIN MARSH INTERNATIONAL
LANOR INTERNATIONAL LTD
SYNERMED PHARMACEUTICALS (K) LTD
SAHAJANAND ENTERPRISES LTD
VEHICLE & EQUIPMENT LEASING LTD
SILVERBIRD TRAVELPLUS
WAUMINI INSURANCE BROKERS LTD
KENAPEN INDUSTRIES LTD
HARDWARE AND WELDING SUPPLIES
ISOLUTIONS ASSOCIATES
MOMBASA CANVAS LTD
EAST AFRICA CANVAS CO
TOTAL SOLUTIONS LTD
PRINT FAST (K) LTD
OPTIWARE COMMUNICATIONS LTD
DEEPA INDUSTRIES LTD
ENDEAVOUR AFRICA LTD
TRAVEL SHOPPE CO LTD
KEMA (E.A) LTD
AMAR DISTRIBUTORS LTD
PWANI CELLULAR SERVICES
SHEFFIELD STEEL SYTEMS LTD
GENERAL ALUMINIUM
CREATIVE EDGE LTD
BROLLO KENYA LTD
TRIDENT PLUMBERS LIMITED
PHYSICAL THERAPY SERVICES LTD
PRAFUL CHANDRA & BROTHERS LTD
DHARAMSHI LAKHAMSHI & CO / Dalco Kenya
MADHUPAPER KENYA LTD
UNION LOGISTICS LTD
OIL SEALS AND BEARING CENTRE LTD
SKYLARK CONSTRUCTION LTD
BIODEAL LABORATORIES LTD
WARREN CONCRETE LTD
57 88
89
90
91
92
93
94
95
96
97
98
99
100
RONGAI WORKSHOP & TRANSPORT
COMPLAST INDUSTRIES LTD
KINPASH ENTERPRISES LTD
SIGHT AND SOUND COMPUTERS LTD
DE RUITER EAST AFRICA LTD
ACE AUTOCENTRE LTD
KENYA SUITCASE MFG LTD
HEBATULLAH BROTHERS LTD
MARKET POWER INT. LTD
NIVAS LTD
SIGMA SUPPLIERS LTD
IMPALA GLASS INDUSTRIES LTD
EGGEN JOINEX LTD
Source, KPMG (2012)
58