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8/20/2019 Finanxczczxcial Managemeczxczxnt and Profitaxczxczxcbility of Small and Medium Enterp
I owe a debt of gratitude to many people who helped me complete this thesis. I wouldlike to acknowledge the help of all. First of all I would like to express my deepest
acknowledgement to my supervisor, Professor Geoffrey Grant Meredith from the
Graduate College of Management (SCU), for his valuable advice and recommendations.
I acknowledge Dr. Lyndon Brooks, his assistants from the Graduate Research
College (SCU), and Mr. Tho Dinh Nguyen from the School of Marketing (UTS) for their
support with statistical techniques and data analysis. I also acknowledge Ms. Rosemary
Graham from the International Office (SCU) for her comments on English in earlier
drafts of my thesis.
In the process of data collection for this research, many people contributed to the
task and I am particularly grateful for their contributions. I am greatly indebted to Dr.
Pham Van Nang, Dr. Le Bao Lam, and Dr. Le Thanh Ha from Ho Chi Minh City
University of Economics for their introduction to contacts with the small and medium
enterprises (SMEs) community located in Ho Chi Minh City.
I also wish to thank Mr. Nguyen Trong Hanh, Vice Director of Department of
Taxation, Mr. Du Quang Nam, Vice Director of Statistical Office – Ho Chi Minh City;
and Mr. Tran To Tu, Managing Director of Investment Consulting Corporation for
providing secondary data related to the current practices of SMEs in Vietnam.
I would like to thank the following organizations which supported me in
completing my thesis and degree: the Swiss Agency for Development and Cooperation
(SDC), the Swiss – AIT – Vietnam Management Development Program (SAV), the
Mekong Project Development Facility (MPDF), the Small and Medium Enterprise
Promotion Centre (Vietnam Chamber of Commerce and Industry – VCCI), HCM City
University of Economics, HCM City Statistical Office, HCM City Department of
Investment and Planning, HCM City Department of Taxation. Specially, I would like to
extend my sincere gratitude to the Government of Switzerland and Dr. Hans Stoessel,
Director of SAV for granting the scholarship which enabled me to participate in a
doctoral degree at Southern Cross University, New South Wales, Australia.
iii
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CERTIFICATE.......................................................................................................................................... ii
ACKNOWLEDGEMENTS ....................................................................................................................... iii
ABSTRACT .............................................................................................................................................. v
GLOSSARY OF TERMS AND ABBREVIATIONS ................................................................................ vii
TABLE OF CONTENTS .......................................................................................................................... ix
LIST OF TABLES..................................................................................................................................... xiii
LIST OF FIGURES .................................................................................................................................. xvii
2.2.1 Overview of the country .............................................................................................19
2.2.2 The Vietnam economy...............................................................................................232.2.3 The Vietnam population and labour...........................................................................38
2.3 VIETNAM BUSINESS STRUCTURE .....................................................................................40
2.3.1 Types of business in Vietnam....................................................................................41
2.3.2 Overview of enterprises in Vietnam...........................................................................43
2.3.3 Small and medium enterprises in Vietnam................................................................44
2.3.4 Policies for supporting SMEs.....................................................................................50
ix
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This chapter provides a general introduction to the research study. The purpose is to
establish foundations for following chapters and the study as a whole, by providing ageneral picture of the study. This chapter is structured into ten sections as presented
by figure 1.1 (page 2).
Section 1.1 provides a general introduction to the chapter and section 1.2
examines the research background where the research problem is identified. Section
1.3 defines the research problem, presents a statement of the problem and expands the
research problem in two subsections 1.3.1 and 1.3.2. Subsection 1.3.1 addresses the
research questions that will be respectively answered in chapters of the study.
Subsection 1.3.2 presents research objectives that the study covers in the process of
solving the research problem defined.
Section 1.4 briefly discusses the general aspects of research methodology such
as selecting from alternative types of research and research design, whereas the details
of research methodology will be discussed in chapter 4. Section 1.5 provides some
justifications for the study including the rationale and arguments for the study.
Section 1.6 explains the context of specialized terms used in the study and
section 1.7 points out the significance and scope of the study. Section 1.8 presents the
analytical model of the study fully developed in chapter 3. Section 1.9 describes
overall structure of the thesis, and finally section 1.10 summarizes conclusions drawn
from the research. Figure 1.1 provides a visual representation of the structure of the
chapter.
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In addition to achievements and contributions as mentioned above, SMEs in Vietnam
are currently being faced with many serious difficulties such as shortage of capital for
expanding and renovating equipment and technology, low productivity and
competitiveness, lack of experience in terms of marketing, production management,
and financial management. Of these difficulties, lack of financing resources and
experience of financial management is currently one of the most serious issues
(Ebashi, Sakai and Takada, 1997). Inefficient financial management may damage
SME profitability and, as a result, the difficulties of SMEs will become greater.
Conversely, efficient financial management will help SMEs to strengthen their
profitability and, as a result, these difficulties can partly be overcome. Most
commercial banks refuse to offer loans for SMEs because the banks think SME profitability could not cover loan risks. However, to date there has not been any
research on SME profitability conducted in Vietnam. Conducting such research will
enable commercial banks to evaluate SME profitability and make decisions on
granting loans for SMEs. In addition, when the stock exchange is established in
Vietnam, conducting research on SME profitability will help SMEs to improve their
performances and reinforce financial management as a preparation to participate in
stock exchange listing.
Originating from recognition of the increasingly important role and
contribution of SMEs as well as the recent promotion and supporting policy on
developing SMEs, this research study is considered a contribution to improvement of
financial management practices and profitability of SMEs in Vietnam. Firstly, it
investigates financial management practices and financial characteristics of SMEs,
and then, examines the impacts of financial management practices and financial
characteristics on SME profitability.
1.3 RESEARCH PROBLEM
Problem definition is essential before conducting a research project, especially
quantitative research. Zikmund (1997, p. 82) recommends that formal quantitative
research should not begin until the problem has been clearly defined. In Vietnam,
defining the research problem of SMEs may begin with a consideration of the typical
characteristics of management. Most SMEs have not appointed financial managers to
be in charge of financial management of the company. Usually, the owner-managers
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with the assistance of the chief-accountant control financial matters of the company.
However, most owner-managers have no formal training in management skills,
especially financial management. Moreover, the concepts of financial management
have also only been recognized in Vietnam since the beginning of the 1990s when the
economy was converted into a market economy. Currently, financial management is
one of the challenges of SMEs.
Lack of knowledge of financial management combined with the uncertainty of
the business environment often lead SMEs to serious problems regarding financial
performances. Regardless of whether owner-manager or hired-manager, if the
financial decisions are wrong, profitability of the company will be adversely affected.
Consequently, SME profitability could be damaged because of inefficient financialmanagement. SMEs have often failed due to lack of knowledge of efficient financial
management. Moreover, undercapitalization and uncertainty of the business
environment cause SMEs to rely excessively on equity and maintain high liquidity
and these financial characteristics probably affect SME profitability (Vuong, 1998).
In summary, the problem that SMEs in Vietnam face appears to be that
inefficient financial management practices have adversely affected their profitability.
Therefore, the problem to be addressed in this research is to investigate the
simultaneous effects of financial management practices and financial characteristics
on SME profitability, and then, to determine the best measures for improving SME
profitability in Vietnam by using efficient financial management tools. Figure 1.2
represents the fields of research problem in this study.
Figure 1.2: Fields of the research problem
Financial management practices
SME profitability
Financial characteristics
Source: Developed for the thesis
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The secondary data method was used to examine the financial characteristics
of SMEs. The variables such as liquidity ratios, financial leverage ratios, activity
ratios, and profitability ratios are derived from financial statements. These financial
statements are available from taxation departments of Vietnam and sometimes from
businesses directly.
One of the objectives of collecting data related to financial management
practices, which are collected from the survey, and data related to financial
characteristics of SMEs, which are derived from the financial statements, was to test
hypotheses. This research study was designed to test two kinds of hypotheses. The
first was the hypothesis of the simultaneous impacts of financial management
practices and financial characteristics on SME profitability. The second was thehypothesis related to differences in the average profits between SMEs with efficient
financial management practices and SMEs with inefficient practices.
1.5 JUSTIFICATION FOR THE STUDY
Concerned with financial management practices, most previous researchers have
concentrated on examining, investigating and describing the behaviour of SMEs in
practising financial management. Five specific areas of financial management
practices including accounting information systems, financial reporting and analysis,
working capital management (including cash management, receivables management,
inventory management and payables management), fixed asset management and
capital structure management have long attracted the attention of researchers
(McMahon, et al. 1993). Their findings are mainly related to exploring and describing
the behaviour of SMEs towards financial management practices. Although they
provided much descriptive statistical data and empirical evidence on SME financialmanagement practices, it appears that there still are some gaps in the literature, which
need to be addressed.
• Firstly, most empirical evidence comes from the developed economies such as
the United States of America (USA), the United Kingdom (UK), Canada and
Australia (McMahon et al. 1993). There seems to be a lack of evidence from
emerging economies, especially from transiting economies such as Vietnam
and China.
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• Secondly, most previous researchers focus on investigating and describing
financial management practices whereas there has been little research
examining the impact of financial management practices on SME profitability
(McMahon et al. 1993).
These are major gaps and it is difficult to convince business financial management
practitioners of the need for changes in practices until evidence of the effects of
financial management practices on SME profitability is provided and the relationship
between the two variables are discovered.
In addition to financial management practices, previous researchers provided
valuable findings related to financial structures/characteristics of SMEs. Fourvariables including liquidity, financial leverage, activity and profitability are
popularly used by previous researchers to identify and measure financial
characteristics of SMEs (McMahon et al, 1993). There are many studies on financial
characteristics of SMEs conducted by researchers over several decades. However,
there still exist gaps in the literature related to financial characteristics of SMEs,
which need to be supplemented.
• Firstly, it appears that the financial characteristics of SMEs in developing
countries, especially in transiting economies such as Vietnam and China have
not been investigated and empirical data has not been produced.
• Secondly, to date, there is no study, which examines the relationship or the
impact of three variables: liquidity, financial leverage, and activity on
profitability variable.
This lack of empirical evidence from emerging economies and the lack of
examination of the impact of financial management practices and financial
characteristics on SME profitability are major gaps in the knowledge of financial
management practices and financial characteristics of SMEs. Based on previous
research findings and recognition of these gaps, a study of the impact of financial
management on SME profitability is justified and a model of the impacts of financial
management practices and the financial characteristics should be developed and tested
by using the empirical data from emerging economies. Vietnam is one of many
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appropriate countries to provide such data. Therefore, this study will extend previous
studies by focusing on examining the simultaneous impacts of financial management
practices and financial characteristics on SME profitability using the empirical
evidence from Vietnam.
1.6 DEFINITIONS OF TERMS USED IN THE STUDY
Specialized terms used in this study include SMEs, private company, limited
company, stock companies, efficient financial management and profitability. These
terms are adopted for Vietnamese context. In this study, SMEs refers to small and
medium enterprises. Currently, Vietnam has not uniformly defined which criteria a
business has to fulfil to be viewed as an SME. In this study, SMEs are understood to
have the same definition given by the Vietnamese Chamber of Commerce and
Industry (VCCI, 1998). According to VCCI, a SME is defined as a business unit that
fulfils the following criteria, depending on its size:
• Small business:
− Manufacturing: less than 200 employees and VND5 billion capital
− Trading and services: less than 200 employees and VND5 billion capital
• Medium business:
− Manufacturing: 200 – 500 employees and VND5 – 10 billion capital
− Trading and services: 50 – 100 employees and VND5 – 10 billion capital
As will be examined in more detail in chapter two, SMEs include many forms of
business organization such as private enterprises, limited companies, joint stock
companies, cooperatives and business households or family businesses. However, this
study only focuses on the forms of business that set up a formal system of financial
management. Based on this criterion, private enterprises, limited companies, and joint
stock companies are the objects of this study whereas others such as cooperatives and
family businesses are beyond the study. Also, the term “company” is used
synonymously with the term “enterprise” in this study. Private enterprises are
companies that are registered under the Vietnam Private Business Law. These
companies have one owner who is responsible for all his or her assets. Limitedcompanies are companies that are registered under the Company Law and they have
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larger initial capital than private enterprises. Owners’ liability is limited to the initial
capital that they have to invest in full at the time of establishment of the company. If
there are more than 12 owners, a formal owner meeting and boards of director
meetings must be held.
Financial management is concerned with all areas of management which
involve finance – not only the sources and uses of finance in the enterprise, but also
the financial implications of investment, production, marketing or personnel decisions
and the total performance of the enterprise (Meredith, 1986). Financial management is
concerned with raising the funds needed to finance the enterprise’s assets and
activities, the allocation of these scarce funds between competing uses, and ensuring
that the funds are used effectively and efficiently in achieving the enterprise’s goals(McMahon, Holmes, Hutchinson and Forsaith, 1993). However, financial
management, in this study, is limited to a framework of five specific areas: (1)
accounting information system (2) financial reporting and analysis, (3) working
capital management, (4) fixed asset management, and (5) capital structure
management. This limitation is necessary and appropriate to financial management
practices of SMEs in Vietnam, given information available for research.
Financial management objectives, in this research, refer to two main
objectives: profitability and liquidity. Profitability management is concerned with
maintaining or increasing a business’s earnings through attention to cost control,
pricing policy, sales volume, stock management, and capital expenditures (McMahon,
1995). Liquidity management is concerned with avoiding any damage at all to a
business’s credit rating, due to a temporary inability to meet obligation by anticipating
cash shortages, maintaining the confidence of creditors, bank managers, pre-arranging
finance to cover cash shortages (McMahon, 1995).
Efficient financial management, in this research, is defined as financial
management that achieves financial management objectives without wasting financial
resources. Conversely, inefficient financial management is not to achieve financial
management objectives or achieve the objectives but wasting or without minimizing
financial resource utilization. Chapter 4 defines variables and criteria to measure the
extent of efficiency of financial management. In this study the context of financial
management practices include accounting information systems, financial reporting
and analysis, cash management, receivable management, inventory management,
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Chapter Two: The Economic Structure and SMEs in Vietnam
2.2 VIETNAM: BACKGROUND INFORMATION
Section 2.2 reviews information on Vietnam background including geographical
location, historical overview, economic development process, population and labour.
This section is structured into three subsections. Subsection 2.2.1 provides an
overview of the country. Subsection 2.2.2 examines the process of economic
development since the country was reunified in 1976. Section 2.2.3 reviews
population and labour force in Vietnam.
2.2.1 Overview of the country
When asked about Vietnam many around the world probably answer that it is a “poor
country” damaged seriously by conflicts. That was the position in the late 1970s. As
of 2000, the country has seen increasingly remarkable changes. Harvie (1996, p. 1)
presents a current impression of Vietnam since the country has introduced its market-
oriented economic policy.
Vietnam has only recently emerged as a participant in the most rapidlygrowing region of the world economy, the Asia Pacific economy. It is poisedto become one of Asia’s most vigorous market economies during theremainder of the 1990s and into the twenty-first century, having rejectedcentral planning, and is widely tipped to become Asia’s next economicdragon.
2.2.1.1 The geographical location
Schuwalow (1996, p.189) described Vietnam as the country that extends more than
1,600 kilometres along the east coast of Indochina, from the Chinese-border mountain
and the Red River delta in the north, the Laotian and Cambodian borders, to the fertile
Mekong River delta in the south. Although in its extreme north the country is more
than 500 kilometres wide, much of the middle section is a relatively narrow strip of
coastal land. For a considerable distance it is 80 kilometres wide, and in the south
expands again to about double that width (see the map, page 20). Vietnam’s total land
area is 325,360 square kilometres, and 75 percent is hill country or mountains.
Climate is typically monsoon, and the temperature varies considerably according to
latitude. In the tropical south, conditions are warm to hot throughout the year and the
humidity is usually high. In the north, particularly in the highlands, markedly warmer
and cooler seasons occur and temperatures are much lower than those at sea level.
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Chapter Two: The Economic Structure and SMEs in Vietnam
2.2.1.2 Historical overview
After the government of South Vietnam fell on 30 April 1975, the north and the south
of Vietnam were reunified by a national election held in April 1976 and in July of the
same year the Socialist Republic of Vietnam was established. This reunification came
in an attempt to transform the south from a basically market economy to a planned
economy. Collectivization and nationalization respectively happened in agriculture
and other industries. In the meantime, trade with the western countries was greatly
restricted due to the United States of America trade embargo. Vietnam’s conflict with
Cambodia during 1977 – 80 and border conflict with China in 1979 further hampered
the country’s progress. Throughout the 1980s most people associated Vietnam with
the word “war”. However this perception is slowly fading as a new image of Vietnam
emerges. Currently Vietnam is a country at peace with a vast variety of natural
resources, a high literacy rate (90 percent), and an increasingly skilled and hard labour
force. Although an often-difficult business climate has been experienced in the past,
Vietnam is currently changing and amending many of its laws in order to attract more
foreign investment and trade opportunities (Vietnam Embassy in USA, 1999).
By the mid-1980s, a decline in the former Soviet Union aid and government’s
tight control over economic policy proved to be an economic disaster leading to adecline of production in many sectors, and an increasing reliance on imports. In
response to this inefficiency, the Vietnamese Government initiated a series of
economic reforms known as doi moi ("renovation") in December 1986. The main
goals of doi moi were to improve lagging productivity, to raise living standards, and
to curb rapid inflation, which reached almost 500 percent a year in mid-1980s
(Kimura, 1993). Renovation process included macro-economic stabilization, the
recognition of Vietnam’s private sector, and the promotion of foreign trade and
investment. Following this paradigm, Vietnam has attempted to transform itself into a
market-oriented economy, and opened itself to the outside world. After more than a
decade of doi moi, Vietnam has experienced huge growth in investment, industry and
an expansion of trade (20% per annum on average) and has had considerable success
in restructuring the economy (Vietnam Embassy in USA, 1999). The government has
opened the country to foreign investment, by allowing many joint venture and wholly
foreign-owned enterprises to flourish. Regulations and rules have more and more
become liberalized.
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Chapter Two: The Economic Structure and SMEs in Vietnam
In July 1995, Vietnam became a full member of the Association of South East
Asian Nations (ASEAN). On January 1st 1996, Vietnam became a member of the
ASEAN Free Trade Agreement (AFTA) and in 1998 Vietnam was admitted into the
Asia Pacific Economic Cooperation (APEC) and has since signed trade agreements
with a number of countries and territories (Australian Department of Foreign Affairs
and Trade, 2001). As of 2000, Vietnam is closer then ever to establishing a long-term
trade relationship with the United States of America, and has submitted an application
to enter the World Trade Organization (WTO). In recent years, the government has
planned to establish a Vietnamese stock market and new laws on foreign investment
are currently being promulgated and amended in order to make Vietnam more
attractive to foreign investment. After many years of preparation, the stock marketwas finally opened and launched the first transaction on 26 June 2000 (USA
Department of Commerce, 1998).
2.2.1.3 Politi cal structure
In Vietnam, leadership structure is divided into three levels. The General Secretary is
in charge of representing and dealing with issues concerning the Vietnamese
Communist Party. The Prime Minister is in charge of handling government affairs and
day-to-day business of the country. Finally, the President focuses on security issues
and the armed forces. Vietnam is a socialist country under the leadership of the
Communist Party. The Communist Party has nearly 2 million members and strongly
influences every aspect and at every level of Vietnamese life. The party holds a
national congress every five years to outline the country’s overall direction and
formalize policies (Commercial Chamber of Vietnam in USA, 1998).
The National Assembly, which includes 450 members, representing all walks
of life throughout the country, and is open to non-party members, is the highest state
authority and the only body with constitutional and legislative power. The National
Assembly elects the President of the State and the Prime Minister (figure 2.2, page
23). The Prime Minister is in charge of handling government affaires with assistance
of 18 ministries. At its meeting, the National Assembly examines reports and plans
presented by the ministries involved, and National Assembly members have rights to
ask ministries to clarify and answer questions raised by members (Commercial
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Chapter Two: The Economic Structure and SMEs in Vietnam
2.2.2.1 The central-planned economy period (1976 – 1986)
The central-planed economy period is characterized by state intervention in almost all
activities of the economy. When the war ended in 1975, along with the unification of
the country, the integration of the economies of the north and the south of Vietnam
was set in motion. Vu (1994, p. 4) mapped out points which characterized the
Vietnam economy in that period as follows:
•
The state determined the important economic activities of the country through
a system of production plans and product distribution and strictly regulated
pricing and interest rates.
•
The state sector and the collectives constituted the foundation of the economy,
the collectives being heavily subsidized in activities such as investment and
loans and they quickly developed to become a sizable part of the national
economy.
•
Large-scale private enterprises were not encouraged to expand further, but
were singled out to be finally incorporated into either state or collective units.
•
The market mechanism operated only in small businesses and the household
economy, that is to say, in only a part of the agricultural, handicraft, and
consumer goods retailing sectors. Many input factors used for production were
not allowed to be bought or sold on the market but were allocated by the
state’s planned distribution systems.
• The state monopolized foreign trade. Due to historical circumstances,
Vietnam’s trade relations had been mainly with the former Soviet Union and
Eastern European countries through bilateral treaties. Foreign trade companies
under the control of the state implemented these trade treaties, and the profit-and-loss account of foreign trade was entirely taken care of by the state.
• The finance of the state was not separated from that of state-owned
enterprises. The state undertook to compensate for losses incurred by state-
owned enterprises by means of subsidies, and when these enterprises produced
profits, these profits were channelled back to the state budget. All production
activities were subsidized by the state through its provisions of raw materials
and other inputs of production. Machinery and equipment were imported withaid funds and credit loans, and sold at low prices to state-owned enterprises.
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Chapter Two: The Economic Structure and SMEs in Vietnam
Table 2.1: Changes in economic structure (1986 – 1991)
1986 (%) 1991 (%)State Non-state State Non-state
National income 29.8 70.2 29.0 71.0Labour 14.7 85.3 10.4 89.6Gross industrial output 56.3 43.7 58.6 41.4Labour in the industry 30.0 70.0 33.0 67.0Source: Statistical data of Socialist Republic of Vietnam (1986 – 1991)
Previously, the state and collective sectors constituted the main part of the
national economy. The private sector, especially private companies, were not
encouraged to develop but were instead the target of nationalization, collectivization
or transformation to state-private joint ventures. With policy reform, enterprises of allownership forms received equal treatment and competition in the market. There still
existed differences in terms of motivations and attitudes between the state and non-
state sectors but it was not necessary to distinguish between the various sectors as
mentioned above (Vu, 1994). Creating equally competitive environment forces all
enterprises regardless of the state, collective or private sectors to consolidate its
competitiveness.
Changes in financial systems
There were three main changes in the financial system in this period (Vu, 1994). The
financial reform in 1985 was the first comprehensive financial readjustment aimed at
decreasing the state budget deficit and inflation rate. Details of this reform were as
follows:
•
trimming subsidies allocated by the state to enterprises through the low prices
of raw materials and other inputs of production,
• switching from the price system fixed by the central government to the system
in which the prices are determined by the market through negotiation by
buyers and sellers,
• reforming the wage system to do away with the rationing of fixed quantities of
food and other necessities, and
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Chapter Two: The Economic Structure and SMEs in Vietnam
Vietnam is endowed with an abundance of other mineral resources such as
coal (3 - 3.5 billion tons), bauxite (3 billion tons), iron ore (700 million tons), copper
(600,000 tons), tin (70,000 tons), chromate (10 million tons), and appetite (1 billion
tons). The country is also rich in granite, marble, clay, and silica sand. Almost all of
these resources remain largely untapped. Foreign investment in the extraction and
processing of these minerals, particularly the mining and processing of those minerals
used in infrastructure projects, such as steel, is strongly encouraged by the
government.
The industrial sector employed about 12% of the country’s work force and
generates about 30% (including construction) of GDP. Over the past years, the
industrial sector has grown an average of 13.0% per annum (Table 2.7, page 32).Light industry, particularly in food processing, textiles and footwear, are the major
sectors, although most factories were operating with old or obsolete equipment. The
textile and garment industry presently accounted for around 16% of industrial output,
but it was a key source of employment and one of the country’s major exports. The
yearly production of the industry was about 450 million running meters of woven
fabric, 15,000 tons of knitting fabric and 100 million units of garments and other
products. Total textile export earnings reached around US$ 700 million in 1995,
making it become the second biggest export after crude oil. The textile industry was
forecasted to produce one billion running meters of fabric and to export between US$
2 billion and US$ 2.5 billion worth of products in 2000.
Heavy industry makes up an insignificant portion of output and, like light
industry, currently suffers from a handicap of old and obsolete machinery and
technology. Government investments in this sector have included power stations,
telecommunication, and coal, shipyards, engineering, steel, and fertilizer, chemical
and cement plants. High-tech industries such as electronics are also receiving
increasing attention. Table 2.9 summarizes achievements of industry in recent years.
Table 2.9: Industry development over the years
Unit 1990 1992 1994 1996 1998
Gross output value billion dong 14,011 18,117 23,214 118,096 150,685Number of establishment 393,518 377,105 463,505 626,177 592,948Labour force 1000 people 3,392 3,450 3,522 3,653 1,210Growth rate % 3.10 17.10 13.70 14.20 12.10Source: Statistical Yearbook 1994, 1998
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Chapter Two: The Economic Structure and SMEs in Vietnam
In the centrally planned system, the government tightly controlled external
trade. Targets were fixed for both imports and exports. A complex system of multiple
exchange rates was maintained. Under the renovation program, trade was gradually
liberalized. Whereas in 1981 there were only 12 import-export companies, the number
rose to 35 in 1987 and 1,250 in 1995 (including private firms). Foreign-invested
entities can handle the importation of their own equipment, machinery and materials
or parts needed for the construction and operation of their projects as well as the
export of their products (Vietnam Embassy in the USA, 1999). Table 2.10
summarizes the achievements of export and import activities in recent years.
Though achieving the objectives mentioned above, like other transition
economies, Vietnam economy still has to face many problems and challenges for thefuture. These problems and challenges significantly affect the business environment
where SMEs start up and grow. The next subsection will review these problems and
challenges.
Table 2.10: Export and import value by major countries (million USD)
1992 1993 1994 1995 1996 1997 1998
Exports value 2,348 2,685 3,686 5,261 6,826 8,956 9,308 Asia
2.2.2.4 Problems and challenges for the future
Although the Vietnam economy in the transition period has achieved its recent
successes, ability to maintain a fast rate of economic growth and development and to
become the next newly industrialized country in Asia requires the country to
successfully address its main problems and challenges. Harvie (1996) pointed out the
key challenges the Vietnam economy has to face as follows:
1,902 2,168 2,919 3,945 5,254 6,017 5,472
Europe 374 409 563 983 1,172 2,208 2,615 America 26 42 134 238 300 426 660 Africa 24 11 20 38 27 50 56 Australia and ocean 22 55 50 57 73 255 505Import value 2,133 3,474 5,076 7,704 10,626 11,360 11,311
Chapter Two: The Economic Structure and SMEs in Vietnam
Table 2.12: Population growth rates and structure (%)
2.2.3.2 Labour force
Vietnam’s well-educated but inexpensive labour force is one of the country’s primary
assets. Investors view the low wages and a high literacy rate (90%) of Vietnameseworkers as one of the most attractive aspects of the country’s investment environment
(Geib, 1999). The labour force - estimated at nearly 34 million in 1995 - is growing at
an average of 5 million in each of five years. Every year around one million new
workers enter the market (Table 2.13). Ninety percent have a secondary level
education, and 57,000 are college or university graduates. Nevertheless, a shortage of
skilled workers in certain areas as well as qualified management personnel has lifted
salaries in some sectors of the economy, but this situation is likely to equalize as
training programs and educational institutions respond to the new demands of the
more open economy.
After the policy reform in 1986, the private sector had been encouraged to
develop. There was a movement of labour force from the state sector to the non-state
sector. This either makes the labour force in the non-state sector rise and the labour
force in the state sector decline or makes the growth rate of labour force in non-state
sector higher than that of labour force in state sector (Table 2.14, page 40).
Chapter Two: The Economic Structure and SMEs in Vietnam
industries. Other industries such as agriculture, fishery, mining, construction, and
others are outside the scope of this study.
2.3.2 Overview of enterprises in Vietnam
According to Statistical Yearbook 1995, there were 32,064 registered enterprises in
Vietnam at the end of 1995. Of this number, 6,310 were state enterprises; 18,243
private enterprises, 7,346 limited companies and 165 stock companies. During 1994
and 1995, the number of state enterprise grew by an average of 400 whereas the
number of non-state enterprises grew by that of 6,500 each year (Table 2.16). Of the
non-state enterprises, the number of private enterprises were the biggest (18, 243
enterprises with the average capital of VND170 million), the next was the limitedcompany (7,346 enterprises with the average capital of VND780 million). Stock
companies were insignificant in terms of number of enterprises and percentage (Table
2.16 and 2.17, page 44) but they represented the biggest in terms of average capital
(VND10.33 billion).
State enterprises had been undergoing reorganization and consolidation since
1991 and there had been large declines in their total number, but in 1994 they began
to grow again, primarily because of joint ventures with foreign companies (Ebashi,
Sakai and Takada, 1997).
Table 2.16: Number of businesses by economic sector and average capital (billion dong).
End of 1994 Licensed in 1994 End of 1995 Licensed in 1995
No. Ave. No. Ave. No. Ave. No. Ave.Capital capital Capital Capital
Chapter Two: The Economic Structure and SMEs in Vietnam
policy for small and medium enterprises of all economic sectors. Many laws such as
company law, private enterprises law, co-operative law, home investment promotion
law, civil law, and commercial law had been passed to create a favourable
environment for the development of small and medium enterprises (Nguyen, 1999).
As a result, SMEs in Vietnam have developed, not only in term of quantity but also in
terms of structure and quality of performance. Once the government commenced
programs of promotion for SME development, the studies on SMEs have attracted
many researchers. In terms of supporting policy, finance, and research, the definition
of SMEs should be clarified. In Vietnam there has not been a common definition of
SMEs. Some popular definitions are examined below.
2.3.3.2 Definitions of SMEs
The concept of SMEs has only existed in recent years in Vietnam. As of 2000, there is
no formal definition of what constitutes a “small and medium enterprises” in Vietnam
(Esbashi, Sakai, and Takada, 1997). Below are some popular definitions of SMEs
stated and used in Vietnam.
1) Definition used by the Vietnam Industrial and Commercial Bank
Enterprises with capital of between VND5.0 and 10.0 billion and/or 500 –1,000 employees are “medium enterprises”; those with less than VND5.0
billion in capital and/or 500 employees are “small enterprises”.
2) Definition used by Ho Chi Minh City
Enterprises with less than VND1.0 billion in capital and/or 100 employees are“small enterprises”, those with VND1.0 – 10.0 billion in capital and/or 500employees are “medium enterprises”.
3)
Definition used by the Vietnam Chamber of Commerce and Industry (VCCI)
A SME is defined as a business unit that fulfils the following criteria,depending on its size:
•
Small business:
− Manufacturing: less than 200 employees and VND5 billion capital
− Trading and services: less than 200 employees and VND5 billioncapital
• Medium business:
−
Manufacturing: 200 – 500 employees and 5 – VND10 billion capital
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− Trading and services: 50 – 100 employees and 5 – VND10 billioncapital
4) Definition defined as Document 681/CP-KTN issued by the Government in 1998
A small enterprise is defined as one with less than 50 employees or a totalcapital of less than VND 1 billion or with a turnover less than VND 1
billion.
•
•
A medium enterprise is one having a number of employees ranging from51 to 200 persons or a total capital, ranging from 1 billion to VND 5
billion.
Table 2.18 compares definitions of SMEs in Vietnam with those of some Asian
countries. All countries define SMEs based on two criteria: number of employees and
the amount of capital or assets. Also note that the definitions in Table 2.18 are not
consistent on whether the amount of capital or assets and number of employees are to
be linked with “and” or “or”. Some countries such as Singapore, Taiwan, Thailand,
Philippines use “and”, Vietnam and Japan use “or” whereas Korea and Malaysia
neither use “and” nor “or” (Table 2.18).
Table 2.18: Definitions of SMEs in Asian countries
Country Definition
Japan Less than 300 employees or less than 100 million yen in legal capitalSingapore Greater than 30% in local equity and less than S$12 million in fixed assetsKorea Less than 300 employees
Taiwan Less than NT$40 million in paid capital and less than NT$120 in total assetsMalaysia Less than MR2.5 million in shareholder’s fund
Thailand Less than 200 employees and 100 million bath in investment capitalPhilippines Less than 200 employees and 40 million peso in total assets
Vietnam Less than 500 employees or less than VND10 billion in total assets
Source: The APEC survey on small and medium enterprises 1994, APEC Committee on Trade and Investment, Ministry of Economic Affairs, Chinese Taipei
2.3.3.3 The role of SMEs in Vietnam
SMEs play a very important role in developing the economy and solving social
problems at the present stage when the economy is transiting into the market
economy. Vu (1998) summarized the contribution of SMEs in developing the
economy. SMEs in Vietnam have:
•
provided a large number of diversified products, representing 26 percent of
GDP and 30 percent of industrial outputs• created jobs for some 4.5 million people
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• change economic structure
• create an equal competitive environment between state and non-state
enterprises.
Finally, regarding the needs for SME support programs, Ebashi, Sakai and Takada
(1997) listed various support programs that SME owners in Vietnam expect (Table
2.21). Table 2.21 demonstrated that 46.6 percent, the highest percentage, of SMEs
expect the support programs related to financial issues.
Table 2.21: The kind of SME support programs
Kind of programs Percentage of interviewee
expecting programs (%)Expansion of bank financing 46.6Sales tax reduction 45.4
2.4 SMALL AND MEDIUM ENTERPRISE FINANCE IN VIETNAM
This section reviews aspects of finance and financial management of SMEs in
Vietnam. The objective of this section is to examine the current state of small and
medium enterprise financial management in Vietnam, including type of finance, use
of finance, financial management practices and problems of financial management.
While there is a large number of articles and books on financial management for
SMEs around the world, there is very little research and literature on finance and
financial management for SMEs in Vietnam.
Development of aid for environment 36.7Simplification of administrative procedures 35.1Stable supply of electricity 25.1
Technological assistance 25.1Development of industrial parks 23.5Financial support for exporting 18.3Deregulation in exporting 13.5Foreign information service 12.4Improvement of law 10.8
Improvement of water supply 9.2Promotion of industrial associations 8.8 Technological information services 8.4Deregulation in production investment 6.8Improvement of traffic infrastructure 6.4
Training service for technology 6.4 Training service for business administration 4.8Establishment of training institution for engineers 3.6Management information service 2.0
Source: Survey conducted by Ebashi, Sakai, and Takada
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2.4.1 Types of finance
SMENET Online Vietnam (1999), a SME support organization, summarizes the types
of finance available in Vietnam for SME owners as sources of finance for their
operations. They include owners’ equity, family loans, friends’ loans, bank loans,
share capital, supplier advances, buyer advances, leasing, hire-purchasing, and
factoring. Owners’ equity remains the first choice of SMEs because it has advantages
of making the business owner independent of third parties. However, owners’ equity
is often not sufficient to allow for business growth. For growth, the businesses need
an external source of finance.
The traditional debt financing sources such as bank loans, loans from family
or friends, supplier or buyer advances are popular types of debt finance. Other recent
types of finance such as leasing, hire-purchasing and factoring were only introduced
on the financial market in Vietnam in 1990s (SMENET Online, 1999).
In recent years, some SMEs have used sources of financing from the
International Financial Corporation (IFC). IFC provides a wide variety of financial
products from which its clients can choose (SMENET Online, 1999). This allows IFC
to offer a mix of financing that is tailored to meet the needs of each project. However,
the bulk of the funding, as well as leadership and management responsibility, lie with
private sector owners.
Loans are the IFC’s largest product. IFC provides fixed and variable rate loans
in any of the leading currencies. These loans typically have maturities of 8 to 12
years, with grace periods and repayment schedules determined on a case-by-case basis
in accordance with the borrower’s cash flow needs. If warranted by the project, IFC
provides longer-term loans and longer grace periods.
IFC’s equity investments are based on project needs and anticipated returns.IFC is never the largest single shareholder in a SME and IFC does not take an active
role in company management. IFC is considered a passive investor. To meet national
ownership requirements, IFC shareholdings can, in some cases, be treated as domestic
capital or “local” shares. IFC usually maintains equity investments for a period of 8 to
15 years and is considered a long-term investor (SMENET Online, 1999).
Other financial products offered by IFC include credit and equity lines,
venture capital, and leasing. IFC is investing in credit lines and private equity funds to
make longer-term finance available to SMEs as they seek to enhance their
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competitiveness in more open economies around the world. Credit lines to developing
country banks help redress the limited availability of term funding that constrains the
ability of these banks to provide working capital and investment financing for their
corporate customers. Leasing is often essential to the development of SMEs, which
typically lease costly capital equipment. Leasing plays a critical role in financial
sector development in countries with small economies or low per capita incomes
(SMENET Online, 1999).
2.4.2 Use of finance
In the middle of 1999 Kack and Lindgren (1999) conducted exploratory research
related to financing SMEs in Vietnam. They interviewed 16 SMEs in Ho Chi MinhCity to identify what type of financing sources they used during and after their
establishment.
Regarding financing during the establishment, SMEs were classified into two
groups: those who had obtained bank loans and those who had used alternative
financing. Of sixteen SMEs, only one SME (Toan Luc) obtained a bank loan as a
source of capital at establishment. The residual 15 SMEs financed their
establishments by using capital from their relatives, friends, or from owner savings.
The main reason for not choosing the bank as a source of capital was the lack of SME
assets that could be used as collateral.
Regarding financing after the establishment, the SMEs were also classified
into two groups: those who have obtained bank loans and those who have not used
bank loans to finance their operations. Of sixteen SMEs, only seven enterprises (ADC
Chapter Two: The Economic Structure and SMEs in Vietnam
commercial banks had to require collateral for their loans. However, this requirement
was not equal between private and state companies. Private companies had to offer
collateral to obtain bank loans whereas state companies do not. Secondly, there were
difficulties in evaluating collateral but this may differ from time to time. Hence the
problem is not collateral itself, but unequal regulations and the difficulties of banks in
evaluating collateral. Thirdly, different rules for different banks and different rules
from time to time made SMEs avoid banks due to common assumptions of poor
stipulation, expensive fees, and changing policies, and owners turned to seeking
sources of finance from their families, relatives and friends. However, often due to
lack of capital, SMEs could not accept business options for further expansion.
Sam Korsmor (Vietnam Investment Review, 1998) also found that SMEs inVietnam face more difficulties than those in regional countries because the state and
non-state do not rest on an equal “playing field”.
Say, there are two companies – one state company and one private enterprise.The state company will be granted the loan every time because it holds agovernment guarantee.
This discrimination may negatively impact on private SME growth. Unless the
government had created an equal “playing field”, it would not be realistic to discuss
promotion policies for SMEs.
2.4.3 Financial management for SMEs
Financial management in general and financial management for SMEs in particular
has only become popular in Vietnam in the 1990s when the economy moved into a
market economy. To date, there is little research related to financial management for
SMEs. Vuong Quan Hoang (1998) found that the current ratio and quick ratio areextremely important for SMEs in Vietnam because they usually have little permanent
working capital. Regarding financial characteristics of SMEs in Vietnam, his findings
are summarized in Table 2.22.
Table 2.22: Some financial characteristics of SMEs in Vietnam
Characteristics Minimum Average MaximumCurrent ratio 1.15x 2.1x 7.1xQuick ratio n.a 1.2x n.a
Chapter Two: The Economic Structure and SMEs in Vietnam
By applying linear regression analysis, it had been found that equity and short-
term liability ratios have a correlation coefficient of about +0.6. In other words, the
equity ratio and short-term ratio are moderately related. The short-term debt ratio is
relatively high (67%) because SMEs had difficulties in accessing long-term sources of
capital and they, therefore, are willing to use short-term borrowing to finance non-
current assets.
2.4.4 Problems in financial management
As mentioned earlier, there is almost no significant research regarding financial
management for SMEs in Vietnam. Based on the exploratory research conducted byKack and Lindgren (1999) and findings of Vuong Quan Hoang (1998), the following
gaps are found in SME financial management practices in Vietnam:
• SMEs in Vietnam use equity as the major source of finance. Sometimes,
equity ratios are up to 90 percent.
• Due to difficulties in obtaining long-term loans, SMEs in Vietnam are willing
to use short-term loans to finance non-current assets.• SMEs in Vietnam seem likely to maintain very high current ratios.
These financial management practices might adversely affect SME profitability.
However, the findings above are not enough evidence to conclude on the relationships
between SME financial management practices and its profitability. Therefore further
descriptive research regarding the financial management practices and impact of
financial characteristics and financial management practices on SME profitability is
justified to provide more convincing evidence. Moreover, because of the uncertainty
of the business environment SMEs in Vietnam tend to maintain relatively high
liquidity ratios and low financial leverage ratios. These financial characteristics may
adversely affect SME profitability. Figure 2.5 (page 56) represents the gap between
financial management practices in Vietnam and findings from the literature reflecting
other country trends.
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The Small Business Act of 1953 of USA defines a small business as “one which is
independently owned and operated and not dominant in its field of operation”. The act
also empowers the Small Business Administration (SBA) to identify standards of size for
“number of employees” and “sales volume” that small business must meet. Whenreviewing the quantitative definitions, these standards will be examined in more detail.
In the UK, the qualitative definitions adopted by the Bolton Committee (1971)
identified three major characteristics of small business:
• Firstly, in economic terms, a small firm is one that has a relatively small share of
the market, and is unable to influence the price or quantity of goods or servicing.
• Secondly, an essential characteristic of a small firm is that it is managed by its
owner or part owner in a personalized way, and not through the medium of a
formal management structure.
• Thirdly, it is also independent in the sense that it does not form part of a larger
enterprise and that the owner-managers should be free from outside control in
making their principal decisions.
In Australia, the qualitative definition commonly used was devised by the Wiltshire
Committee of Inquiry in 1973. Wiltshire (1973) defines a small business as:
A business in which one or two people are required to make all the criticaldecisions (such as finance, accounting, personnel, purchasing, processing orservicing, marketing, selling) without the aid of internal specialists and withspecific knowledge in only one or two functional areas.
The second annual report of small business released by the Department of Industry,
Technology and Commerce (1992, p.5) employs a definition of a small enterprise that is
based on the following characteristics:
• independently owned
• closely controlled by owner-managers who have responsibility for principal
decisions
• owner-managers contribute most, if not all, of the capital
• operations are locally based, although its market might not be.
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The problem of definitions of small business in Australia is that each State Government
has its own definition. For instance while the Western Australia Small Business Advisory
Service has followed the Wiltshire Committee’s definition, Victoria and New South
Wales have their own definitions, which emphasize the role of ownership, legal structure,market share and management (Price, 1984, p. 2).
A small business is one which is wholly owned and operated by an individual, orindividual persons in a partnership or by a proprietorship company and which hasrelatively small share of the market in which it competes; is managed personally by the owners or directors; is not part of a larger business or enterprise.
The Small Business Agency of New South Wales includes in its definition reference to
annual turnover and the number of employees (Price, 1984).
A small business is one, which is owned and operated by an individual or groupof people either, as a sole trader, in partnership, or as an incorporated company. Inmajority of cases the annual turnover of business generally does not exceed$500,000.
In addition to the definitions of small business stated by the organizations mentioned
above, there are many other different definitions of small business put forward by many
authors and researchers. Meredith (1986, p.3) defines small enterprises as enterprises
where one or two owners are required to make all critical decisions, and these owners,
therefore, rely on specialist advice multiplier agents. McMahon (1995, p. 3) confirmed
that many people think small business should be defined as:
A business in which one or two persons are required to make all the criticalmanagement decisions: finance, accounting, personnel, processing or servicing,marketing, selling, etc. without the aid of internal specialists and with specificknowledge in only one or two functional areas.
Although qualitative definitions have the great advantage of attempting to capture the
essential nature of small business, they still have the disadvantage of being unworkable in
carrying out research or in gathering statistical information. It is, therefore, useful to
define small business from the quantitative characteristic perspective.
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3.2.2 Quantitative definitions
Quantitative definitions define small and medium enterprises based on their quantitative
characteristics. Unfortunately, quantitative characteristics may be difficult to measure.
Firstly, there are a variety of ways in which enterprise size can be measured, including
(1) number of employees, (2) sales revenue or turnover, (3) total assets, and (4) net
worth. The first of these is the most widely used measure of size in qualitative definitions
of small enterprise around the world, although the second and the third also find
significant use (McMahon et al. 1993).
Secondly, the quantitative characteristics of small enterprises vary from industry to
industry and from country to country. For example, an enterprise, which is small in one
industry such as cement manufacture, may be regarded as large in another industry suchas trading or tourism. Similarly, an enterprise, which is considered small by the USA
standards, may be relatively large in other countries such as Thailand, Malaysia or
Vietnam.
Regarding the number of employees, in the USA the government decided to use
500 employees as the general cut-off between small and other businesses (Back, 1985,
p.4) while most studies in Australia have assumed a firm is small, if it employs less than
100 employees (Back, 1985, p.3). In addition to the number of employees, some other
countries such as the USA, Britain, Japan define small business based on turnover and
industry breakdown. Table 3.1 (page 65) summarizes the quantitative definitions of
SMEs in the developed countries.
The quantitative definitions of SMEs, especially their quantitative characteristics,
are very important because they provide the bases for carrying out research and gathering
statistical information. They also provide quantitative standards for the comparative
studies between SMEs in one country and SMEs in another country.
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Table 3.1: Summary of the quantitative definitions of small business
Country Industry Quantitative characteristicsRetailing Annual sales or receipts not exceeding $2 to $7.5
million, depending on the industryServices Annual receipts not exceeding $2 to $8 million
depending on the industry Wholesaling Yearly sales must not be over $9.5 to $22 million,
depending on the industry The US Agriculture Annual receipts not exceeding $1million
General construction Average annual receipts not exceeding $9.5million
Special trade construction Average annual receipts not exceeding $1 or $2million
Manufacturing Maximum number of employees may range from250 to 1,500, depending on the industry.
Manufacturing 200 employees or lessRetailing Turnover £50,000 pa or less
Wholesale £200,000 pa or less The UK Construction £200,000 pa or less
Mining 25 employees or lessMotor trader Turnover £100,000 pa or less
Miscellaneous services Turnover £50,000 pa or lessRoad transportation 5 vehicles or less
Australia Manufacturing 50 employees or lessGeneral Turnover not exceeding $500,000
Manufacturing Less than 300 employees Japan Wholesales Less than 100 employees
Retail and service Less than 50 employees
Sources: ( 1) Small Firms, Report of the Committee of Inquiry on Small Firms (Bolton, 1971), (2) SmallBusiness Management (Price, 1984), (3) The US Small Business Administration, “Business Loans for theSBA”, Washington, D.C., September 1981.
3.2.3 The forms of ownership of SMEs
In general, SMEs in every country have many different legal forms of ownership. This
subsection reviews the main legal forms of ownership of SMEs. In the USA, there are
three forms of ownership: proprietorship, partnership and corporations (Walker and Petty,
1978, p.6; Scarborough and Zimmerer, 1984, p.68). The percentage of each of the major
business ownership forms is examined in Table 3.2.
Table 3.2: Forms of SME ownership in the USA
Partnership CorporationProprietorshipPercentage of business 76.2 8.0 15.8Percentage of business receipts 8.9 4.1 87.0
Source: Effective small business management, Scarborough & Zimmerer (1984, p.69)
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McMahon et al. (1993, p.3) defines financial management based on mobilizing
and using sources of funds:
Financial management is concerned with raising the funds needed to finance theenterprise’s assets and activities, the allocation of theses scare funds between
competing uses, and with ensuring that the funds are used effectively andefficiently in achieving the enterprise’s goal.
According to McMahon et al. (1993), modern financial management involves planning,
controlling and decision making responsibilities embracing:
• Various types and sources of finance an enterprise may employ, how these may
be accessed, and how to choose among them.
•
Alternative ways in which finance raised may be used in an enterprise and how to
select those that are likely to prove most profitable.
• Different means of ensuring that finance entrusted to specific activities realizes
the returns that were anticipated on its allocation to them.
However, according to Meredith (1986) 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. English (1990) argues
financial management is concerned with what is going to happen in the future. Its
purpose is to look for ways to maximize the effectiveness of financial resources.
Definitions mentioned above only emphasize areas or scopes of financial
management, which financial management is concerned with, but they do not emphasize
the objectives of financial management. While English (1990) indicated financial
management consists of working simultaneously toward three objectives: liquidity,
profitability and growth. The next subsection discusses more detail on these objectives.
3.3.2 Objectives of financial management
Like many other management sciences, financial management, firstly, establishes its goal
and objectives. Objectives of financial management are foundations or bases for
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While discussing the objective function of a privately held small firm, Ang (1992)
indicated that its objective function is to maximize three components. The first is to
maximize its current market price, to avoid unwanted mergers and to obtain outside
financing in the securities market. The second is to maximize long term or intrinsic value,if the two values diverge. The last is to maximize non-owner manager’s own pecuniary
and non-pecuniary incomes by avoiding control rights. Whether the absence of
marketable securities means that small firms need not be concerned with current
performance and can concentrate on long-term values, depends on the organizational
types and circumstances. Profitable firms, where outside funding is not a major concern,
can afford to maximize long-term value whereas for those small businesses, which need
outside financing, current performance may be very important. Thus, a number of small
businesses would have a weighted average objective function consisting of both current
profit and long-term value. Weight for current profit is expected to be higher for small
businesses approaching loan re-negotiation, initial public offering, potential sale to an
acquirer, signing long-term contracts with supplier or customers and possible dissolution
of a partnership. On the other hand, its weight will be smaller when the business is due to
pay estate taxes, renegotiate employee contracts, discourage a non-managing family
member from their shares, and avoid tax on excess accumulation.
In making decisions related to financial management, the owner-manager or the
financial manager should remember objectives of financial management and balance
between liquidity and profitability objectives, and between current and long-term
(growth) objectives.
3.3.3 Major decisions of financial management
Generally, previous authors had no differences in opinions of major decisions in financial
management. Ross, Westerfield and Jaffe (1999, p.1) indicated three kinds of decisions
the financial manager of a firm must make in business: (1) the budgeting decision, (2) the
financing decision, and (3) decisions involving short-term finance and concerned with the
net working capital. Similarly, Ang (1992) also indicated three main financial decisions
including the investment decisions, financing decisions and dividend decisions.
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intermediate financing and going public). Barrow (1984) emphasizes a practical rather
than theoretical perspective. Instead of identifying specific areas of financial
management, he listed the tools of financial analysis, including business controls;
measure of profitability; control of working capital (or liquidity); control of fixed assets,cost; volume; pricing and profit decisions, and business plans and budgets.
Meredith (1986) emphasizes information systems as a base for financial
management including financial management records and reports. This is considered very
important because the owner-managers or financial managers find it is difficult, if not
impossible, to make decisions if they lack finance information. Cohen (1989) focuses on
working capital management and tools of financial management such as ratio analysis,
profitability measures and bread-even analysis. English (1990) emphasizes objectives of
financial management including liquidity, profitability and growth. Therefore, the
specific areas that financial management should be concerned with are liquidity
management (cash flow budgeting, working capital management), profitability
management (profit analysis, profit planning), and growth management (capital resource
planning and decisions).
McMahon (1995) examines specific areas of financial management including all
areas that relate to items on the balance sheet of the business. The specific areas financial
management covers consist of managing working capital, managing long-lived assets,
managing sources of finance, planning financial structure, and planning and evaluating
profitability.
In summary, financial management is concerned with many specific areas.
Probably the balance sheet of a business may demonstrate how to recognize these areas
including:
• current asset or working capital management,
• fixed asset or long-lived asset management,
• funding management,
•
financial budgeting and planning,
• leverage and capital structure,
• financial analysis and evaluating performance of the business, and
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• profit distribution (dividends and retained earnings policy).
Figure 3.4 below, adopted from financial management for small business
(McMahon, 1995), illustrates a model of financial management, which covers most issuesdiscussed earlier and shows relations between objectives and decisions of financial
management.
Figure 3.4: A model of financial management
uses makes
with
Financial management
Resources:− Capital
− Labor
− Raw materials
− Technology
− Information
Decisions:− Investment
− Financing
− Profit distribution
Specific objectives:
− Profitability
− Liquidity
General/Final goal
To maximize the owner’s wealth
Source: Adopted from Major Decisions in Financial Management (McMahon, 1995)
This study examines financial management practices in relation with objectives,decisions and specific areas of financial management. Objectives, decisions and areas of
financial management are relevant to financial management practices. The specific areas
of financial management are viewed as a theoretical framework for financial management
practices while objectives and decisions of financial management are viewed as factors
Chapter Three: Financial Management and SME Profitability
In the survey of 69 small enterprises across the USA, Farhoomand and Hryck
(1985) reported on the most important applications of computers, which are presented in
Table 3.9, in which 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.
Table 3.9: The most important applications of computers Application Percentage rating as most important Accounting 32 Word processing 16Spread sheet 13Database management 12Point of sale 4 Telecommunications 1Others 22
Source: Adapted from Farhoomand and Hryck (1985)
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.
In the UK the most significant studies of small enterprises were conducted by
Bolton Committee (1971). Additionally, there are several researchers who studied
accounting systems such as Corner (1967), Murphy (1978 and 1979), Lovett (1980),
Arnold-McCulloch and Lewis (1985, 1986) and Gorton (1999). According to McMahon
et al. (1993) the inadequacy of financial record keeping system in small enterprises was
well documented in the main Bolton Report (1971) and in various supplementary
research reports. This situation reflected a poor appreciation of the significance of
financial management amongst owner-managers who were often technically-or sales-
oriented.
Concerned with costing systems, Corner (1967) reported on the results of studies
including 119 small enterprises, 62 medium-sized enterprises and 29 large enterprises in
1963. The study results showed the extent of use of costing systems in large enterprises
was 82.1 percent, while in small and medium enterprises was 62.1 and 69.4 percent
respectively. Awareness of use of costing systems was found to be very high in the study
of Murphy (1978 and 1979) whereas the utilization of costing systems was lower (Table
3.10, page 81). Murphy (1978) explained that smaller enterprises were often aware of the
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In summary, the accounting system practices of SMEs have long attracted the
attention of many researchers. Several findings have been found and modified over past
decades. Table 3.13 summarizes research areas related to the accounting system practices
of SMEs conducted by previous researchers in the developed economies such as theUSA, Canada, the UK, and Australia. Previous research describes characteristics of
accounting information system practices but without empirical evidence of links between
accounting information system practices and profitability of SMEs.
Table 3.13: Summary of research areas related to the accounting system practices of SMEsResearcher(s) and year Country Main research areasCorner (1967) UK Use of cost accounting systemMurphy (1973, 1978, 1979) UK Use of cost accounting systemLovett (1980) UK Costing system
D’Amboise and Gasse (1980) Canada Cost accounting systemCheney (1983) USA The most important applications of computer
softwareRaymond and Magnenat- Thalmann (1982)
3.4.3 Financial reporting and analysis
Recording and organizing the accounting information systems will not meet objectives
unless reports from systems are analyzed and used for making managerial decisions. This
section provides a review of financial reporting and analysis of SMEs. In the USA and
Canada Computer software applications
DeThomas and Fredenberger(1985)
USA Financial record keeping
Farhoodman & Hryck (1985) USA The most important application of computersoftware
Raymond (1985) Canada Computer software applicationsPeacock (1985, 1987, 1988) Australia The effects of cost accounting system on business
failure
Williams (1986) Australia Accounting recordsHolmes (1987) Australia Double entry systemHolmes and Nicholls (1988) Australia Accounting information preparationGul (1991) Australia The effects of management accounting systems
on small business manager’s performanceChen (1993) UK Computer software applications in accounting
systemsPalmer (1994) USA Using computerized accounting systems by small
businessesGorton (1999) UK Use of financial accounting techniques and
computerized accounting systemsSource: Adapted as indicated above
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Canada, the key researchers of this issue include Luoma (1967), D’Amboise and Gasse
(1980), Lindecamp and Rice (1983), DeThomas and Fredenberger (1985), Thomas and
Evanson (1987), and Palmer (1994). Louma (1967) conducted a survey of 62
manufacturing SMEs on the use of accounting information in managerial decision-making. Eighty-six percent of respondents reported that they used some form of financial
statement analysis and interpretation. Of these, 40 percent indicated that the founder of
the businesses was actively involved.
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 as
presented in Table 3.14.
Table 3.14: Use of financial statement techniques by small manufacturers in Quebec Technique Shoe industry Plastic industry
% use % useRate of return analysis 72 76.9Financial situation analysis 96 92.3
Source: Adapted from D’Amboise and Gasse (1980)
Lindecamp and Rice (1983) studied familiarity with financial statement analysis
of 102 owner-managers of small retail stores in Mississippi. Some 73 percent of
respondents reported that they analyzed their cost figures on a frequent or regular basis.
Nearly 60 percent indicated that they did not maintain up-to-date figures on the
contribution to profit of individual product or product lines. Nearly 50 percent seldom or
never compared their concern’s performance with industry figures. Over 50 percent of
respondents did not appear to understand the meaning of “debt/equity ratio” and 59
percent did not know the value of this ratio for their business.
In their survey, 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. Regarding responsibility for interpretation of financial statements,
DeThomas and Fredenberger’s findings are summarized in Table 3.15 (page 85).
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investments, net return on sales, and gross return on sales, is not more than 12 percent
respectively.
Table 3.17: Percentage of use of financial ratiosKind of financial ratio Percentage of use
Debtors/Creditors 10 Acid test 6Sales to debtors and cash 8Inventory turnover 10Return on investments 12Net return on sales 10Gross return on sales 10
Source: Adapted from Arnold-McCulloch and Lewis (1986)
McMahon and Davies (1994) examined significant associations between financial
reporting and analysis and achieved growth rates and financial performance and found
the following:
• Enterprises that had more comprehensive reporting in terms of both the number of
statements obtained and their frequency were more likely to employ financial
analysis.
• There is apparently no statistically significant association between rates of growth
in turnover and employment achieved by participating enterprises and their
historical financial reporting practices.
• There appears no statistically significant association between achieved rates of
growth in turnover, employment, and net profit and use of financial ratio analysis.
In Australia, Holmes (1986,1987), Williams (1986), Holmes and Nicholls (1988), and
McMahon (1998, 1999) are considered key researchers who studied financial reporting
and analysis. Holmes (1986) examined preparing the accounting statements of 60 small
enterprises and found that they were both internally and externally prepared but taxationreturns were mainly prepared by external accountants (92.7 percent). Similar results were
also found from a study conducted by Holmes and Nicholls (1988). With only a minor
change in percentage of internal and external taxation return preparation (Table 3.18 page
88).
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between enterprise size in employment terms and the likelihood of being asked to provide
more financial information by potential financiers.
In summary, researchers reporting in the literature have spent much time studying
financial reporting and analysis practices and effects on the performance of SMEs. Table3.19 (page 89) summarizes the main research areas related to the financial reporting and
analysis practices of SMEs conducted by previous researchers in the developed countries.
Table 3.19: Summary of the main research areas related to the financial reporting and analysisResearchers Country Main research areasD’Amboise & Gasse (1980) Canada Use of financial statement techniquesLindecamp and Rice (1983) USA Familiarity with financial statement analysisHankinson (1982, 1983) UK Financial ratio analysisRay & Hutchinson (1983) UK Frequency of financial reportingDeThomas & Fredenberger
(1985)
USA Use and interpretation of financial statement
Holmes (1986, 1987) Australia Preparing accounting statements Arnld-McCulloch & Lewis(1986)
UK Use of financial ratios
Thomas & Evanson (1987) USA Association between financial ratio and businesssuccess
Holmes & Nicholls (1988) Australia Preparing accounting statementMcMahon & Davies (1994) Australia Association between financial reporting analysis and
achieved growth rateMcMahon (1998) Australia The impact of financial reporting practices on
achieved business growth and performance.McMahon (1999) Australia Financial reporting to financiers by Australian
manufacturing SMEsSource: Adapted as indicated above
3.4.4 Working capital management
This subsection reviews the literature on working capital management practices of SMEs.
The context of working capital management includes cash management, receivables and
payables management, and inventory management.
In the USA and Canada, Luoma (1967), Grablowsky (1978), Grablowsky and
Rowell (1980), Cooley and Pullen (1979), D’Amboise and Gasse (1980), Anvari and
Gopal (1983), Thomas and Evanson (1987), Kathawala (1988), Khoury, Smith and
MacKay (1999) are considered the key researchers who studied working capital
management practices. In the UK and Australia, Murphy (1978), Arold-McCulloch and
Lewis (1986), Williams (1987), and Peel and Wilson (1996) are the main researchers.
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Regarding cash management practices, Grablowsky (1978) and Grablowsky and
Rowell (1980) conducted a questionnaire survey concerned with the cash management
practices of 66 small enterprises from a number of industries located in and around
Norfolk, Virginia. The results showed that 67 percent of respondents replied they did notdo forecasting of cash flows. When asked how they determined the level of cash to be
held by the business, less than 10 percent of enterprises reported using any type of
quantitative technique. The method most often employed was to hold cash as a fixed ratio
of projected expenses, forecasted sales or anticipated purchases. Non-quantitative
methods used consisted of meeting compensating balance requirements, maintaining the
level considered safe by management or achieving a level recommended by outside
advisers. Additionally, seventy-one percent of business in the Virginia survey reported
that they had no short-term surpluses of cash in their recent history. Only 23 percent had
a long-term surplus. Nearly 30 percent of respondents had invested excess cash in
earnings securities or accounts. The most common investments were savings accounts,
certificates of deposit, treasury bills, repurchase agreements, commercial papers, shares,
bonds and other investments.
Based on Cooley and Pullen’s (1979) research, 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.
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. Comparison of cash surplus investment practices of
businesses in Grablowsky and Rowell’s survey and Cooley and Pullen’s survey are
summarized in Table 3.20.
90
Table 3.20: Cash surplus investment practicesGrablowsky and Rowell’s
survey (1978)
Cooley and Pullen’s survey
(1979)Outlet Percentage use (%) Percentage use (%)Saving account 17 57Cheque account n.a 25Repurchase agreement 3 n.a Treasury bills 6 15Common sock n.a 9Certificate of deposit 11 8Commercial paper 3 8Other investments 6 8
Source: Adapted from Grablowsky and Rowell (1978, 1980) and Cooley and Pullen (1979)
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examined. Burns and Walker’s (1991) findings can be summarized into some main points
as follows:
•
Thirty-nine percent of the company’s total assets were working capital, but only24 percent of the financial manger’s time were spent on working capital. Overall,
companies had an informal procedure or no written policy for working capital
management. However, those that did have a written policy were probably more
profitable than others.
• For cash management, the typical company used cash budgeting on a weekly
basis mainly to plan for shortages and surpluses of cash. Company would
determine target cash balances based on needs for transaction balances, and put its
idle cash in cash management accounts or certificates of deposit.
• For accounts receivable, the typical company used both the collection period and
aging schedule to monitor the payment behavior of credit customers.
• With regard to inventory policy, the typical firm used computerized inventory
control systems to decide on the appropriate amount to replenish its storage points
by using ad hoc decisions. Company mainly considered the availability of parts
and materials in deciding on reorder quantities for inventory purchased.
•
As for accounts payable, the typical firm became a net supplier of credit believing
that the cost of foregoing trade discounts was only about 13%, yet it always or
sometimes took the discounts.
In summary, working capital management practices have long attracted the attention of
previous researchers. The main research areas related to these practices included cash,
receivable and inventory management summarized in Table 3.25 (page 95). This table
shows that studies on working capital management practices conducted by previousresearch provided detailed descriptions of working capital management practices of
SMEs. However, relationships between working capital management practices and SME
profitability have not been investigated. To date there almost are no tests of associations
between working capital management practices and SME profitability.
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Table 3.25: Summary of working capital management practicesResearcher(s) and year Country Main research areasGrablowsky and Rowell (1980) USA • Short-term surplus of cash
• Low standards of receivable management
bad debtCooley and Pullen (1979) USA • Cash forecasting
• Cash surplus investment
• Cash control
Anvari and Gopal (1983) Canada • Preparing cash forecasts
• Techniques used to determine cash balance
• Short-term cash surplus
• Investment of short-term investment
Mrphy (1973) UK • Awareness and utilization of credit controlsystem
D’Amboise and Gasse (1980)
3.4.5 Fixed asset management
This subsection reviews research on fixed asset management practices of SMEs. The keyresearchers in this field include Soldofsky (1964), Corner (1967), Taylor Nelson
Investment Services (1970), Scott et al. (1972), Murphy (1978), Hankinson (1979),
Grablowsky and Burns (1980), Pattillo (1981), Arnold-McCulloch and Lewis (1986),
Williams (1986), Holmes (1986, 1987), Brigham (1992), Proctor and Canada (1992),
Ruyon (1993), and Block (1997) in the developed countries such as the USA, Canada, the
UK, and Australia.
Brigham (1992) 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.
Canada Inventory control system
Grablowsky and Rowell (1980) USA•
Capital invested in inventory• Poor standard of inventory management
• Methods used to determine inventory level
Pell and Wilson (1996) UK • Frequency of using and reviewing working
capital managementSource: As indicated above
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Soldofsky (1964) found there was considerable variation in the methods of calculating
payback period and in determining payback standards. In many businesses, required
payback periods were flexible according to circumstances such as the variability of cash,
planned product changes and business outlook. In the smaller enterprises, approvals forcapital outlays tended to be given as required, whereas larger concerns were more likely
to have annual capital budgets. Only four firms attempted to calculate some variation of
the average cost of capital for use as a hurdle rate for capital projects. Most businesses
seemed unaware of the link between their financing and investment decisions. On the
positive side, it was quite clear that the evaluation of capital projects was heavily cash
flow oriented.
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 are
summarized in Table 3.26 which shows around 58 percent of respondents used payback
period methods whereas only 4.1 percent employed accounting rate of return technique.
Table 3.26: Percentage of firms using capital project selection methodsMethods Percentage usePayback period 57.7
Accounting rate of return 4.1
Domination of payback period methods compared with other techniques in
evaluating capital investment projects of SMEs was also found in the study of Louma
(1967). Louma (1967) conducted a survey of small and medium-sized manufacturing
businesses in the United States and found that more than 22 percent of SMEs used formal
methods of capital investment evaluation (Table 3.27).
No formal criteria 41.5Source: Adapted from Soldofsky (1964)
Table 3.27: The extent of use of formal methods of the capital investment evaluationMethod SMEs with annual sales SMEs with annual sales >
< $5 million (% use) $5 million (% use)Payback period 63 77Simple rate of return 30 46Discounted cash flow methods 22 31Not specified 26 8
Source: Adapted from Louma (1967)
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Thirty years after the Louma’s (1967) study, 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 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. The question to be answered is not always how profitable the project is, but
how quickly a loan can be paid back. Nevertheless, more sophisticated methods using
discounted cash flow (IRR and NPV) have increased in use over time (Table 3.28).
Table 3.28: Primary method of investment analysisFirms Percentage
Payback period (PP) 99 42.7 Accounting rate of return (ARR) 52 22.4Internal rate of return (IRR) 38 16.4Net present value (NPV) 26 11.2Others, not specified 17 7.3 Total 232 100.0Source: Adapted from Block (1997)
The predominance of the payback period method can be attributed to its
simplicity, emphasis on liquidity, and response to external financing pressures. While
other more complicated methods are not as popular. Similarly, Grablowsky and Burns
(1980) found that the level of understanding and use of more advanced capital budgeting
polices and techniques were very low. For example only 4.6 and 13.8 percent of
respondents in the Grablowsky and Burns (1980) survey indicated they use the net
present value and internal rate of return methods respectively. In the UK, Corner (1967)
found remarkable differences in methods used for assessing capital projects between
smaller and lager enterprises. The percentage use of different methods depending upon
business size (Table 3.29) illustrated by Corner (1967).
Table 3.29: Percentage use of different methods by small, medium, and large enterprisesSize category Payback period Rate of return Discounted cash flow
Chapter Three: Financial Management and SME Profitability
Scott et al. (1972) examined the capital investment evaluation procedures of 135
small manufacturing enterprises in the USA and the following are some principal
findings:
• Eighty-four percent of respondents indicated that some investments were
necessary in the short-run, regardless of their profitability.
• 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.
• Sixty-one percent of respondents indicated that they screened capital expenditures
by comparing the expected rate of return on investment with the cost of capital or
some cost of financing.
• Regarding the screening rates used to evaluate the capital projects, the
respondents indicated the percentages in Table 3.30.
Table 3.30: Percentage of kinds of screening rate used to evaluate the capital projectsPercentage use
Cost of some specific source of fund (e.g., cost of borrowing) 37Some mix of financing cost (e.g., average cost of capital) 13
Similarly, Block (1997) found that, of the 64 firms using discounted cash flow as the
primary method of investment analysis, only 9 used a concept closely related to weightedaverage cost of capital as the discount or hurdle rate. The majority of firms used the cost
of funding the specific project as the cut-off point. Others relied on such concepts as an
arbitrarily determined cut-off point or historical rate of return (Table 3.31, page 99). The
reason for not using weighted average cost of capital is that smaller firms have difficulty
in estimating the cost of equity capital. They were accustomed to relating cost to
Some other hurdle rate (e.g., historic rate of return n investment) 9Others 1No response 40
Source: Adapted from Scott et al. (1972)
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contractual obligations, and not other concepts such as opportunity cost related to
retained earnings. Furthermore, smaller firms have less access to the public capital
markets and fewer alternatives overall than larger firms and feel a less compelling need to
measure the relative cost of each.
Table 3.31: Methods of determining the required rate of return as using discounted cash flowFirms Percent
Cost of funding a specific project
In summary, subsection 4.2.1 shows the previous findings related to fixed asset
management practices. Payback period method continues keeping its dominant position
in evaluating capital investment projects of SMEs as shown in Table 3.32.
34 53.1 Arbitrary cut-off point 13 20.3 Weighted average cost of capital 9 14.1Historical rate of return 5 7.8Non-specified or other 3 4.7
Source: Adapted from Block (1997)
Table 3.32: Summary of fixed asset management practicesResearcher Country Research areas Main findingsSoldofsky (1964) USA Capital project • Domination of payback period method
selection• Most businesses seemed unaware of the
techniques link between their financing andinvestment decisions
Luoma (1967) USA Methods of • Domination of payback period method
capital •
Percentage of using discounted cashinvestment flow methods was risen when the firmevaluation size increases
Scott et al.(1972)
USA Capital • Domination of payback period method
investment• Cost of some specific source of funding
evaluation is mainly used as the screening rate toevaluate the capital projects
Block (1997) USA Methods of • Payback period method remainsinvestment dominant methodanalysis
• More sophisticated methods haveincreased in use over time
• Cost of funding a specific project used
as the required rate of returnGrablowsky andRowell (1980)
USA Capital • Level of understanding and use of morebudgeting advanced capital budgeting polices andpolicy and techniques ere very lowtechniques
Corner (1967) UK Methods used • There are the significant differences
for assessing between larger and smaller enterprisescapital projects
Source: As indicated above
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3.4.6 Capital structure management
Subsection 3.4.2.4 examined financial management practices related to capital investment
decisions. The current subsection reviews capital structure management or financial
management practices related to the decisions of sources of financing. It includes
examining what factors affect capital structure decisions and how capital structure impact
on SME profitability.
Small companies frequently suffer from a particular financial problem – lack of a
capital base. Small businesses are usually managed by their owners and available capital
is limited to access to equity markets, and in the early stages of their existence owners
find it difficult in building up revenue reserves if the owner-managers are to survive. A
question concerns how small businesses determine sources of finance in such difficultcircumstance. According to Brigham (1995, p. 447), modern capital structure theory
began in 1958, when Modigliani and Miller’s (1958) seminal article on capital structure
was published. Since that point of time, researchers have attempted to explain how firms
choose their capital structure. Myers (1984, p. 575) stated:
How do firms choose their capital structure? The answer is we don’t know… wedo not know how firms choose the debt, equity, or hybrid securities they issue.
Though some theoretical work focuses on small business capital structure (Day et al.
1985; McConnell and Pettit, 1984; Pettit and Singer, 1985; and Walker, 1988), empirical
work on small business and capital structure is minimal (Norton, 1991).
Literature of the 1980’s has attempted to explain small firm financing decisions
by using modern financial theories. McConnell and Pettit (1984) suggested that small
businesses generally have proportionally less debt than large firms because: (1) small
firms generally have lower marginal tax rates than larger firms, thereby, less tax
deduction benefit of debt, (2) small firms may have higher bankruptcy costs than large
firms, and (3) small firms may find it more difficult to express their business health to
creditors.
Another attempt to explain small firm financing behaviour relied on agency
theory. Agency theory holds that investors who have equity or debt in a firm require costs
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to monitor the investment of their funds by management or the small business owner
(agency costs). This view suggests that financing is based on the owner-manager being
able to assess these agency costs for each type of financing, and then select the lowest
cost method of financing the firm’s activities. One weakness of this explanation is that noone has yet been able to measure agency costs, even in large firms (Myers, 1984).
In contrast, more recent theoretical and empirical work suggests that a strategic
perspective may have promise in explaining the financing decisions. Barton and Gordon
(1988) suggest that the following characteristics must be accounted for in any explanation
of firm financing decisions:
behavior at the firm level•
•
•
fact that the capital structure decision is made in an open systems context by top
management, and
decisions reflects multiple objectives and environmental factors, not all of which
are financial in nature.
The firm’s financing decision, then, appears to be a product of many internal and external
factors, as well as managerial values and goals.
The arguments of Barton and Gordon (1988) for the management choice
perspective on large-firm financing decisions may have even more relevance and validity
for small firms. First of all, because most small firms are not actively traded on a
financial market as large, public firms are, they are unconcerned with the financial
market’s assessment of their capital structure. As a result, modern financial leverage
theory, which is based on the market’s assessment of total stock valuation, does not
always apply. Second, as Levin and Travis (1987) pointed out the owners’ attitudes
toward personal risk – not the capital structuring policies public companies use –determine what amounts of debt and equity are acceptable. In effect, the authors argue
that small firms choose debt based on personal, managerial preference.
While the classic strategy paradigm is not explicitly theoretical in nature, it does
identify key decision categories, which are affected by top managers, when they make
strategic decisions. Based on dimensions of the strategy paradigm, Barton and Matthews
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(1989) suggested five propositions to explain how small firms determine their capital
structure listed as follows: (1) top management’s risk-taking propensity affects the firm’s
capital structure; (2) top management’s goal for the firm will affect the firm’s capital
structure; (3) top managers would prefer to finance firm needs from internally generatedfunds rather than from external creditors or even new stockholders; (4) the risk
propensity of top management and financial characteristics of the firm affect on the
amount of debt lenders are willing to offer and on what terms; and (5) financial
characteristics moderate the ability of top management to select a capital structure for the
firm.
However, the authors mentioned above and Barton and Matthews (1989) have not
provided empirical evidence to support their propositions. Conversely, Norton (1991)
provided empirical evidence on capital structure selection by conducting a survey of 400
small, high-growth corporations. In his survey, respondents were asked to describe the
underlying firm philosophy in making debt and equity decisions. There were 261
respondents answering this question and the results are shown in Table 3.33.
b. Consider market response to new issues of debt and equity 16.9c. Alternate between debt and equity issues 4.6d. Choice depends on the existence of any differences in firm value
between management and the marketplace 7.7e. Try to balance present value of the tax shield of debt with the present
value of possible bankruptcy costs 0.0f. Issue debt and equity to stay close to a target debt: equity ratio 6.1g. Use no long-term debt 5.4h. Borrow the maximum available 1.9
i.
Borrow the maximum available with an “A” rating 1.9j. Maintain a given coverage ratio 5.0k. Careful firm evaluation of cash flow variation and bankruptcy given
financing choice 1.1l. Issue debt when interest rates are low, issue stock when prices are
high, to finance capital budgeting projects 10.0m. Issue debt when interest rates are low, issue stock when prices are
high, even though present needs are not great in order to build up along-term funds “cushion” 7.7
Source: Adapted from Norton (1991)
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Section 3.4 reviewed the literature of financial management practices of SMEs in
the developed countries. Most previous researchers in the literature concentrated on
examining, investigating and describing the behavior of SMEs in implementing financial
management. Specific areas of financial management practices including accountinginformation system, financial reporting and analysis, working capital management, fixed
asset management and capital structure management, have attracted the attention of many
researchers. However, their findings are mainly related to exploring and describing
behavior of SMEs in financial management practices. As a result, they provided many
descriptive findings but seem to lack the associative findings of the relationship between
financial management practices and financial performance of SMEs.
3.5 FINANCIAL CHARACTERISTICS OF SMEs
This section reviews the literature on financial characteristics of SMEs. Its objectives are
(1) to examine how previous researchers identify and measure financial, characteristics,
(2) to review the findings related to financial characteristics that were found by previous
researchers, and (3) to identify gaps in knowledge of financial characteristics of SMEs.
This section is structured into three subsections. Subsection 3.5.1 examines the variables
of financial characteristics identified by previous researchers. Subsection 3.5.2 discusses
measuring these variables. Lastly, subsection 3.5.3 summarizes all the previous findings
related to financial characteristics of SMEs.
3.5.1 Identifying financial characteristics
This subsection mainly discusses the concept of financial characteristics of SMEs. It
reviews definitions of financial characteristics that were mentioned and used by previous
Chapter Three: Financial Management and SME Profitability
Financial characteristics of enterprise, often in the form of accounting ratios,derived from financial statements provide useful information for numerous purposes. This information can be used to quantify the position of small businessin terms of their profitability, liquidity, and leverage and to compare them withother or large enterprises.
Stevens (1973), who studied financial characteristics of acquired firms, conducted factor
analysis on several ratios and reduced the number of ratios into the following six factors:
leverage, profitability, activity, liquidity, dividend policy and earning ratio identifying
financial characteristics. Burns (1985) analyzed financial characteristics and profitability
of small companies in the UK. He used the following ratios: quick ratio, current ratio,
gearing, long-term debt ratio, and interest cover ratio to define financial characteristics of
the companies.Hutchinson, Meric and Meric (1988) studied financial characteristics of small
firms, which achieved quotation on the United Kingdom Unlisted Securities Market.
They used financial ratios including liquidity ratios, leverage ratios, activity ratios,
profitability ratios and growth ratios to identify financial characteristics of the firm. In
another study, Hutchinson and Mengersen (1993) examined the effect of growth on
financial characteristics. The variables used to define financial characteristics were
profitability, liquidity, and leverage.
Jaggi and Considine (1990) examined whether financial characteristics of owner-
controlled acquired firms differ from those of the non-owner-controlled acquired firms.
Four variables: profitability, liquidity, leverage, and dividend payment capability were
used to identify financial characteristics of the firm. To reduce the large number of ratios
produced, some researchers such as Stevens (1973), Laitinen (1992) used factor analysis.
According to Laitinen (1992) factor analysis is a useful statistical tool reducing a large set
of correlated variables to fewer unrelated dimensions and identifying a typology. Laitinen
(1992) studied financial characteristics of newly-founded firms and used the following
variables: profitability, dynamic liquidity, quick ratio, indebtedness or static solidity,
dynamic solidity, logarithmic net sales, and capital intensiveness to identify financial
characteristics.
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Davidson and Dutia (1991) explored whether small firms have distinctively
different financial characteristics from larger firms and determined the extent of the
under-capitalization problem. In their study, four variables: liquidity, profitability, debt
and solvency, and turnover are viewed as the variables to determine financialcharacteristics of SMEs. Meric et al. (1997) conducted a comparative study on financial
characteristics of 87 Japanese and 87 USA chemical firms. In their study, they compared
financial characteristics between the USA and Japanese chemical firms by using ten
financial ratios. Financial ratios used to define financial characteristics in their study
included: (1) operating profit margin, (2) total asset turnover, (3) return on assets, (4)
return on equity, (5) fixed charge coverage, (6) common equity ratio, (7) long-term debt
ratio, (8) current ratio, (9) quick ratio and (10) inventory turnover.
In summary, depending upon the purpose of each study, previous researchers
selected appropriate variables to identify financial characteristics of the small firms. The
following variables: liquidity, leverage, profitability, and activity were most popularly
used by most researchers to describe financial characteristics of the firms. Table 3.35
summarizes the variables used by previous researchers to define financial characteristics.
Table 3.35: Summary of literature review of financial characteristic variablesResearcher(s) Business type Variables for identifying financial
characteristics
Stevens (1973) 40 acquired and 40 Leverage, profitability, activity, liquidity, dividendnon-acquired firms policy, price and earning ratio
Burns (1985) General Current ratio, quick ratio, gearing, long-term debtratio and interest cover ratio.
Hutchinson,Meric and Meric(1988)
The UK Unlisted Liquidity ratios, leverage ratios, activity ratios,Securities Market profitability ratios and growth ratiossmall firms
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calculated by dividing the cost of goods sold by average inventory while inventory ratio
is calculated by dividing inventory by sales.
3.5.2.4 Profitability
Profitability ratios are viewed as another variables to identify and measure financial
characteristics of SMEs. According to Jaggi and Considine (1990), profitability is a
crucial indicator for determining the financial position of the firm. The firm is considered
financially weak when its profitability is sliding or the profitability is weak compared to
other firms in the industry. In their study, they also used return on assets as the indicator
to reflect profitability.
Burns (1985) and Meric et al. (1997) measured profitability by three ratios: return
on total assets, return on net assets, and return on equity. According to Burns (1985)
return on total assets is the best measure of a firm’s efficient use of assets because it is
independent of financing methods. While return on equity is a measure of the profit
return to shareholders.
In summary, depending on the purpose of their study the researchers in the
literature use different ratios to measure financial characteristics of a firm. Table 3.36
(page 110) summarizes ratios used by previous researchers in measuring financialcharacteristics. Table 3.36 reveals that previous researchers have used many different
variables and ratios to identify and measure financial characteristics of a firm. However,
the variables most popularly used by most previous researchers included (Table 3.36,
page 110):
• liquidity measured by current and/or quick ratios,
• financial leverage measured by debt (long-term and short-term) ratio, debt-to-
equity ratio, and/or equity-to-total asset ratio,
• activity measured by total asset turnover, receivables turnover, and/or inventory
turnover, and
• profitability measured by return on sales, return on assets and/or return on equity
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Leverage Long term debt/Common stock equityDividend payment Cash dividend/Net incomecapability
Profitability Return on investment ratioDynamic liquidity Cash flow to net salesStatic liquidity Quick ratio
Laitinen (1992) Static solidity Shareholders’ capital to total capitalDynamic solidity Cash flow to total debtCapital Net sales to total capital ratiointensiveness
Operating profit/SalesProfitability Net income/Total assets
Net income/Common equityMeric et al.(1997)
Sales/Total assets Activity Income before fixed charges/Fixed charges
Cost of goods sold/InventoryLeverage Common equity/Total assets
Long-term debt/Total capitalLiquidity Current assets/Current liabilities
(Current assets – Inventory)/Current liabilitiesSource: As indicated above
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(1993), the effects of growth are likely to manifest themselves in financial characteristics
and performance of small enterprises.
Weston and Brigham (1981) consider the financial implications of five stages of
development: formation, rapid growth, growth to maturity, maturity, and decline, andfound that major sources of finance at formation are the owners’ personal resources.
However, according to McMahon et al. (1993) the major financial problems likely to
arise at this stage are that these resources are insufficient and that the small enterprise is
thereby under-capitalized. Growth beyond formation is likely to be financed by retained
earnings, trade credit and bank borrowing. As a result, growth may have the following
effects:
• Growth may outstrip financial resources, leading to over-trading and liquidity
crises.
• Growth may also cause a financial gap where the small enterprise is forced to rely
too much on short-term finance because of a lack of long-term finance.
• Further growth may require a stock market flotation in order to overcome the
finance gap.
The effect of growth and size on financial characteristics and performance were
examined by Elliott (1972). Size was found to affect performance in two ways. Below-
average sized enterprises were found to have higher growth in cash flow and to have
undertaken higher rates of capital spending than above-average enterprises. Growth
affected on enterprise’s debt position, with both debt equity ratios and the proportion of
non-equity financed assets being higher for slowly growing enterprises than for rapidly
growing ones. Additionally, below-average growth enterprises had significantly higher
rates of capital spending than above-average growth enterprises. In contrast, Chen andBalke (1979) reported that the size of enterprises did not seem to have a significant effect
on most financial ratios. Only the current ratio was found to have significantly negative
effects by different sizes of enterprise.
When studying the effect of growth and size on financial characteristics, Gupta
(1969) looked at variations in asset utilization, leverage, liquidity and profitability
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between manufacturing enterprises operating at different size levels and with different
growth rates. Gupta’s (1969) findings are summarized as follows:
•
Activity ratios and leverage ratios decrease with an increase in the size of theenterprise but increase with the growth of the enterprise.
• Liquidity ratios rise with an increase in the size of the enterprise but fall with
growth rates.
• Larger enterprises tend to have higher profit margins on sales than small
enterprises.
In contrast, Whittington’s (1971) conclusions regarding size and profitability, derived
from regression analysis using cross-sectional data, are that the average profitability of
enterprises is independent of their initial size during the period studied. These
conclusions are largely in line with those of an earlier study by Samuel and Smyth
(1968), and thus tend to confirm the law of proportionate effect which asserts that the
profitability of an enterprise growing at a given rate during any specific period of time is
independent of the initial size of the enterprise.
In addition to growth and size, financial characteristics were also found to be
affected by contingent factors. McMahon et al. (1993, p.179) comment on the importance
of keeping in mind that there are many other factors, in addition to stage of development,
growth rate, and stock market flotation, which affect financial characteristics and
performance of small enterprises. However, according to Neck (1977), these factors can
be grouped into three categories: host, agent and environment.
• The host is taken to be the owner-manager of the small enterprise. Financial skills
of small enterprise owner-managers can have a direct impact on the financial profile of the business in terms of its profitability, financial leverage and liquidity
management.
• The agent is taken to be various financial environmental institutions. Financial
characteristics of small enterprises will be affected by the availability of finance
from institutions. If the finance gap does exist so that small enterprises cannot
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raise long-term finance in the same way as large enterprises, then this will directly
affect their financial structure.
• The environment is taken to be that created by legislation, taxation, and economic
conditions.
3.5.3.2 Comparative studies of financ ial characteristics
Small versus large enterprises
Comparative studies of financial characteristics between small and large enterprises have
long attracted the attention of several researchers. There are many findings, which report
or describe differences of financial characteristics between small and large enterprises.
McMahon et al. (1993) made an important contribution to reviewing the literature on
financial characteristic differences between small and large enterprises. According to
McMahon et al. (1993, p. 189) these differences can be summarized and classified into
three basic groups:
Differences in liquidity – Liquidity in small enterprises has been found to be lower for
small enterprises than for large by Bates (1971), Gupta (1969), Walker and Petty (1978),Wilson (1979) and Burns (1985). In contrast, Chen and Balke (1979) and Elliott (1972)
found small enterprises to be more liquid than large enterprises whilst the Bolton
Committee (1971) and the US Small Business Administration (1984) found no significant
differences between the two groups.
In recent years, Davidson and Dutia (1991) found that whilst small enterprises
had higher levels of current liabilities they also had higher cash balances. Based on the
current and quick ratio, Davidson and Dutia (1991) also found that small firms are less
liquid than large firms. Conversely, Osteryoung, Constand and Nast (1992) found that the
liquidity ratios, including current and quick ratio, are not different across the large and
small firms.
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Differences in financial leverage – Financial leverage in small enterprises is not
significantly different from large enterprises, as reported by Bolton (1971), Chen and
Balke (1979), Elliott (1972), Tamari (1980), and Wilson (1979). Only Bates (1971) found
that total debt levels to be lower for small enterprises, whilst Davidson and Dutia (1991),Gupta (1969), the US Small Business Administration (1984), and Walker and Petty
(1978) and Burns (1985) found small enterprises to be more highly leveraged than large
firms. Small growth enterprises have higher leverage than large enterprises or other small
enterprises according to Bolton (1971). Recently, Davidson and Dutia (1991) also found
that small firms use more short-term debt than larger firms.
Differences in profitability – Profitability has generally been found to be lower for small
enterprises than large in USA studies such as Anderson (1967), Gupta (1969), and the
USA Small Business Administration (1984). Only Tamari (1980) and Walker and Petty
(1978) found small enterprises to be more profitable than large enterprises. In the UK,
only Bates (1971) found small enterprises to be less profitable than large enterprises.
Both Bolton (1971) and Wilson (1979) found that small enterprises were more profitable
than large. The Bolton (1971) Committee also found that growth small enterprises were
more profitable than either large enterprises or other small enterprises.
In more recent, Davidson and Dutia (1991) also found smaller firms in their study
tend to have lower profit margins than large firms. However, small firms did not have
lower ROA ratios. Conversely, Osteryoung, Constand and Nast’s (1992) results of
studying indicated that two profitability ratios, return on sales and return on net worth,
are not different across the large and small firms.
Owner controlled versus non-owner controlled acquired firms
Jaggi and Considine (1990) examined whether financial characteristics of owner
controlled acquired firms differ from those of the non-owner controlled acquired firms.
Their study was based on 73 firms from each group and the results indicated that the
financial position of owner controlled acquired firms was significantly different
compared to that of the non-owner controlled acquired firms. The financial position, as
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any greater impact on the probability of flotation by a small firm than would have been
the case during the 1970s.
These conclusions are not consistent with Walker and Petty’s (1978) findings.
Walker and Petty (1978) found that small firms preparing to enter the USA public stockmarket had a significantly different financial profile from that of large corporations. The
differences for small firms entering the stock market were lower dividend payout, lower
liquidity and higher profitability.
Internationally comparative studies of financial characteristics of SMEs
In addition to comparative studies of financial characteristics as indicated above, a review
of literature also provides many international comparisons of financial characteristics of
SMEs. McMahon et al. (1993) provides the best review of these international
comparisons based on the study conducted by Tamari (1980). From Tamari’s (1980)
analysis, levels of equity, measured either as a percentage of total funds or as a
percentage of long-term finance, are very similar for USA and UK small enterprises
which are, in turn, very much higher than those for Japanese and French small
enterprises, with Israeli small enterprises being in between.
Meric and Meric (1994) compared the overall financial characteristics of 562
USA and Japanese firms from 28 different industries. However, their study did not
compare financial characteristics of USA and Japanese firms in an individual industry.
Meric and Meric (1997) followed with a comparison of financial characteristics of
Japanese chemical firms and those of the USA chemical firms by using ten well-known
financial ratios (Table 3.37)
Table 3.37: Financial ratios used in the study of Meric and Meric (1997)Operating profit margin = Operating profit/Sales
Total assets turnover = Sales/Total assetsReturn on assets = Net income/Total assetsReturn on equity = Net income/Common equityFixed charge coverage = Income before fixed charges/Fixed chargesCommon equity ratio = Common equity/Total assetsLong-term debt ratio = Long-term debt/Total capitalCurrent ratio = Current assets/Current liabilitiesQuick ratio = (Current assets – Inventory)/Current liabilitiesInventory turnover = Cost of goods sold/Inventory
Source: Adapted from Meric and Meric (1997)
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6. A measure of the current yield on investment in a particular stock (Cohen,
1989)
=
Rate of dividends on
common stock equity
Common stock dividends per share
Market value per share of common stock
Some researchers, who have studied financial characteristics of SMEs, also mentioned
measuring profitability. For example, Burns (1985) used three ratios: return on total
assets, return on net assets and return on equity to measures SME profitability while
Hutchinson, Meric and Meric (1988) measured profitability by the following ratios: net
profit after tax/sales, earnings before interest and tax/total assets, and net profit after
tax/owners’ equity.
Altman (1968), in a study of financial ratios, discriminant analysis and the
prediction of corporate failure, measured profitability by two ratios: retained
earnings/total assets (RE/TA) and earning before interest and taxes/total assets
(EBIT/TA). According to Altman (1968), retained earnings to total asset ratio is the
measure of cumulative profitability over time and the age of a firm is implicitly
considered in this ratio. A relatively young firm will probably show a low RE/TA ratio
because it had not had time to build up its cumulative profits. EBIT/TA ratio is calculated by dividing the total assets of a firm into its earning before interest and tax reductions. In
essence, it is a measure of the true productivity of the firm’s assets, abstracting from any
tax or leverage factors.
In summary, previous researchers in the literature have used several different
ratios to measure profitability of SMEs depending on their research purposes. Table 3.39
(page 123) summarizes the ratios used by previous researchers to measure profitability of
SMEs. Of the ratios summarized in table 3.39 (page 123), three ratios: return on sales,
return on assets and return on equity are the most popularly used as the measurement of
SME profitability.
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Table 3.39: Summary of measurement of SME profitabilityResearcher(s) and year Ratio Measurement or computation
3.6.3 Factors influencing profi tability
This subsection reviews the factors affecting SME profitability. Its objectives are (1) to
identify which factors affect SME profitability and (2) to isolate those factors that are
caused by financial management practices and financial characteristics.
Based on the profitability measures presented by Westerfield and Jaffe (1999) and
by Cohen (1989), the main factors influencing profitability include revenue, costs and
capital. In general, revenue is determined or influenced by marketing, sales management
and new product development, whereas cost and capital are mainly affected the financial
management practices.
When analyzing factors affecting profitability, Burns (1985) found that
profitability could be affected by many different economic factors. Lev (1983) found that
variability of profit measures over time is affected by type of product, degree of
competition, degree of capital intensity as well as firm size. The effect of size on SME
profitability was also discussed by Gupta (1969), Whittington (1971), Bates (1971),
Walker and Petty (1978), Tamari (1980), and Storey et al. (1987).
Kirchhoff and Kirchhoff (1987) examined family contributions to productivity
and profitability in small businesses. The evidence showed that family members are more
Return on total assets Measure of firm’s efficient use of assetsBurns (1985) Return on net asset The key measure of performance
Return on equity A measure of the profit return to theshareholdersHutchinson, Return on sales Net profit after tax/SalesMeric and Meric (1988) Return on assets Earnings before interest and tax/Total
assetsReturn on equity Net profit after tax/Owners’ equity
Jaggi andConsidine (1990) Return on assets Operating profit/Total assetsLaitinen (1992) Return on investment Return on investment ratioMeric et al. (1997) Return on sales Operating profit/Sales
Return on assets Net income/Total assetsReturn on equity Net income/Common equity
Source: As indicated above
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margin, volume, and leverage. All represent areas of financial management and are
affected by financial management practices.
While DuPont analysis technically only includes the three ratios discussed above,
the framework can be extended to incorporate most major financial ratios (Eisemann,1997). It helps to think of the ratios as analogous to parts of a tree. The trunk is ROE and
there are three major branches: profit margin, total asset turnover, and assets to equity.
Each of these three branches in turn further divides to include more ratios, as illustrated
by the figure 3.6.
Figure 3.6: Financial ratios linked to return on equity
Return on equity
Asset turnover Asset/equityProfit margin
Source: Adapted from DuPont analysis (Eisemann, 1997)
Figure 3.6 provides a quick insight into factors affecting SME profitability
including gross margin, operating expenses, interest, taxes, accounts receivable days,
inventory days, fixed-asset turnover, leverage and coverage. From the equation 6.1, it
appears that as leverage increases, ROE will also rise. The problem with this thinking is
that another effect of an increase in leverage is larger interest expense, which, in turn,
causes a decrease in the profit margin and ROE. Thus leverage spreads its effects over
two ratios, making it hard to disentangle the impact of leverage and operations.
Moreover, profit margin is not really an accurate measure of operations, since it
combines operations with financial leverage.
To overcome this problem, the number of ratios is broken-down into smaller
groups while permitting a more complete separation of operations and financial leverage
(Eq. 6.3).
−
Gross margin
− Operating expense
− Interest
− Taxes
−
Accounts receivabledays − Debt/equity
− Inventory days − Coverage
− Fixed-asset turnover
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• profitable firms always or sometimes take discounts on payables whereas
aggressive firms and those with written working capital policies were net users of
trade credit.
Some theoretical researchers do indicate the relationships between financial management
and profitability. For example, Van Horne (1986, p. 145) indicated the relationship
between liquidity and profitability:
The greater the relative proportion of liquid assets, the less risk of running out ofcash… profitability unfortunately, also will be less … resolution of the trade-off between risk and profitability with respect to these decisions depends upon therisk preferences of management.
According to Van Horne (1986), if the firm maintains a relatively large proportion of
liquid assets, its profitability probably will decrease.
Regarding the relationship between financial leverage and profitability, Edwards
and Cooley (1979) indicated that the effects of financial leverage on returns available to
equity holders are typically analysed in either one of two contexts. In many financial
management books, financial leverage is examined in a net-operating-income (NOI) or
equivalent context for its effects on rates of return available to stockholders. In the
literature of real estate finance, the effects of leverage on equity return are evaluated in a
cash flow (CF) context. In both settings, the evaluation of leverage effect reduces to a
convenient rule exemplified by the following statement (Edward and Cooley, 1979):
In general, whenever the return on assets exceeds the cost of debt, leverage isfavourable, and the higher leverage factor, the higher the rate of return oncommon equity.
The statements mentioned above should be tested by the empirical data. In doing so, this
research will contribute to filling a gap and building up a model of the impact of financial
management on SME profitability. The next section will consider the possibility of such a
model.
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3.8 MODEL OF THE IMPACT OF FINANCIAL MANAGEMENT ON SME
PROFITABILITY
Based on the literature, this research chapter was seeking to provide an overview of the
findings of financial management practices, financial characteristics and SME
profitability.
Related to financial management practices, most previous researchers from the
literature concentrated on examining, investigating and describing the behaviour of SMEs
in implementing financial management. The specific areas of financial management
practices including accounting information system, financial reporting and analysis,
working capital management, fixed asset management and capital structure management
have attracted the attention of many researchers. Their findings are mainly related to
exploring and describing behaviour of SMEs in financial management practices.
Although they provided much descriptive statistical data and empirical evidence on SME
financial management practices, it appears that there are some limitations in past
research, which need to be addressed.
• Firstly, most empirical evidence comes from developed economies such as the
USA, UK, Canada and Australia. Evidence seems to lack evidence from emergingeconomies, especially from the transiting economies such as Vietnam and China.
• Secondly, most researchers in the literature only focus on investigating and
describing financial management practices, whereas few examine the impact of
financial management practices on SME profitability.
It will be difficult to convince financial management practitioners of the importance of
financial management until evidence on the impact of financial management practices on
SME profitability is provided and the relationship between the two variables are
discovered.
In addition to financial management practices, the literature also provided the
valuable findings related to financial characteristics of SMEs. Four variables including
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liquidity, financial leverage, activity and profitability are popularly used by previous
researchers to identify and measure financial characteristics of SMEs.
Many studies on financial characteristics of SMEs have been conducted by
researchers over several decades. Subsection 3.5.3.2 (page 114) concerned with thecomparative studies of SME financial characteristics indicated that most researchers
focused on examining whether or not there exist differences in financial characteristics
between different groups of SMEs. However, there still exist gaps in the literature on
financial characteristics of SMEs, which need to be examined.
• Firstly, it appears that financial characteristics of SMEs in developing countries,
especially in the transiting economies such Vietnam and China have not been
investigated with empirical data
• Secondly, to date there is no study, which examines the relationship or the impact
of three variables: liquidity, financial leverage, and activity on profitability.
As such, the lack of empirical evidence from the emerging economies and the absence of
examination of the impact of financial management practices and financial characteristics
on SME profitability, are gaps that this review found from the literature. Based on these
findings provided by previous researchers and these gaps, a model of the impact of
financial management on SME is developed. Such a model is presented in Figures 3.7
(page 130). The model needs to be tested by the empirical data and this will be
demonstrated in chapters 4 and 5.
Figure 3.7 (a) describes the general model of the simultaneous impact of financial
management including the impact of financial management practices and the impact of
financial characteristics on SME profitability. Figure 3.7 (b) describes the detailed model
of the impact of financial management practices on SME profitability in which thecomponents measuring financial management practices such as accounting information
system, financial reporting and analysis, working capital management, fixed asset
management, capital structure management and financial planning, and components
measuring financial characteristics such as liquidity, financial leverage, and business
activity are identified.
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3.9 CONCLUSIONS
As indicated in the introduction, the objectives of this chapter were to review the
literature, find gaps and build a model of the impact of financial management on SME
profitability based on this review. These objectives could not be separated as different
activities, and all are fulfilled when a model of the impact of financial management on
SME profitability was created (Figure 3.7, page 130).
Sections 3.2, 3.3, 3.4, 3.5 and 3.6 respectively reviewed literature on definitions
of SMEs, definition of financial management, financial management practices, financial
characteristics, and profitability of SMEs. Generally, previous researchers provided
valuable and detailed insights into financial management, financial management practices
and financial characteristics. However, it appears that no investigation has been
undertaken of the relationship between financial management including financial
management practices and financial characteristics, especially the simultaneous impact of
many variables such as accounting information system, financial reporting and analysis,
working capital management, fixed asset management, financial planning practices,
liquidity, financial leverage and activity ratios on SME profitability.
Finally in this chapter, a model of the impact of financial management on SME
profitability was developed. This model indicates that the objectives of this chapter have been satisfied. Collecting data for testing the model will be examined in chapter 4, which
is designed to discuss aspects of research methodology, while chapter 5 will present the
results of data analysis applied in this study.
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The purpose of this section is to provide an initial appraisal of prior SME research
undertaken internationally from a methodological viewpoint. Reviews and surveys ofSME research related to financial management practices and financial characteristics,
which has been reflected in this and earlier chapters, include those of D’Amboise and
Gasse (1980), Raymond and Magnenat-Thalmann (1982), Cheney (1983), Raymond
(1985), DeThomas and Fredenberger (1985), and Farhoodman and Hryck (1985), Corner
(1967), Murphy (1978 and 1979), Lovett (1980), Arnold-McCulloch and Lewis (1985,
1986) and Gorton (1996) Peacock (1985, 1987, and 1988), Williams (1986, 1987),
Holmes (1987) and Holmes and Nicholls (1988), Luoma (1967), Lindecamp and Rice
(1983), Thomas and Evanson (1987), Ray and Hutchinson (1983), Hankinson (1982,
1983), McMahon and Davies (1994), McMahon (1998, 1999), Grablowsky (1978),
Grablowsky and Rowell (1980), Cooley and Pullen (1979), Anvari and Gopal (1983),
Khoury, Smith and MacKay (1999), Peel and Wilson (1996), Soldofsky (1964), Scott et
capital structure management and financial planning) on SME profitability have
not been examined and investigated.
2. These studies and surveys provided largely descriptive but little evidence. For
example, regarding financial reporting and analysis, the Bureau of Economic andBusiness Research (1961) of Temple University, Philadelphia, was the first to
study the use of financial ratios in small businesses. Unfortunately, this Bureau
report was largely descriptive and provided very little associative evidence. In
other research, Ray and Hutchinson (1983) investigated financial reporting and
analysis practices in small growth enterprises but the provision of historical
financial reports did not differ markedly between growth enterprises and a
matched sample of non-growth enterprises. However, there was a tendency
towards more frequent financial reporting as growth enterprises developed and
became public companies. Thomas and Evanson (1987) examined possible
associations between financial reporting and analysis practices and performance
characteristics. The results of a study of 398 small pharmacies located in
Michigan, North Carolina, Nebraska, Rhode Island, and Washington revealed that
there was no significant difference in frequency of obtaining financial statements
between continuing enterprises, those which eventually closed, and those which
changed hands. Using regression analysis, Thomas and Evanson (1987) were
unable to demonstrate a significant association between the number and frequency
of use of financial ratios and enterprise profitability or survival. They
hypothesized that this may have been due to a lack of sophistication in financial
interpretation that prevented usage from making a discernible difference to
performance.
3. Previous research focused on examining performance of SMEs in general without
any emphasis on SME profitability whereas profitability is the final and survival
goal of the business. Peel and Wilson (1996) found that increasing profitability
was ranked higher than other objectives such as increasing sales growth or
increasing employment.
4. Regarding financial characteristics of SMEs, previous researchers only
emphasized differences in financial characteristics between groups of SMEs by
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This section, firstly, examines the types of business research in terms of classification,
purpose and technique and then, explains how the research design is selected as mostappropriate for the study. Many definitions of “research design” have been advanced, but
no one definition imparts the full range of important aspects (Emory, 1985). Emory
(1985) did not define but reviewed a definition of research design from Kerlinger (1973):
Research design is the plan, structure, and strategy of investigation conceived soas to obtain answers to research questions and to control variance. The plan is the
overall scheme or program of research. It includes an outline of what the
investigator will do from writing the hypotheses and their operational implications
to the final analysis of the data.
4.3.1 Classif ication of research design
According to Emory (1985) research design is a complex concept that may be viewed
from different perspectives. McMahon (1998) reviewed classifications of research
conducted by Gay and Diehl (1992) in which classifications of research designs are based
on the broad strategy, orientation, emphasis and approach of research. In their
classifications, research designs consisted of the following:
Historical research – which involves studying, understanding and explaining past
events
•
•
•
Descriptive research – which involves collecting and examining data in order to
answer questions concerning the status or condition of the research subject at
some point of time.
Associative research – which attempts to determine whether, and to what degree,a relationship exist between the status or condition of the research subjects at
some point of time and other factors which cannot be manipulated by the
researchers.
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Causal-comparative (or ex post facto) research – which attempts to establish the
cause of the status or condition of the research subjects at some point of time on
the basis of knowledge of factors which cannot be manipulated by the researchers.
•
•
•
•
Experimental research – which attempts to establish the cause of the status orcondition of the research subjects at some point of time on the basis of knowledge
of factors that can be manipulated by the researchers.
Based on the manipulation of independent variables, Davis and Cosenza (1988) classified
research into ex post facto design and experimental design. In ex post facto design, the
researchers cannot manipulate the independent variables or factors whereas in
experimental design they can. Based on the degree of understanding, ex post facto design
can be classified into two subtypes, field study and survey, whereas experimental design
can be classified into field experiment and laboratory experiment. Based on the degree of
problem crystallization, Emory (1985) classified research as exploratory or formal.
Exploratory studies tend to be loosely structured with an objective of learning what the
major research tasks are to be whereas the goal of a formal research design is to test the
hypotheses or answer the research questions posed.
Because there are a variety of different research approaches, it is helpful to
categorize types of research. This thesis is concerned with types of research applied in
business. Business research can be classified on the basis of either technique or function
(Zikmund, 1997, p. 37). Based on technique, business research can be classified into
three main types: experiments, surveys, and observational studies. Based on the purpose
or function, the business research can be classified into (1) exploratory, (2) descriptive, or
(3) causal research.
Exploratory research is conducted with the expectation that subsequent researchwill be required to provide conclusive evidence. Exploratory research could be
used for clarifying ambiguous problems.
Descriptive research seeks to determine the answers to who, what, when, where
and how questions. Its major purpose, as designed, is to describe characteristics of
a population or a phenomenon.
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Causal research is conducted to identify cause-and-effect relationships among
variables where the research problem has already been defined. Its major
objective is to identify the cause-and-effect relationships between variables
(Zikmund, 1997).
•
In summary, there are a number of different design approaches, but unfortunately there is
no simple classification system that defines all the variations to be considered (Emory,
1985). Table 4.1 summarizes classification of research designs based on seven different
perspectives, indicated by Emory (1985), in which (*) represents the type of research
design selected in this study.
Table 4.1: Classification of research designs
Classification criteria Types of research designs
Degree of problemcrystallization
• Exploratory research – to develop hypotheses or questions forfurther research
• Formal research *– to test the hypotheses or answer the researchquestions posed
The method of datacollection
• Observation – The researcher monitors and records informationabout subjects without questioning them.
•
Survey *– The researcher interrogates subjects and collects theirresponses.
Researcher’s control of variables
•
Experimental design – The researcher attempts to control ormanipulate the variables in the study.
• Ex post facto design *– Investigators have no control over the variables in sense of being able to manipulate them.
The purpose of thestudy
•
Descriptive research *– concerned with answering who, what, where, when or how much questions
• Casual research *– concerned with learning why, i.e., how one variable affects another
The time dimension • Cross-sectional research * – carried out once
• Longitudinal research – repeated and studied changes over time The topical scope • Statistical study * – emphasis on breadth of coverage and interested
in the frequency of certain characteristics or instances
•
Case study – emphasis on the detailed analysis a limited number ofevents or conditions and their relationships
The researchenvironment
• Field study *
• Laboratory study
Source: Adapted from Emory (1985)(*) Selected for this research
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because exploratory research is usually conducted to clarify and define the nature of a
problem whereas descriptive research is designed to describe characteristics of a
population or phenomenon. This study is also seeking to explain how financial
management practices and financial characteristics affect SME profitability. Thus thisstudy is concerned with learning “why”, that is, how “financial management practices
and financial characteristics” variables affect the “SME profitability variable”. This
concern required a causal design to identify the cause-and-effect relationships between
efficient financial management practices and profitability of SMEs. Thus causal research
is implemented in combination with descriptive research in this study.
4.3.3 Selecting research methods or techniques
Based on the methods of data collection, Emory (1985) classified research into two types:
observation and surveys. However, Zikmund (1997) expands this classification into four
basic types: surveys, experiments, observation and secondary data studies.
Survey is a research technique in which information is gathered from a sample of
people by use of a questionnaire (Zikmund, 1997, p. 49).
•
•
•
•
Experiment holds the greatest potential for establishing cause-and-effect
relationships. The use of experimentation allows investigation of changes in one
variable while manipulating other variables under controlled conditions
(Zikmund, 1997, p. 49).
Observation allows the researcher to monitor and record information about
subjects without questioning them (Emory, 1985).
Secondary data study is a research technique by using previously collected data or
secondary data. Secondary data are data gathered and recorded by someone else prior to the current needs of the researcher (Zikmund, 1997, p.143).
In terms of research technique, this research utilizes both survey and secondary data
methods. Survey was chosen as a research technique in this study to investigate and
describe financial management practices of SMEs in Vietnam. The argument for
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choosing survey was based on two major reasons. Firstly, survey provides a quick,
efficient and accurate means of assessing information about the population. Secondly,
survey is more appropriate where there is a lack of secondary data. In this case,
secondary data of financial management practices of SMEs in Vietnam is not available;thus, conducting a survey to gain information about financial management practices was
necessary. Surveys may be further classified by the communication medium used into
mail, telephone survey and personal interview (Emory, 1985, Zikmund, 1997).
Mail survey is a self-administered questionnaire sent to respondents through the
mail.
•
•
•
Telephone survey is a method of survey in which respondents are contacted by
telephone to gather responses to survey questions.
Personal interview are direct communications wherein interviewers in face-to-
face situations ask respondents questions.
In Vietnam, there are difficulties in collecting data, especially data regarding financial
information. Therefore, selection of appropriate methods to communicate with
respondents was very important in the surveys. This selection may be based on (1) the
possibility of communicating with respondents, (2) the advantages and disadvantages of
the most typical surveys as summarized in Table 4.2, and (3) the budget allocated for the
research.
Table 4.2 (page 143) shows that each of survey methods (personal interview,
telephone interview and mail survey) has both advantages and disadvantages in terms of
different perspectives. However, item non-response, possibility for respondent
misunderstanding, and respondent cooperation or participation are probably the most
important factors for success of a survey. Therefore, this study used “personal interview”as a technique to obtain information about financial management practices from the
respondents – key managers or owner-managers.
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Table 4.2: Summary of advantages and disadvantages of the most typical surveysPersonal interview Telephone
interviewMail survey
Speed of data collection Moderate to fast Very fast Slow, researcher has no controlover questionnaire return
Geographic flexibility Limited to moderate High HighRespondentcooperation
Excellent Good Moderate
Versatility Quite versatile Moderate Highly standardized formatQuestionnaire length Long Moderate Varies depending on incentiveItem non-response Low Medium HighPossibility for to berespondentsmisunderstood
Lowest Average Highest
Degree of interviewinfluence on answer
High Moderate None
Supervision of
interviewers
Moderate High Not applicable
Anonymity ofrespondent
Low Moderate High
Ease of call-back orfollow-up
Difficult Easy Easy, but take time
Cost Highest Low tomoderate
Lowest
Special features Visual materials maybe shown or
demonstrated,extended; probing
possible
Simplified field- work and
supervision ofdata collection
Respondent may answerquestions at own convenience;has time to reflect on answer
Source: Adopted from Zikmund (1997)
Arguments for selection of personal interview as a mean of communicating with
respondents in this study are based on the following advantages of personal interview
compared with other survey methods:
Item non-response – Social interaction between interviewer and respondent
increase the likelihood that a response will be given to all items on the
questionnaire. As a result, item non-response is lowest for personal interview.
•
• Possibility for respondent misunderstanding – Personal interview provides an
opportunity to probe. If a respondent’s answer is brief or unclear, the interviewer
may be able to probe for a clearer or more comprehensive explanation. As a
result, the possibility for respondent misunderstanding is lowest.
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planning and control. However, McMahon (1998) study and most previous studies were
designed with an emphasis on descriptive rather than explanatory research. Thus, onlydescriptive perspectives of these concepts were considered, while measuring perspectives
have not been considered. This study emphasizes the relationships between the efficiency
of financial management practices and SME profitability in which the efficiency of
financial management is viewed as an independent variable. In such circumstances,
measuring this variable is very important. However, the efficiency of financial
management practices is a complex and multi-dimension construct. In term of context,
financial management practices consists of the following components (McMahon, 1998).
Accounting information systems
DeThomas and Fredenberger (1985) measured the efficiency of an accounting
information systems with three indicators: (1) extent to which financial information is
prepared, (2) extent of owner/manager involvement in the interpretation and use of
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financial information, and (3) suitability of the information and services provided by
outside accountants. Gul (1991) used a modified version of a 20-item scale developed by
Chenhall and Moris (1986) to measure management accountant systems. This instrument
requested participants to state their perception of the usefulness of each of characteristicsof information. Perception of usefulness of information represented the extent to which
these characteristics of information were available that would have a direct impact on
performance.
In this study, accounting information systems included all systems of recording
transactions, bookkeeping, cost accounting, and use of computers in financial record
keeping for management decision-making. However, this study was concerned with not
only the context but also measurement of efficiency of accounting information systems.
The efficiency of an accounting information system was measured by 8 items on the
nine-point scales on which the respondents were asked to rate where the positions of their
businesses were for each item as described below:
attitude of owner/manager to accounting information systems•
•
•
•
•
•
•
•
frequency of accounting information preparation
promptness of accounting information system in reflecting business transactions
owner/manager involvement in preparing accounting information
owner/manager involvement in the interpretation and use of accounting
information
reasonableness of accounting information systems
usefulness of accounting information in decision-making
extent of computerization of accounting information
Figure 4.2 lists questions related to accounting information systems that owners or
managers were asked to answer. Based on their ratings, interviewers circled the
appropriate number on the scale corresponding to each of 8 items.
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analysis and use of financial statements to serve for making decisions of business and
management.
McMahon and Davies (1994), firstly, ascertained the relationship between
financial reporting and financial analysis, then, examined significant associations between these practices and achieved growth rates and financial performance. In their
study, financial reporting and analysis practices were derived from the three following
questions, which the respondents were asked to answer:
• Which financial statements do you use regularly to monitor financial position and
performance?
• How frequently do you prepare your financial statements?
• Do you use financial ratios when reading your financial statements?
Their study first employed a simple index of the historical financial reporting practices of
the participating enterprises based on responses to the first of three questions mentioned
above. The starting point was five dichotomous variables indicating preparation of
particular financial statements (balance sheet, profit and loss statement, funds statement,
cash-flow statement and other statements; Yes = 1, No = 0). The simple financial index
was the sum of the values of these variables, which had a possible range of 0 to 5. Their
study also employed a further historical financial reporting index, based on responses to
the second question presented earlier, asking for the usual frequency of preparation
(annually, semi-annually, quarterly, monthly, weekly, daily, and never) of historical
financial reports. Taken as a whole, responses reflected the perceived financial
information needs of participation of small enterprises from the experienced viewpoint of
their owner-managers. The starting point was 35 dichotomous variables – five financial
reports by seven reporting frequencies – indicating the preparation of particular historicalreports and their frequency of preparation (for each report and frequency combination,
Yes = 1, No = 0).
Unlike McMahon and Davie (1994) study, this study emphasized efficiency of
financial reporting and analysis practices rather than context. The efficiency of financial
reporting and analysis practices was measured by the following indicators:
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attitude of owner/manager to financial reporting and analysis•
•
•
•
•
•
•
•
frequency of financial statement preparation
owner/manager involvement in preparing financial statements
owner/manager involvement in the interpretation and use of financial statements
usefulness of financial statements in managing financial position of the business
frequency of financial statement analysis
number of financial ratios (current ratios, debt ratios, activity ratios and
profitability ratios) used for financial statement analysis
computerization of financial reporting and analysis practices.
Respondents were asked to rate the position of their businesses on nine-point scales
corresponding to each item as listed by Figure 4.3.
Figure 4.3: Survey instrument for measuring financial reporting and analysis
Low regard High regard1. How does your business regard financial reporting andanalysis?
1 2 3 4 5 6 7 8 9
Not frequent at all Very frequent2. How frequent does your business prepare financialstatements (balance sheet, income statements, statementsof cash flows)?
1 2 3 4 5 6 7 8 9
Low involvement High involvement
3. How involved is the owner/manager in preparingfinancial statements?
1 2 3 4 5 6 7 8 9
Low involvement High involvement4. How involved the owner/manager in interpreting andusing financial statements?
1 2 3 4 5 6 7 8 9
Not useful at all Very useful5. How useful are the financial statements of your businessin providing information for making decisions?
1 2 3 4 5 6 7 8 9
Not frequent at all Very frequent6. How frequent does your business analyze financialstatements (balance sheet, income statements, statementsof cash flows)?
1 2 3 4 5 6 7 8 9
Not useful at all Very useful
7. How useful are financial ratios applied in financialanalysis of your business?
1 2 3 4 5 6 7 8 9
Low Highcomputerization computerization
8. How computerized are the financial reporting andanalysis practices in your business?
1 2 3 4 5 6 7 8 9
Source: Developed for this study
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The extent of efficiency of financial reporting and analysis was measured by the
sum of values of eight of indicators as presented in Figure 4.3. This sum had a possible
range from 8 to 72 points, and the more points a business recorded, the higher its
efficiency of financial reporting and analysis. The financial reporting and analysis practices of a business were said to be “efficient” if the sum of points is greater than the
average point of 40. Conversely, if the sum of points is less than the average point of 40,
the business was said to be “inefficient” in practising financial report and analysis.
Working capital management
Firstly, components of working capital management are clarified. Most researchers, for
example, Burns and Walker (1991), Belt and Smith (1992), Khoury, Smith, and MacKay
(1999) agreed that working capital management includes three components: cash
management, receivable management, and inventory management.
a) Cash management practices
In their survey, Cooley and Pullen (1979) reported on the cash management practices of
122 small businesses in petroleum marketing. Cash management, in their survey,
consisted of three basic components: cash forecasting, investing temporary cash surplus,
and controlling cash inflows and outflows. Anvari and Gopal (1983) conducted a study to
gain insights into how small Canadian firms manage their cash resources. They used five
indicators: cash forecasts, cash balance, basis for determining cash balance, and cash
surplus investment to measure cash management practices. Burns and Walker (1991)
used the following indicators to measure practices of cash management: (1) the interval
of time for cash budgeting (daily, weekly, monthly, quarterly, semi-annually, annually or
never), (2) techniques used to determine the target balance, and (3) the forms of idle cash
investment for profitable purpose.
In this study, the efficiency of cash management practices was considered in
terms of cash forecasting or budgeting, target cash balance determining, and cash surplus
investing. The extent of efficiency of cash management practices was measured by the
following indicators:
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The extent of efficiency of cash management practices was measured by the sum
of values of eight indicators, which had a possible range from 8 to 72 and are measured
by the survey instrument as designed in Figure 4.4. The more points a business recorded
the higher its efficiency of cash management practices, and the cash management practices of a business were said to be “efficient”, if the sum of points is greater than the
average point of 40. Conversely, if the sum of points is less than the average point of 40,
the business was said to be “inefficient” in practising cash management practices.
b) Receivable management practices
Peel and Wilson (1996) examined the working capital management and capital budgeting
practices of a sample of small firms based in the North of England. In their survey,
respondents were requested to indicate (on a scale 1= “never use/review”, to 5 =
“use/review very often”) the frequency with which they reviewed their debtors’ credit
period, debtors’ discount policy, bad debts and doubtful debts.
In this research, the efficiency of receivable management was defined and
measured by the frequency of review and extent of reasonability of debtors’ credit period,
debtors’ discount policy, bad debts and doubtful debts. Respondents were requested to
indicate on nine-point scales (1 = never review/very unacceptable, to 9 = very often/ very
acceptable) the frequency of review and extent of acceptability of debtors’ credit period,
debtors’ discount policy, bad debts and doubtful debts based on the following items:
attitude of owner/manger to receivable management•
•
•
•
•
•
•
•
frequency of reviewing debtors’ credit period
reasonability of debtors’ credit period
frequency of reviewing debtors’ discount policyreasonability of debtors’ discount policy
frequency of reviewing bad debts
reasonability of bad debts
utilizing receivable management theories
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In examining inventory management practices, Peel and Wilson (1996) focused on
reviewing stock turnover, stock levels, stock re-order levels and using the economic order
quantity model. They used five-point scales to measure the degree of frequency of
reviewing/using these indicators. This research used nine-point scales, which is similar to
the scales developed by Peel and Wilson (1996), to measure the efficiency of inventory
management practices via the following indicators:
attitude of owner/manager to inventory management•
•
•
•
•
•
•
•
frequency of reviewing inventory turnover
frequency of reviewing inventory level
reasonableness of inventory turnover
reasonableness of inventory level
usefulness of inventory budget in providing information for making decisions
utilizing inventory management theories
computerization of inventory management
Respondents were asked to answer the questions listed in Figure 4.6 (page 156) and based on their ratings the interviewer circled the appropriate number on the scale
corresponding to each item.
The extent of efficiency of inventory management was measured by the sum of
values of eight indicators designed as in Figure 4.6. This sum had a possible range from 8
to 72 and the more points a business recorded, the higher its efficiency of inventory
management practices.
In this way, inventory management practices of a business were said to be
“efficient” if its sum of points is greater than the average point of 40. Conversely, if its
sum of points was lower than the average point, the business was said to be “not
efficient” or “inefficient” in practising inventory management.
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The extent of efficiency of fixed asset management was measured by the sum of
values of eight indicators designed as in Figure 4.7 (page 157). This sum had a possible
range from 8 to 72 and the more points a business recorded, the higher its efficiency of
fixed asset management practices. Fixed asset management practices of a business weresaid to be “efficient” if its sum of points was greater than the average point of 40.
Conversely, if its sum of points is not greater than the average point, the business was
said to be not efficient or inefficient in fixed asset management practices.
Financial planning practices
McMahon (1998) examined financial planning and control including financial objectives
and targets, cost-volume-profit analysis, pricing, financial budgeting and control, and
managerial responsibility centers. These were the main contexts of financial planning.
The current study was concerned with not only the context but also efficiency of financial
planning practices. The efficiency of financial planning was defined as its quality and
benefit and measured by the following indicators on nine-point scales:
attitude of owner/manager to financial planning•
•
•
•
•
•
•
•
frequency of preparing master budgets
involvement of owner/manager in preparing master budgets
involvement of owner/manager in interpreting and using master budgets
usefulness of master budgets in providing information for making decisions
frequency of comparing budgeted and actual results
reasonability of financial planning techniques applied in financial analysis
computerization of financial planning.
Respondents were asked to rate the position of their businesses on the scale
corresponding to each item as designed in Figure 4.8 (page 159). The extent of efficiency
of financial planning practices was measured by the sum of values of eight indicators
designed as in Figure 4.8. This sum had a possible range from 8 to 72, and the more
points a business obtained, the higher its efficiency of financial planning practices.
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This subsection discusses the basic concepts of models and develops a model for this
research. Objectives are to review types of models and to build a model for this study based on the literature reviewed in chapter 3 and variables defined in subsection 4.4.1.
4.4.2.1 Model classification
According to Pattillo (1980), in general, a model is a representation of real-world
phenomena as they exist (descriptive models) or as they ought to exist (normative
models). A model is defined as any highly formalized representation of a theoretical
system, usually designated through the use of symbols (Davis, 1996, p.300). Davis (1996,
p. 301) emphasized the importance of models to decision-makers as follows:
Models are extremely important to decisions-makers because they form the basis
for the development of decision support system.
There are a variety of ways to classify models. According to Davis (1996) all useful
classification schemes have three elements in common: (1) level of aggregation, (2) time
dimension, and (3) degree of uncertainty in the process being modeled. Based on theseelements, Davis (1996) provided a model classification as summarized in Table 4.3 (page
163).
Based on the basic forms of decision models, Davis (1996) classified models into
two types: verbal and mathematical models. Each can be used to transform a complex
real-world process into a more manageable representation of that process. The verbal
model has broad appeal in that it is more easily understood by decision makers but it is
quite difficult to implement, since many implied variables and relationships that affect
the objective are omitted (Davis, 1996, p. 302).
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and the efficiency of financial management practices as described in the model illustrated
by Figure 4.9 were respectively stated in this subsection.
Van Horne (1986, p. 145) indicated the relationship between liquidity and
profitability:
The greater the relative proportion of liquid assets, the less risk of running out ofcash… profitability unfortunately, also will be less … resolution of the trade-off
between risk and profitability with respect to these decisions depends upon the
risk preferences of management.
Based on the exploratory research conducted by Kack and Lindgren (1999) and
findings of Vuong Quan Hoang (1998), it was found that SMEs in Vietnam seem likely
to maintain excessively high current ratios and the financial management practices might
adversely affect SME profitability. As reviewed in the literature, liquidity is measured by
current and quick ratio and the two ratios are high correlated each other. Thus, this study
only used current ratio as a measure to define liquidity and the hypothesis to test the
relationship between profitability and current ratio is stated as follows:
Hypothesis 1: Profitability of SMEs is negatively related to the current ratio.
Regarding the relationship between financial leverage and profitability, Edwards
and Cooley (1979) indicated that the effects of financial leverage on return available to
equity holders are typically analyzed in either one of two contexts. In many financial
management books, financial leverage was examined in a net-operating-income (NOI) or
equivalent context for its effects on rates of return available to stockholders. In the
literature of real estate finance, the effects of leverage on equity return were evaluated in
cash flow (CF) context. In both settings, the evaluation of leverage effect reduced to a
convenient rule exemplified by the following statement (Edward and Cooley, 1979,
p.12):
In general, whenever the return on assets exceeds the cost of debt, leverage is
favorable, and the higher leverage factor, the higher the rate of return on
common equity.
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Additionally, in many financial management books, debt is viewed as deductible
factors, which helps the firm to save its income tax, and thus, to increase net profit
(Brigham, 1995, Ross, Westerfield and Jaffe, 1999). These conclusions are the basis for
the hypothesis to test the relationship between profitability and financial leverage, whichwas measured by the debt ratio in this study. Thus, the second hypothesis in this study is
as follows:
Hypothesis 2: Profitability of SMEs is positively related to the debt ratio.
Profitability of SMEs was assumed to relate to activity ratios. Hutchinson, Meric
and Meric (1988) measured activity by inventory ratios, receivable ratios, fixed asset
ratios, and total asset turnover whereas Meric et al (1997) only used two ratios: total asset
turnover and inventory turnover. For simplicity purpose, this research study used total
asset turnover as a ratio to measure activity characteristics. Total asset turnover is the
ratio between sales and total assets. It measures the efficiency of total asset utility by
representing how many sales are produced by one unit of total asset value. The higher
total asset turnover, the higher sales are produced by one unit of total asset value. On the
other hand, high sales produce high profits for the business. As a result, profitability was
assumed to positively relate to total asset turnover and the hypothesis to test the
relationship between profitability and total asset turnover is stated as follows:
Hypothesis 3: Profitability of SMEs is positively related to total asset turnover.
From the literature, the final goal of financial management is to maximize the
financial wealth of the business owner and this general goal can be viewed in terms of
two specific objectives: profitability and liquidity (McMahon, 1995). DuPont analysis
reviewed in chapter 3 provided a quick insight of factors affecting SME profitability
including gross margin, operating expenses, interest, taxes, accounts receivable days,
inventory days, fixed-asset turnover, leverage and coverage. These factors negatively or
positively affect SME profitability depending on the efficiency of financial management
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used as a basic for inference or reckoning. Data can be described as qualitative or
quantitative. Qualitative data is concerned with qualities and non-numerical
characteristics, whilst quantitative data is all data that is collected in numerical form.
Hussey and Hussey (1997, p. 150) indicated that there will always be a combination ofquantitative and qualitative data in a research study no matter what paradigm is being
followed.
Whether you are following a broadly positivist or phenomenological paradigm,
there will always be a combination of quantitative and qualitative inputs into yourdata generating activities.
In terms of data sources, there are two main sources of data: primary data and secondary
data. As mentioned in section 4.3, this study used both types of data: secondary and
primary data. Secondary data collection is examined in subsection 4.5.1 and primary data
collection will be examined in subsection 4.5.2.
4.5.1 Secondary data col lection
Zikmund (1997, p.143) defined secondary data as data gathered and recorded by someone
else prior to the current needs of the researchers. Secondary data are usually historical,
already assembled, and do not require access to respondents or subjects. In this study,
major secondary data were mainly used to derive the financial ratios measuring liquidity,
financial leverage, activity and profitability of SMEs.
This method has been popularly used by previous researchers in examining the
financial characteristics of SMEs. For example, Osteryoung, Constand, and Nast (1992)
used two sources of secondary data for their study of financial ratios in large public and
small private firms. The small firm data sample was drawn from the Financial Studies of
the Small Business (FSSB) published by Financial Research Associates and the raw data
for the large firm sample was collected from the COMPUSTAT PC PLUS database.
Meric et al. (1997) used secondary data drawn from the DISCLOSURE
Worldscope/Global data file in a comparative study of the financial characteristics of
U.S.A and Japanese chemical firms. Van Auken, Doran, and Yoon (1993) used financial
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position statement data for the year 1988 obtained from An Annual Report of Korean
Companies, published by the Korean Productivity Center in 1990 in their study of
financial comparison between Korean and USA firms.
To date, a database of financial performances of SMEs has not been available inVietnam. However, the possibility of financial statement collection from which financial
ratios can be derived was feasible. In Ho Chi Minh City, these financial statements can be
obtained from the following organizations:
Ho Chi Minh City Department of Taxation•
•
•
Vietnam Bank for Non-state Enterprises (VP Bank)
Faculty of Accounting, Finance and Banking – Ho Chi Minh City University of
Economics.
4.5.2 Primary data col lection
Section 4.5.1 explained how secondary data could be collected to reflect financial
characteristic variables. However, in Vietnam, such sources of data have not been
available for collecting data that reflects the variables of financial management practices.
In this case primary data is viewed as an appropriate source. Zikmund (1997, p. 46)
defined primary data as data gathered and assembled specifically for the project at hand.
Section 4.3, explained why this study used survey as a method of data collection to
answer the research questions outlined in chapter 1. This section further explains how
primary data was collected in the survey.
4.5.2.1 Target population
Target population is the complete group of specific population elements relevant to the
research (Zikmund, 1997). Due to limitations of time and funds, the target population in
this research could not cover all SMEs in Vietnam. Moreover, this research was not
designed to study all SMEs in Vietnam but was only designed to study the impact of
financial management on SME profitability with evidence from Vietnam. It is not
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therefore necessary to define the target population as the whole of SMEs in Vietnam.
Vietnam has four large cities (Ho Chi Minh City, Hanoi, Hai Phong and Da Nang) and 57
provinces. Ho Chi Minh City is the biggest city in term of numbers of SMEs, labor force,
industrial outputs, trading and service volumes (Statistical Yearbook, 1998). Typically,SMEs in Ho Chi Minh City may be viewed as representative of SMEs in the country.
Therefore, in this research, SMEs in Ho Chi Minh City were defined as the target
population from where the sample was drawn for research.
Figure 4.10: Structure of SMEs in Vietnam and the target population
SMEs in Vietnam
+ SMEs not located in Ho ChiMinh City
SMEs located in Ho ChiMinh City
Source: Developed for this research
As examined chapter 2, in Vietnam SMEs include many forms of business such as
state enterprises, private enterprises, limited liability companies (or limited companies),
joint stock companies, cooperatives and business households or family business.
However, this study examined the impact of financial management practices on
profitability of private SMEs. Therefore, only forms of private businesses that have set up
a relatively complete system of financial management practices including practices of
accounting information system, financial reporting and analysis, working capital
management, fixed-asset management, capital structure management, and financial
Privateenterprises
The target population
Limitedcompanies
Joint stockcompanies
Stateenterprises
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planning were included in this study. As indicated in chapter 2, only private enterprises,
limited companies, and joint stock companies satisfy this criterion were, therefore,
viewed as the target population (Figure 4.10, page 171) whereas other businesses
including cooperatives and family business were beyond the limits of this study.
4.5.2.2 Sampling frame
Selecting a sampling frame was the next step after determining the target population. A
sampling frame is the list of elements from which the sample may be drawn (Zikmund,
1997, p.420). In this research, the List of Businesses provided by Ho Chi Minh City
Department of Investment and Planning in 2000 was chosen as the sampling frame from
which the sample of SMEs was drawn for interviewing. Generally, it was not feasible to
compile a list that did not exclude some members of the population (Zikmund, 1997, p.
420). Thus, sampling frame error was unavoidable. For example, the List of Businesses
in 2000 may exclude SMEs, which registered late, did not register or exist due to other
reasons.
4.5.2.3 Sampling methods
There are several alternative methods of selecting a sample. In general, these methods
may be grouped into two: probability and non-probability techniques. A probabilitysample is one in which each element (person or company) in the population has an equal,
or at least a known, chance of being selected while in a non-probability sample some
elements have a greater, but unknown, chance than others of selection (De Vaus, 1985,
p.60). All probability samples are based on chance selection procedures. This eliminates
the bias inherent in the non-probability sampling procedures because the probability
sampling process is random (Zikmund, 1997).
This research used probability-sampling method. Based on the probability
sampling method, there are four main sampling techniques: simple random sampling,
systematic sampling, stratified sampling, and cluster sampling (Zikmund, 1997).
Simple random sampling – A sampling procedure that assures each element in the
population an equal chance of being included in the sample. For simple random
•
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sampling, the sampling process is straight forward (Zikmund, 1997, p.431) but is
most appropriate when a good sampling frame exists and when the population is
geographically concentrated or the data collection technique does not involve
travelling (De Vaus, 1985, p. 64). Because of these limitations, simple randomsampling is not appropriate in this study.
Systematic sampling – A sampling procedure in which an initial starting point is
selected by a random process, and then every “nth number” on the list is selected
(Zikmund, 1997, p.432). Systematic sampling is similar to simple random
sampling and has the same limitations (De Vaus, 1985, p.65).
•
•
•
Stratified sampling – A probability sampling procedure in which sub-samples are
drawn from samples within different strata that are more or less equal on some
characteristics. The reasons for taking a stratified sample are (1) to have a more
efficient sample than could be taken on the basis of simple random sampling, and
(2) to assure that the sample will accurately reflect the population on the basis of
the criterion or criteria used for stratification (Zikmund, 1997, p. 433). Stratified
sampling is a modification of simple random and systematic sampling designed to
produce more representative and thus more accurate samples (De Vaus, 1985, p.
65).
Cluster sampling – An economically efficient sampling technique in which the
primary sampling unit is not the individual element in the population but a large
cluster of elements (Zikmund, 1997, p. 435). The problem of cluster sampling is
that travel costs are likely to be enormous because the amount of time spent
travelling will be substantially greater than the time spent in the interviewing
process (Zikmund, 1997).
In selection for sampling techniques, this study was concerned with two important principles. The first was that the sample had to reflect the population. The second was
that the sampling technique did not cause an increase in travelling costs. Based on these
principles and characteristics of sampling techniques as discussed above, stratified
sampling was seen as most appropriate in this study. Moreover, as examined in chapter 1
and subsection 4.5.2.1 (page 170) this study was only concerned with private enterprises,
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This correlation matrix was also used as a tool to recognize whether
multicollinearity occurs in the multiple regression equation (Eq. 4.3). Murphy (1989, p.
504) indicated how the correlation matrix can be used to recognize multicollinearity.
The correlation matrix should be examined on the computer printout to determinewhich, if any, independent variables are substantially related. A general rule is
that if a correlation between any two independent variables is greater than or
equal 0.70, then a high degree of interrelationship can be inferred, and the
possibility of multicollinearity exists.
4.7.3.2 Test of differences
Zikmund (1997, p. 586) defined test of differences as an investigation of hypotheses that
state that two or more groups differ with respect to measures of a variable. This study
was also concerned with examining whether the average profitability of SEMs achieved
the efficient financial management practices differs that of SMEs which do not. The t-test
may be used to test this hypothesis. The t-test for differences in two means is a technique
used to test the hypothesis that the mean scores on some interval-scaled variable will be
significantly different for two independent samples or groups (Zikmund, 1997, p.591).
4.7.4 Multivariate analysis
4.7.4.1 Overview
Like most other business problems, profitability is inherently multidimensional. It can be
simultaneously influenced by many dimensions. In term of management, profitability can
be influenced by the efficiency of marketing management, financial management,
production management, and quality management. By assuming other things hold equal,
this study concentrated on examining the effect of financial management on SME
profitability. Even though this assumption is held, the effect of financial management on
SME profitability still has a multidimensional characteristic since profitability can be
influenced by the efficiency of accounting information system, financial reporting and
analysis, working capital management practices, fixed-asset management practices,
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financial planning practices, liquidity, financial leverage and business industry.
Therefore, multivariate analysis was utilized in this research (Davis, 1996).
When problems are multidimensional and three or more are involved, we utilizemultivariate analysis. Multivariate statistical methods allow the effects of more
than one variable to be considered at one time (Zikmund, 1997, p. 656).
There are many multivariate techniques, however, two basic groups of multivariate
techniques are classified: dependence methods and interdependence methods. Figure 4.11
adapted from Zikmund (1997, p.657) presents a classification and selection of
multivariate methods.
Figure 4.11: A classification of multivariate methods
All multivariate methods
Are some of the variables dependent
on others?
Yes No
Source: Adapted from Zikmund (1996, p.657)
This study was concerned with investigating and explaining the effects of a large
number of variables of financial management practices and financial characteristics on
profitability. Multivariate dependence analysis was appropriate to be selected in this
study. Zikmund (1997, p.657) defined dependence analysis as a multivariate statistical
Dependence methods Interdependence methods
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technique that attempts to explain or predict the dependent variable on the basis of two or
more independent variables. Dependence analysis consists of multiple regression
analysis, multiple discriminant analysis, multivariate analysis of variance, and canonical
correlation analysis.
Multiple regression analysis is an analysis of association that simultaneously
investigates the effect of two or more independent variables on a single, interval-
scaled or ratio-scaled dependent variable (Zikmund, 1997, p. 659).
•
•
•
•
Multiple discriminant analysis is a statistical technique for predicting the
probability of objects belonging in two or more mutually exclusive categories
based on several independent variables (Zikmund, 1997, p. 662).
Multivariate analysis of variance is a statistical technique that provides a
simultaneous significance test of mean difference between groups, made for two
or more dependent variables (Zikmund, 1997, p. 668).
Canonical correlation analysis is a technique used to determine the degree of
linear association between two sets of variables, each consisting of several
variables (Zikmund, 1997, p. 667).
In summary, there are many multivariate analysis techniques and each is appropriate with
a specific purpose of investigation. Table 4. 5 (page 181) adapted from Zikmund (1997,
p. 669) summarizes multivariate techniques for the analysis of dependence and indicates
how to select the appropriate technique for utility. This study investigates the
simultaneous effect of several independent variables (CUR, DER, TAT and EFF) on a
dependent variable (PRO). Multiple regression is appropriate to be selected in this study.
However, as presented in subsection 4.4.1, because the efficiency of financial
management practices (EFF) is a multi-dimension construct measured by 57 items relatedto financial management, factor analysis was applied to group strongly correlated items
into some main components or factors. This assisted the researcher to reduce a large
number of variables into few factors and avoid multicollinearity phenomena in multiple
regression analysis (Lehmann, Gupta, and Steckel, 1998, Laitinen, 1991, Murphy III,
1989).
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This chapter examined aspects of research methodology for this study, including research
designs, variable definitions and measurements, model development, data collectionmethods, and data analysis. As respectively indicated by sections, this study was a
combination of descriptive and explanatory research in which the stratified sampling
technique was used to draw a sample of 160 SMEs located in Ho Chi Minh City for data
collection via personal interview.
Personal interview provided information of financial management practices of
SMEs in the sample. In addition, secondary data was used to derive financial ratios such
as liquidity, financial leverage, activity ratios from financial statements (balance sheets
and income statements) collected directly and indirectly from SMEs.
Data collected was transformed into more suitable format for analysis by utilizing
Excel software. After data processing, the Statistic Package for Social Science (SPSS)
was utilized for data analysis. Statistical techniques used in this study included
descriptive and inference statistics.
Descriptive statistics such as means, frequency, tabulation, cross-tabulation were
used to summarize and describe characteristics of financial management practices of
SMEs in sample. More complicated statistical analysis techniques such as bivariate
analysis, multivariate analysis, factor analysis were used to determine whether a
relationship exists between efficient financial management and SME profitability, and to
explain this relationship. Results of the survey and findings of the relationships between
financial management practices, financial characteristics and SME profitability will be
presented in chapter 5: “Data Analysis and Findings”.
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Investigating financial management practices and financial characteristics of SMEs is one
of the objectives of this research study. This section presents descriptive findings of the
research study, which are linked to the objective of describing financial management
practices and financial characteristics of SMEs in Vietnam.
5.3.1 Sample descript ions and SME characterist ics
5.3.1.1 Sample descriptions
As indicated in chapter 4, this research study used the stratified sampling technique with
the fraction of 90 to select the sample and the plan procedure for selecting sampling units
was presented in Table 4.4 (page 174). Based on the list of businesses provided by the Ho
Chi Minh City Department of Investment and Planning, 14,424 SMEs operating in Ho
Chi Minh City consisting of 5,170 manufacturing (accounting for 35.8%) and 9,254
trading (accounting for 64.2%) SMEs were defined as the target population. Using a
random digit table, a sample of 400 SMEs was randomly selected from the list for
personal interview aiming at obtaining a sample size of 160 SMEs as described by Table4.4 (page 174). Thirty interviewers were recruited and trained to contact and interview
SMEs selected. One hundred sixty-two of 400 SMEs contacted (a response rate of 40
percent) participated in the survey. After data editing, twelve cases were not usable
because of important data omission, and thus eliminated from the data set. As a result, a
sample of 150 SMEs was used for data analysis in this study. Structure of SMEs by type
of industry and form of ownership in the sample is described in Table 5.1.
Table 5.1: Structure of SMEs in the sample by type of industry and form of ownershipNumber of firms Percentage
Type of industry Trading 99 66.0%Manufacturing 51 34.0%
Total 150 100.0% The form of ownership Private enterprise 40 26.7%
Limited company 105 70.0% Joint stock company 5 3.3%
Total 150 100.0%Source: Data analysis for the study
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Table 5.2: Sample distribution by form of ownership within industry Type of industry
Trading Manufacturing The form of ownership Number of firms Percentage Number of firms PercentagePrivate enterprise 31 31.3% 9 17.6%Limited company 65 65.7% 40 78.4% Joint stock company 3 3.0% 2 3.9% Total 99 100.0% 51 100.0%Source: Data analysis for the study
5.3.1.2 SME characteristics
Table 5.3 provides an insight/review of business characteristics of SMEs in the sample.
Ninety-six percent of SMEs reported the age of the business as less than 10 years, only 4
percent operating for more than 10 years. In term of size, 92 percent of businesses had
not more than 100 employees and 95 percent had total assets less than VND10 billion1.
These businesses satisfy the criteria of SME definitions in Vietnam. Additionally, 73.3
percent of SMEs had annual sales less than VND5 billion, 22 percent had annual sales
from 5 to VND30 billion, and less than 5 percent had annual sales over VND30 billion.
Table 5.3: Business characteristics of SMEs in the sampleNo. of firms Percentage
Age of business Less than 2 years 47 31.3%2 -5 years 55 36.7%
6 -10 years 42 28.0%More than 10 years 6 4.0%
Total 150 100.0% Annual sales Less than 5 billion dong 110 73.3%
5 to 30 billion dong 33 22.0%31 to 50 billion dong 2 1.3%
More than 50 billion dong 5 3.3% Total 150 100.0%
Total assets Less than 5 billion dong 135 90.0%5 To 10 billion dong 8 5.3%
More than 10 billion dong 7 4.7% Total 150 100.0%
Labour 1 to 10 employees 66 44.6%11 to 30 employees 52 35.1%31 to 50 employees 8 5.4%
51 to 100 employees 10 6.8%101 to 250 employees 10 6.8%
More than 250 employees 2 1.4% Total 148 100.0%
Source: Data anal sis for the stud
1 At the current rate of exchange, USD1 = VND14, 000
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produce reports to help the owner/managers control financial position and performance of
the business.
Table 5.7: Kinds of financial statements prepared
No. of firms PercentageBalance sheet
Secondly, preparing and analyzing financial statements are frequently conducted
with SMEs. About 70 percent of respondents have financial statements prepared and
analyzed monthly, while only 3 percent of SMEs have never analyzed financial
statements (Table 5.8).
Thirdly, like accounting information system practices, responsibility for preparing
and analyzing financial statements is often left to the chief-accountant and/or employed
accountants (Table 5.9, page 154). One hundred and fourteen of 150 respondents (76%)
reported that employed accountants were in charge of preparing financial statements
compared with nearly 2 percent of respondents who said that the owner or external
accountants were responsible (Table 5.9, page 194). This finding is similar to DeThomas
and Fredenberger’s (1985) finding in that SMEs have rarely asked the external
accountants to analyze and interpret financial statements.
140 93.3%Income statement (Profit and loss statement) 146 97.3%Statement of cash flows 87 58.0%Statement of funds 92 61.3%Others 11 7.3% Total cases 150Source: Data analysis for the study
Table 5.8: Frequency of preparing and analyzing financial statementsNo. of firms Percentage
Below is a summary of descriptive findings related to cash management practices
that SMEs in the sample:
• In general, about 80 percent of SMEs always or often prepare cash budgets, and preparing and reviewing cash budgets are frequently based on monthly periods.
• Only 2.7 percent of responding SMEs always or often have shortage of cash while
about 40 percent always or often have a surplus of cash. Nevertheless, only 19
percent of SMEs deposit their cash surplus into bank accounts while up to 75
percent did not invest the temporarily cash surplus for profitable purposes.
5.3.2.4 Receivable management practices
On receivable management practices, respondents were asked questions concerned with
credit sales and policies, reviewing levels of receivables and bad debts, and percentage of
bad debts compared with sales. Below are descriptive findings of receivable management
practices of SMEs in the sample.
Table 5.14 demonstrates 80 percent of respondents “always or often” sell their
products or services on credit, only 2 percent “never” use credit sales. However, only 63
percent of SMEs which always or often sell products on credit, answered that they“always or often” set up a credit policy for the customers. Seven percent never have
credit policies for the customers but they tend to sell on credit to anyone who wishes to
buy.
Table 5.14: Sales on credit and credit policesNo. of firms Percentage
Sell products or services on credit Never 3 2.0%Rarely 7 4.7%
Sometimes 19 12.7%
Often 78 52.0% Always 43 28.7% Total 150 100.0%
Set up credit policy to the customers Never 11 7.3%Rarely 15 10.0%
Sometimes 30 20.0%Often 60 40.0%
Always 34 22.7% Total 150 100.0%
Source: Data analysis for the study
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In general, descriptive findings of receivable management practices of SMEs in
the sample revealed the following:
• Eighty percent of SMEs always or often sell their products or services on creditand 63 percent always or often set up credit polices for the customers. However,
there are still 7 percent of SMEs that tend to sell on credit to anyone who wishes
to buy.
• Most SMEs review their levels of receivables and bad debts monthly. As a result,
the percentage of bad debts is controllable and maintained at a relatively low
level.
5.3.2.5 Inventory management practi ces
On inventory management practices, respondents were asked questions related to
preparing and reviewing inventory budgets, determining inventory levels, and using the
economic order quantity (EOQ) model. Below are descriptive findings of inventory
management practices of SMEs in the sample.
Table 5.17 shows a relatively high percentage (86%) of SMEs in the sample
always or often review inventory levels and 80.7 percent always or often prepareinventory budgets. Only about 5 percent never prepare inventory budgets.
Table 5.17: Frequency of reviewing inventory levels and preparing inventory budgetsNo. of firms Percentage
Review inventory levels Never 2 1.3%Rarely 8 5.3%
Sometimes 11 7.3%Often 52 34.7%
Always 77 51.3% Total 150 100.0%
Prepare inventory budgets Never 7 4.7%Rarely 9 6.0%
Sometimes 13 8.7%Often 52 34.7%
Always 69 46.0% Total 150 100.0%
Source: Data anal sis for the stud
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• A majority of SMEs in the sample (76.6%) “always or often” prepared financial
budgets in the process of business operation.
• Types of budgets such as sales, selling and administration expenses, labour and
cash budgets are prepared by a majority of SMEs whereas fewer SMEs prepare budget balance sheets and income statements.
• A majority of SMEs has employed accountants and chief-accountants prepare
budgets whereas the number of SMEs using external accountants to prepare
financial budgets is not significant.
• Up to 83 percent of SMEs in the sample frequently compare budget and actual
results monthly.
In addition to financial management practices as reported earlier, this study also aims at
describing financial characteristics of SMEs. The next subsection presents descriptive
findings of financial characteristics of SMEs in the sample.
5.3.3 Descriptive findings of financial characteristics
Four financial ratios used as variables to measure financial characteristics in this study
were current ratio (liquidity measure), debt ratio and debt-to-equity ratio (leverage
measure), and total asset turnover (activity measure). In addition, three other ratios used
as measures of profitability were return on sales (ROS), return on assets (ROA), and
return on equity (ROE). For the purpose of profitability emphasis, profitability ratios will
be examined in subsection 5.3.4.
In this study, data related to financial characteristics were derived from financial
statements of firms. The responding SMEs were asked to use the financial statements of
the current year including balance sheets and income statements to calculate financialratios. These ratios were filled into part C of the questionnaire (Appendix 1), which was
designed to collect data regarding financial characteristics. Below are the descriptive
findings of financial characteristics of SMEs in the sample.
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Table 5.25a reports descriptive statistics of financial characteristics of the sample
of 150 SMEs without distinction between trading and manufacturing industries while
Table 5.25b and 5.25c respectively report descriptive statistics of financial characteristics
of the trading and manufacturing SMEs. Table 5.25b and 5.25c also demonstrate
differences in means of financial ratios between two groups (trading and manufacturing)
of SMEs. However, Table 5.26 reveals that the results of t-tests applied for testing the
Table 5.25a: Descriptive statistics of financial ratiosN Minimum Maximum Mean Std. Deviation
Current ratio 150 0.33 12.00 2.4939 1.4980Debt ratio 150 0.01 1.08 0.2936 0.1822
Debt-to-equity ratio 150 0.01 4.59 0.5396 0.7232 Total asset turnover 150 0.07 36.00 3.8386 5.3630Return on sales(%) 150 - 3.00 31.50 4.1977 4.6126Return on assets(%) 150 - 9.00 30.00 7.5131 6.3770Return on equity (%) 150 -25.00 40.00 10.7515 8.6592 Valid N 150Source: Data analysis for the study (N= Number of SMEs in the sample)
Table 5.25b: Descriptive statistics of financial ratios of trading SMEsN Minimum Maximum Mean Std. Deviation
Current ratio 99 0.33 12.00 2.5049 1.5493Debt ratio 99 0.01 0.90 0.3080 0.1892Debt-to-equity ratio 99 0.01 4.59 0.6130 0.8503 Total asset turnover 99 0.09 36.00 4.4359 6.1891Return on sales (%) 99 -3.00 21.00 3.9125 4.0661Return on assets (%) 99 -9.00 30.00 7.4743 6.4427Return on equity (%) 99 -25.00 40.00 10.6208 9.0835 Valid N 99
Source: Data analysis for the study (N= Number of trading SMEs in the sample)
Table 5.25c: Descriptive statistics of financial ratios of manufacturing SMEsN Minimum Maximum Mean Std. Deviation
Current ratio 51 1.00 8.00 2.4725 1.4077Debt ratio 51 0.05 1.08 0.2657 0.1660Debt-to-equity ratio 51 0.01 1.85 0.3971 0.3321 Total asset turnover 51 0.07 12.00 2.6792 2.9248Return on sales(%) 51 -2.00 31.50 4.7512 5.5249Return on assets (%) 51 -1.00 30.00 7.5882 6.3102Return on equity (%) 51 -4.00 40.00 11.0051 7.8502 Valid N 51Source: Data analysis for the study (N= Number of manufacturing SMEs in the sample)
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differences in the means of financial ratios between two groups report that the differences
do not provide enough statistical evidence to conclude that there are differences between
two the groups.
Table 5.26: Test for difference of means of financial ratios between two groups
5.3.3.1 Liquidi ty (Current ratio)
Tables 5.25 (a, b, and c, page 207) report that SMEs in the sample maintain relatively
high liquidity ratios. On average, current ratios of SMEs are 2.50 for trading and 2.47 for
manufacturing. Some SMEs have current ratios up to 12.00. These ratios are higher than
Vuong Quan Hoang (1998)’s findings, which reported that the average current ratio of
SMEs in Vietnam is 2.10 (chapter 2, Table 2.21, page 54).
t df Sig. (2-tailed) Mean Std. ErrorDifference Difference
Current ratio 0.125 148 0.901 3.240E-02 0.2591Debt ratio 1.352 148 0.178 4.234E-02 3.131E-02Debt-to-equity ratio 1.744 148 0.083 0.2160 0.1238 Total asset turnover 1.917 148 0.057 1.7566 0.9162Return on sales (%) -1.055 148 0.293 -0.8387 0.7947Return on assets (%) -0.103 148 0.918 -0.1139 1.1028Return on equity (%) -0.257 148 0.798 -0.3843 1.4972Source: Data analysis for the study
Table 5.27: Comparison of current ratiosOsteryoung, Constand and Nast (1992)’s research Current research
Industry Cur. Ratio Industry Cur. ratioTrading (Average) 2.67 Trading 2.50 Apparel 2.60Building materials and supplies 2.40Drugs 3.20Food and beverage 2.50Furniture/appliances 2.40
However, comparing the current research’s findings with Osteryoung, Constand and Nast
(1992)’s findings (Table 5.27, page 208) reveals that both studies reported current ratios
similar for trading but rather different for manufacturing industry. The current research
finds that, on average, the current ratio of manufacturing SMEs in Vietnam (2.47) is
rather higher that of Osteryoung, Constand and Nast (1992)’s research (2.05).
Table 5.28 reveals that over 90 percent of SMEs in the sample have a current ratio
greater than 1.00, and about 53 percent have a current ratio more than 2.00.
Table 5.28: Descriptive findings of SME current ratiosNo. of firms Percentage
Maintaining excessively high current ratios has two outcomes. On one hand, it
reinforces liquidity, which help SMEs to sustain the uncertainty of business environment.
On the other hand, it affects profitability of SMEs because liquid assets have not been
used as profitable assets. In this context Van Horne (1986, p145) has stated that:
The greater the relative proportion of liquid assets, the less risk of running out of
cash … profitability unfortunately, also will be less… resolution of trade-off
between risk and profitability with respect to these decisions depends upon therisk preferences of management.
If resolving the trade-off between risk and profitability depends upon risk preferences of
management then for SMEs in Vietnam, maintaining excessively high current ratios is
acceptable because they operate in a relatively risky environment. However, from a
profitability perspective, it seems that maintaining high current ratio causes SMEs to beless profitable than would be expected. This will be analyzed in section 5.4 where
bivariate techniques are used to examine the relationship between liquidity and
profitability of SMEs and the hypothesis of relation between current ratio and
profitability will be tested.
Current ratio Below 1 15 10.0%From 1 to 1.5 40 26.7%Over 1.5 to 2 15 10.0%More than 2 80 53.3%
Total 150 100.0%Source: Data analysis for the study
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Table 5.25a (page 207) shows that the average total asset turnover (Sales/Total assets) of
SMEs in the sample is 3.84 and a few SMEs had total asset turnovers very high up to
36.00. This means that, on average, one dollar of total assets of SMEs produces 3.84
dollars of sales, relatively high efficiency in utilizing assets. Concerned with distribution
of total asset turnover, Table 5.30 reveals that only 18.7 percent of SMEs had total asset
turnovers less than 1 while the remainder had total asset turnovers greater than 1. This
suggests that most SMEs (81.3%) produce more than one dollar of sales from a dollar of
total assets. In addition, Table 5.30 shows that 18.7 percent of SMEs produce more than 5
dollars of sales from a dollar of total assets.
Table 5.30: Descriptive findings of SME activity ratioNo. of firms Percentage
It appears that the efficiency of utilizing total assets of SMEs in the sample isrelatively high. However, this is not sufficient evidence to conclude that SMEs are
profitable. The next subsection analyzes profitability of SMEs in the sample.
5.3.4 Descriptive findings of profi tability of SMEs
One of the main objectives of this research study was to investigate profitability of
SMEs. As indicated in chapter 1, this research investigated (1) whether or not SMEs in
Vietnam are profitable, and (2) whether financial management practices and financial
characteristics affect their profitability. Below are descriptive findings related to the first
question while findings to answer the second question will be reported in section 5.4.
Total asset turnover Below or equal 1 28 18.7%More than 1 to 3 77 51.3%More than 3 to 5 17 11.3%
More than 5 28 18.7% Total 150 100.0%
Source: Data anal sis for the stud
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As defined in chapter 1, a business is said to be “profitable” if it produces an annual
average profit return that is greater than the free-risk rate of interest, which is estimated
as 5.4 percent in the 1990’s in Vietnam. Conversely, if the annual average profit of a
business is not greater than the free-risk rate of interest, the business is said to be “not
profitable or unprofitable”. The annual average profits are averaged from three
profitability ratios: return on sales, return on assets and return on equity. The free-risk
rate of interest is here defined as the deposit rate of interest of state-owned commercial
banks, which is of 0.45% per month or 5.4% per year in the year 2000.
The arguments for the definition of SME profitability as mentioned above are
based on the following propositions:
• Firstly, the deposit rate of interest offered by state-owned commercial banks is
considered free-risk because these commercial banks are secured by the
Government.
• Secondly, the free-risk rate of interest is considered the opportunity cost of
capital, and SMEs have to produce annual average profits greater than their
opportunity cost, otherwise they should cease operating and deposit money into
the banks for free-risk rate of interest.
Based on the definition of profitability as indicated earlier, Table 5.31 (page 213) reports
that 99 of 150 SMEs surveyed (66%) were profitable. While the remainder (34%) was
not profitable, that is, they could not produce an annual average profit return that was
higher than the free-risk rate of interest. Table 5.31 also shows the size of annual profits
of SMEs. Only about 10 percent of SMEs had annual profits of more than VND5002
million while about 50 percent have annual profit range from VND50 to VND300million, and 18 percent annually earn less than VND50 million. Levels of annual profit of
SMEs in Vietnam are small compared to other countries because firm size is low in terms
of total assets and labour.
2 Equivalent of USD35, 714, by the current exchange rate of VND14, 000 for 1USD
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What has been discussed above is only an overview of SME profitability, which
answered the first research question outlined in chapter 1. A more specific analysis was
carried out in subsections 5.3.4.2 and 5.3.4.3 to provide a deeper analysis of profitability
of SMEs in the survey.
5.3.4.2 Profitability and business structure
This subsection analyzes profitability of SMEs in relation to business structure to
investigate which types of SMEs are profitable. Table 5.32 reports relationships between
profitability and type of industry in which manufacturing SMEs are found to be more profitable than trading. In terms of business structure, manufacturing industry accounted
for 34% of SMEs in the sample but 36.4 percent of manufacturing SMEs are profitable
while trading industry accounted for 66% but only 63.6 percent are profitable.
Conversely, up to 70.6 percent of trading SMEs are not profitable while this percentage is
only 29.4 percent for manufacturing.
Profitability Not profitable 51 34.0%Profitable 99 66.0%
Total 150 100.0% Annual profits Less than 50 million dong 27 18.0%50 to 300 million dong 74 49.3%
301 to 500 million dong 33 22.0%More 500 million dong 16 10.7%
Total 150 100.0%Source: Data analysis for the study
Table 5.32: Relationship between profitability and types of businessNot profitable Profitable Total
No. % No. % No. % Type of industry Trading 36 70.6% 63 63.6% 99 66.0% Manufacturing 15 29.4% 36 36.4% 51 34.0% Total 51 100.0% 99 100.0% 150 100.0% The form of ownership Private enterprise 8 15.7% 32 32.3% 40 26.7% Limited company 40 78.4% 65 65.7% 105 70.0% Joint stock company 3 5.9% 2 2.0% 5 3.3% Total 51 100.0% 99 100.0% 150 100.0%
Source: Data analysis for the study
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Table 5.34: Total variance explained and three principal components of financial management practicesInitial Eigenvalues Extraction sums of squared loadings Rotation sums of squares loadings
information system practices (r = - 0.310). Similarly, inter-correlation is also found
among other variables. However, correlation coefficients are not strong enough to cause
multicollinearity because, as indicated by Murphy III (1989), if a correlation between
any two independent variables is greater than or equal 0.70, then the possibility of
multicollinearity exists.
The first row of Table 5.39 shows the correlation coefficients between ROS and
the independent variables as well as among independent variables.
Table 5.39: Correlation matrix of ROS and the independent variables
As expected, the relationship between return on sales and working capitalmanagement and short-term planning practices is significantly positive with r = 0.248.
Return on sales and financial and accounting information system practices are also
positively but not strongly correlated with r = 0.168 and a significance level of 0.05.
Conversely, Table 5.39 reveals the relationships between return on sales and current
ratio, and between return on sales and total asset turnover are significantly negative with
correlation coefficients r = - 0.286 and – 0.256 respectively. However, Tables 5.39
demonstrates there are no significant relationships between return on sales and debt ratio
as well as between return on sales and fixed asset management and long-term planning
practices.
Bivariate analysis with using Pearson’s correlation coefficients and presenting the
results by correlation matrix only examines association between the dependent variable
and each of independent variables. It is not appropriate and, thus, could not used to
examine the simultaneous impact of many independent variables on dependent variable,
whereas multivariate analysis is appropriate for examining the simultaneous impact of
many independent variables on the dependent variable (Zikmund, 1997).
5.4.3 Multiple regression analysis and findings
In this subsection, multiple regression analysis was used to determine whether
independent variables (CUR, DER, TAT, WCSP, FALP and FAIS) simultaneously
impact the dependent variable (ROS or PRO). As a result, the subsection examines
whether the multiple regression equation can be used to explain the causal theory of
impact of financial characteristics and financial management practices on SME
profitability.
5.4.3.1 Simultaneous impact of financial characteristics and financial management
practices on SME profitability (Model 1)
For this model, profitability was used as the dependent variable and independent
variables included current ratio, debt ratio, total asset turnover, working capital and short-
term planning practices, fixed asset management and long-term planning practices, and
financial and accounting information systems. The relationship between dependent
variable and independent variables, and results of testing significance of the model have
been respectively interpreted. In interpreting the results of multiple regression analysis,
three major elements considered were the coefficient of multiple determination, the
standard error of estimate and the regression coefficients (Emory, 1985; Davis, 1996;
Lehmann, Gupta, and Steckel, 1998). These elements and the results of multiple
regression analysis were presented and interpreted in Table 5.40 below.
Firstly, Table 5.40 (page 226) reveals that SME profitability and financialcharacteristics (measured by current ratio, debt ratio and total asset turnover) and
financial management practices (measured by working capital management and short-
term planning practices, fixed asset management and long-term planning practices, and
financial and accounting information system) are significantly correlated with the
correlation coefficient R = 0.78. Table 5.40 also reports the model of SME profitability
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with the coefficient of determination R 2 = 0.608 at a significant level of p = 0.0001. The
coefficient of determination indicated that 60.8% of the variation in profitability for the
sample of 150 SMEs can be explained by the changes in current ratio, total asset
turnover, working capital management and short-term planning practices, fixed asset
management and long-term planning practices, and financial and accounting information
system while 39.2% remains unexplained.
In addition, Table 5.40 reports the summary ANOVA (analysis of variance) table
and F statistic, which reveals the value of F (36.994) is significant at the 0.0001 level.
The value of F is large enough to conclude that the set of independent variables (CUR,
TAT, WCSP, FALP, and FAIS) as a whole was contributing to the variance in SME
profitability and therefore the model represents actual performance of SMEs (Keller,
Warrack, and Bartel, 1994; Davis, 1996).
Table 5.40: SME profitability regression model using profitability as dependent variable
The remaining step in the evaluation of the regression equation is to estimate the
contribution of each independent variable in the study. Generally, all independent
variables, except debt ratio, significantly contributed in variance of profitability at a
UnstandardizedCoefficients
Std. Error Standardized t Sig.Coefficients
Model B Beta1 (Constant) 8.831 .936 9.436 .000
Current ratio -.907 .233 -.256 -3.893 .000Debt ratio .570 1.693 .020 .337 .737
Total asset turnover .196 .055 .198 3.590 .000 Working capital management and short-
term planning practices1.614 .303 .305 5.321 .000
Fixed asset management and long-termplanning practices
1.980 .305 .374 6.488 .000
Financial and accounting informationsystem practices
1.240 .299 .234 4.152 .000
Model SummaryModel R R Square Adjusted R Square Std. Error of the Estimate
1 .780 .608 .592 3.3851 ANOVA b
Model Sum of Squares df Mean Square F Sig.1 Regression 2543.548 6 423.925 36.994 .000a
Residual 1638.658 143 11.459 Total 4182.207 149
a Predictors: (Constant), Financial and accounting information system practices, Fixed asset managementand long-term planning practices, Working capital management and short-term planning practices, Debt
ratio, Total asset turnover, Current ratiob Dependent Variable: Profitability (%)
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significance level of 0.0001. However, the relative importance of association of each
independent variable was different. This was evaluated and interpreted by the
standardized coefficients of correlation (beta).
Current ratio – Profitability was negatively related to current ratio with β = -0.256 at a significance level of 0.0001 and support was found for hypothesis one, which
stated that current ratio is negatively related to profitability. This finding is also
consistent with Van Horne (1986)’s theory of relationship between profitability and
liquidity.
The greater the relative proportion of liquid assets, the less risk of running out of
cash … profitability unfortunately, also will be less… resolution of trade-off between risk and profitability with respect to these decisions depends upon the
risk preferences of management (Van Horne, 1986).
As such the result of testing indicated hypothesis one, which was based on Van Horne’s
(1986) theory, was strongly supported. This implies that SMEs that have relatively high
current ratios will be less profitable and vice versa. Additionally, it provided empirical
evidence to support the theory of relationship between profitability and liquidity
developed by Van Horne (1986) and explained why the percentage of SMEs that were
not profitable is relatively high in this research study. This finding is also consistent with
the descriptive finding of relationship between profitability and current ratio as shown in
Table 5.41 below.
Table 5.41: Descriptive finding of relationship between profitability and current ratioProfitability Total
Not profitable Profitable No. %No. % No. %
Table 5.41 shows all SMEs with current ratio below 1 are profitable, and the higher
current ratio, the higher percentage of unprofitable SMEs.
Current ratio Below 1 0 0.0% 15 15.2% 15 10.0%From 1 to 1.5 2 3.9% 38 38.4% 40 26.7%
From 1.51 to 2 4 7.8% 11 11.1% 15 10.0%More than 2 45 88.2% 35 35.4% 80 53.3% Total 51 100.0% 99 100.0% 150 100.0%
Source: Data analysis for the study
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• Current ratio is negatively related to SME profitability at a significance level of
0.0001 and with the standardized correlation coefficient of – 0.256. Debt ratio
was not found to be related to SME profitability.
• Total asset turnover is positively related to SME profitability at a significancelevel of 0.0001 and with the standardized correlation coefficient of 0.198.
• All variables of financial management practices (WCSP, FALP, and FAIS) are
positively related to SME profitability at a significance level of 0.0001 and with
the standardized correlation coefficients of 0.305, 0.374 and 0.234 respectively. In
addition, variables of financial management practices are found to be more
important than that of financial characteristics in contributing to variation of SME
profitability.
As indicated earlier (page 228), because debt ratio was not related to SME profitability it
should be remove from the multiple regression equation to improve the accuracy of the
model (Murphy III, 1989). After removing the debt ratio and rerunning the program, the
results of multiple regression analysis are shown in Table 5.43.
Table 5.43: Regression model of SME profitability after removing debt ratioUnstandardized
Fixed asset management and long-termplanning practices
1.967 .302 .371 6.518 .000
Financial and accounting informationsystem practices
1.247 .297 .235 4.197 .000
Model SummaryModel R R Square Adjusted R Square Std. Error of the Estimate
1 .780 .608 .594 3.3747
ANOVA bModel Sum of Squares df Mean Square F Sig.
1 Regression 2542.250 5 508.450 44.646 .000a
Residual 1639.957 144 11.389 Total 4182.207 149
a Predictors: (Constant), Financial and accounting information system practices, Fixed assetmanagement and long-term planning practices, Working capital management and short-term planningpractices, Total asset turnover, Current ratio.b Dependent Variable: Profitability
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Table 5.43 reveals that all statistical parameters including F-value, t-test statistics
and standard error of estimate have been significantly improved after removing the debt
ratio from the multiple regression equation.
5.4.3.2 Simultaneous impact of financial characteristics and financial management
practices on return on sales (Model 2)
In the second model, return on sales (ROS) is used as the dependent variable while
independent variables including current ratio, debt ratio, total asset turnover, working
capital management and short-term planning practices, fixed asset management and long-
term management practices, and financial and accounting information system. Table 5.44
reports the results of testing the model and following are the findings and result
interpretation.
Table 5.44: SME profitability regression model using return on sales as dependent variable
Table 5.44 (page 232) reports the model representing the impact of financial
characteristics and financial management practice on return on sales with the coefficient
UnstandardizedCoefficients
Std. Error Standardized t Sig.Coefficients
Model B Beta
2 (Constant) 7.266 1.126 6.452 .000 Current ratio -.553 .280 -.180 -1.973 .050 Debt ratio -1.755 2.037 -.069 -.861 .391 Total asset turnover -.306 .066 -.355 -4.658 .000 Working capital management and short-
term planning practices
1.078 .365 .234 2.954 .004
Fixed asset management and long-termplanning practices
.733 .367 .159 1.997 .048
Financial and accounting informationsystem practices
.798 .359 .173 2.220 .028
Model SummaryModel R R Square Adjusted R Square Std. Error of the Estimate
2 .501 .251 .220 4.0738 ANOVA b
Model Sum of Squares df Mean Square F Sig.2 Regression 796.916 6 132.819 8.003 .000a
Residual 2373.220 143 16.596 Total 3170.136 149
a Predictors: (Constant), Financial and accounting information system practices, Fixed asset managementand long-term planning practices, Working capital management and short-term planning practices, Debtratio, Total asset turnover, Current ratiob Dependent Variable: Return on sales(%)
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This section summarizes conclusions related to the research questions and testing the
model analyzed and presented in chapter 5. Conclusions of financial management
practices, financial characteristics, and SME profitability are respectively presented in
subsections 6.2.1, 6.2.2, and 6.2.3 while subsection 6.2.4 presents conclusions and the
revised model of SME profitability.
6.2.1 Conclusions related to financial management practices
As indicated in chapter 1, one of the objectives of the research was to collect empirical
evidence of financial management practices to describe behaviours of SMEs in practisingfinancial management. This subsection summarizes findings of financial management
practices of SMEs in the sample.
6.2.1.1 Account ing information system practices
Descriptive findings of accounting information system practices were investigated and
reported in subsection 5.3.2.1 of chapter 5 (Tables 5.4, 5.5, and 5.6, page 190, 191, and
192). From these tables the following conclusions related to accounting information
system practices of SMEs are listed.
• Firstly, 100 percent of SMEs have systems for accounting information organized
formally (Table 5.4, page 1990). This finding demonstrates that all SMEs legally
organized in the form of private enterprise, limited liability company or joint
stock company have organized and maintained formal accounting information
systems in which two kinds of financial statements, balance sheets and income
statements, are frequently and regularly prepared. This is a prerequisite forexamining practices of financial reporting and analysis.
• Secondly, employed accountants and chief-accountants still play an important role
in carrying out most accounting responsibilities whereas external accountants
have not been engaged by firms effectively (Table 5.5, page 191). This finding
reveals that, to date, the external accountants have not been regularly engaged and
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most SMEs continue to use employed accountants in their businesses. This proved
that the central-planned management mechanism continues to strongly affect
management styles of SMEs after a decade of policy reform and transformation to
a market economy.
• Thirdly, chief-accountants are frequently employed for more sophisticated
accounting responsibilities such as preparing and interpreting accounting reports
while employed accountants are mainly employed for recording business
transactions (Table 5.5, page 191). This finding shows that the chief-accountant
still plays an important role in controlling financial position of SMEs. Most SMEs
appoint a chief-accountant who is responsible for controlling financial matters
whereas the financial manager position is rarely found in businesses. These
indicate continuity of old management styles, which have not been changed after
a decade of reform.
• Finally, most SMEs have frequently applied computers in their accounting
information systems and the most frequent application of computers is to prepare
accounting reports (Table 5.6, page 192). Although most respondents answered
that they usually use computers in accounting information systems, the ability to
apply accounting software is limited. This is an outcome of limitations of
financial and human resources within SMEs, which means SMEs have difficultyin developing and carrying out projects providing accounting information system
computerization.
6.2.1.2 Financial repor ting and analysis pract ices
As indicated in subsection 5.3.2.2 of chapter 5 (page 192), findings of financial reporting
and analysis practices were analyzed and presented in tables 5.7 to 5.10. Based on these
tables, conclusions and discussions of financial reporting and analysis practices of SMEs
are summarized below.
Almost 100 percent of SMEs produced financial statements including balance
sheets and income or profit and loss statements prepared and analyzed frequently and
regularly (Table 5.7, page 193). This shows that SMEs have a strong regard for financial
reporting practices and preparing financial statements has become frequent for most
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Results of data analysis and findings of fixed asset management practices were
examined and reported in subsection 5.3.2.6 (page 201) of chapter 5. Following are
conclusions on fixed asset management practices of the sample of 99 trading and 51
manufacturing SMEs.
Firstly, near 80 percent of SMEs always or often evaluate capital projects before
making decisions of investment, and review the efficiency of utilizing fixed assets after
acquisitions. Some 87 percent of SMEs stated that they use payback period techniques in
capital budgeting, only 27.3 percent use the more sophisticated discounted cash flows;
that is, the net present value (NPV), internal rate of return (IRR) and modified internal
rate of return (MIRR).
These findings revealed that SMEs highly regard fixed asset management
although their knowledge of management techniques is not outstanding. The majority of
SMEs always or often evaluate capital investment projects before making decisions on
investment. In addition, efficient utilization of fixed assets after investing is reviewed
frequently. However, like the findings of previous researchers, this research indicated
that payback-period methods are most popularly used in evaluating capital investment
projects while the more sophisticated methods such as NPV, IRR or MIRR are rarely
used.
The predominance of the payback-period method can be attributed to its
simplicity, emphasis on liquidity, and response to external financing pressures. Under
the conditions of lack of long-term capital sources, uncertainty of business environment,
and financial pressures, the payback capital period seems to be more important than
profit return from a project as indicated by Block (1997):
The firms (small firms) continue to be dependent on the payback method as the
primary method of analysis. This is not necessarily evidence of a lack ofsophistication, as much as it is a reflection of the financial pressures put on the
small business owner by financial institutions. The question to be answered is notalways how profitable the project is, but how quickly a loan can be paid back.
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Table 6.1: Summary of conclusions related to financial management practicesItems Tables Conclusions
Accountinginformationsystem
5.4; 5.5& 5.6
1. One hundred percent of SMEs have systems of accounting informationorganized formally.2. Employed accountants and chief-accountants play an important role incarrying out most accounting responsibilities whereas external accountants have
been extensively engaged.3. Most SMEs have applied computers in their accounting information systemsand the most frequent application of computers is preparing accounting reports.
Financialreporting andanalysis
5.7;5.8; 5.9& 5.10
1. Nearly 100 percent of SMEs have financial statements including balancesheets and income (profit and loss) statements prepared and analyzed frequently.2. Most SMEs (about 70 percent) prepare and analyze their financial statements
based on the monthly periods. Nevertheless, about 2 percent of SMEs havenever analyzed financial statements.3. In financial analysis, about half of SMEs in the sample have frequently appliedboth trend and ratio analyses.4. Ratios of activity such as receivable turnover, inventory turnover, total assetturnover are most frequently used, followed by ratios of liquidity and finally
ratios of profitability . Workingcapitalmanagement
5.11;5.12 &5.13;5.14;5.15 &5.16;5.17; &5.18
1. In general, about 80 percent of SMEs always or often prepare and review cashbudgets based on monthly periods.2. Only 2.7 percent of responding SMEs always or often face cash shortages forspending while about 40 percent always or often have a surplus of cash.Nevertheless, only 19 percent of SMEs deposit cash surpluses into bankaccounts while up to 75 percent did not know how or where to invest thetemporary cash surplus for profit.3. Eighty percent of SMEs always or often sell their products or services oncredit and 63 percent always or often set up their credit polices for thecustomers. In addition, 7 percent of SMEs tend to sell on credit to anyone who
wishes to buy, without reviews.4. Most SMEs review their levels of receivables and bad debts monthly. As aresult, the percentage of bad debts is controllable and maintained at a relativelyappropriate level.
5. SMEs lack management knowledge. For example, although they often reviewinventory levels and prepare inventory budgets, the ability to apply theories ofinventory management to inventory budgeting is limited.
Fixed assetmanagement
5.19 &5.20
1. Near 80 percent of SMEs always or often evaluate capital projects beforemaking decisions on investment and review the efficiency of utilizing fixedassets after acquisitions.2. Eighty-seven percent of SMEs stated that they used payback periodtechniques in capital budgeting, only 27.3 percent use the more sophisticateddiscounted cash flows; that is, the net present value (NPV), internal rate ofreturn (IRR) and modified internal rate of return (MIRR).3. These findings reveal SMEs relatively strongly regard to fixed assetmanagement although their knowledge of sophistication management is not sohigh.
Financialplanning
5.21;5.22;5.23 &5.24
1. A majority of SMEs in the sample (76.6%) always or often prepares financialbudgets in the process of business operation.2. Budgets such as sales, selling and administration expenses, labor and cashbudgets are prepared by a majority of SMEs whereas few SMEs prepare thebudgeted balance sheets and income statements.3. A majority of SMEs let employed accountants and chief-accountants prepare
whereas few SMEs engage external accountants to prepare financial budgets.4. Up to 83 percent of SMEs in the sample frequently compare budgeted andactual results monthly.
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6.2.3.4 Simultaneous impacts of financial management practices and financial
characteristics on SME profitability
By using multiple regression analysis, this study investigated simultaneous impacts of
financial management practices and financial characteristics on SME profitability. This
analysis and its findings were presented in section 5.4.3 of chapter 5 (page 225).
Financial management practices (measured by the efficiency of three principal
components including working capital management and short-term planning practices,
fixed asset SME profitability and long-term planning practices, and financial and
accounting information system) and financial characteristics (measure by current ratio,
debt ratio and total asset turnover) are significantly correlated with a correlation
coefficient of R = 0.78 at a 0.0001 significance level (Table 5.40, page 226). With thecorrelation coefficient of 0.78, financial management practices and financial
characteristics were found to be strongly and simultaneously related to SME profitability.
In other words, financial management practices and financial characteristics
simultaneously impact on SME profitability.
Additionally, t-test statistics were used to evaluate the impacts of each variable on
SME profitability. Results revealed that, with the exception of debt ratio, all variables
including current ratio, total asset turnover, working capital management and short-term
planning practices, fixed asset management and long-term planning practices, and
financial and accounting information systems were significantly related to SME
profitability. Specifically, current ratio was found to be negatively related to SME
profitability with the standardized coefficient β = - 0.256 at a 0.0001 significance level.
In contrast, total asset turnover was found to be positively related to SME profitability
with β = 0.198 at a 0.0001 significance level. Similarly, working capital management and
short-term planning practices, fixed asset management and long-term planning practices,
and financial and accounting information systems were found to be positively related to
SME profitability with β = 0.305, 0.374 and 0.234 respectively. These findings conclude
that support was demonstrated for the hypotheses one, three and four but not for the
hypothesis two.
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Since the debt ratio was not related to SME profitability, it was removed from the
multiple regression equation to improve the accuracy of the model (Murphy III, 1989).
The analysis program was rerun to obtain a revised model of SME profitability, which is
presented in section 6.2.3.6 and Figure 6.2 (page 254).
6.2.3.5 Difference in mean profits between efficient and inefficient financ ial
management groups of SMEs
This research study was also designed to test the hypothesis of differences in average or
mean profitability between “efficient” and “inefficient” financial management groups of
SMEs. Definitions and measurement of “efficient” and “inefficient” financial
management were presented in sections 1.6 (page 10) of chapter 1 and 5.4.4 (page 234)of chapter 5. A business is said to be “efficient” in financial management practices if all
components of financial management practices are efficient. A component of financial
management practices is said to be “efficient” if its sum of points, which is measured by
8 items on nine-point scales (1 = not efficient at al, 9 = Very efficient), is greater than the
average point of 40 (8 x 5 point average). Testing the hypothesis of differences in mean
profits of the two groups of SMEs was conducted and presented in section 5.4.4 of
chapter 5 (page 234). The result of the test rejected the null hypothesis of equality of
mean profits of the two groups of SMEs (Table 5.46, page 235). Result of the test
supports the hypothesis, which states that the mean profit of SMEs that are efficient in
financial management practices is greater than that of SMEs, which are inefficient in
financial management practices.
This finding leads to the conclusion that the efficiency of financial management
practices can bring about a higher profitability for SMEs. Therefore SMEs can improve
their profitability by raising the efficiency of financial management practices.
6.2.3.6 The revised model of SME profitabi lity
This section presents the revised model of SME profitability, which was obtained after
removing the debt ratio from the group of independent variables and rerunning the
program. After removing the debt ratio and rerunning the program, the model of SME
profitability was revised and presented in Figure 6.2 (page 254). This figure is derived
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Table 6.3: Summary of research questions and answers
Research questions Research question answers
defined Chapter Answer summary
1. How importantare SMEs in Vietnam
and are theyprofitable?
2 & 5 • SMEs play an important role in creating employmentand growing GDP.
•
Sixty-six percent of SMEs are profitable, while 34percent are not profitable (Table 5.31, page 213).
2. How haveresearchers in theliterature reviewidentified the contextof financialmanagement practicesand financialcharacteristics, andhow have theyproposed to measure
SME profitability?
3 • Financial management practices include accountinginformation system, financial reporting and analysis, working capital management practices, fixed assetmanagement practices and financial planning(McMahon, 1998).
• Financial characteristics include liquidity, financialleverage, activity and profitability (Meric et al, 1988;Laitinen, 1992).
• Profitability is generally measured by the followingratios: return on sales, return on assets, and return on
equity (Burns, 1985; Meric et al, 1988; Laitinen, 1992)3. How importantare financialmanagement practicesand financialcharacteristics toSME profitability?
3 • Financial management practices and financialcharacteristics significantly affect SME profitability(Edwards and Cooley, 1979; Van Horne, 1986;Burns and Walker, 1991)
4. What are therelationships betweenfinancial managementpractices, financialcharacteristics and
• Current ratio negatively affects SME profitability, while total asset turnover, working capitalmanagement and short-term planning practices,fixed asset management and long-term planningpractices, and financial and accounting informationsystem positively affect SME profitability (Table5.40, page 226).
6.
What action canimprove financialmanagement andprofitability of SMEsin Vietnam?
6 •
Maintain the appropriate current ratio and payingattention to the trade-off between liquidity andprofitability.
• Raising the efficiency of utilizing total assets toincrease total asset turnover.
• Raising the efficiency of financial managementpractices, particularly the efficiency of workingcapital management, fixed asset management, andfinancial and accountin s stems.
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financial management could lead to high profits and, as such, financial management not
only controls the financial position but also significantly contributes to improving and
increasing profitability of small business. These conclusions suggest that SMEs should
highly regard financial management and view financial management practices as one of
the tools to improve and increase profitability. Moreover, based on the findings of this
research study, the central role of financial management to the success of any SMEs as
indicated by Meredith (1986) has been demonstrated by the empirical data from SMEs in
an emerging economy.
Implication 2: Actions to improve SME profitability
The research model of SME profitability indicates that SME profitability depends upon
efficiency of financial management practices and financial characteristics of SMEs.
Therefore any action that influences financial management practices and financial
characteristics should be carefully considered to determine whether they positively or
negatively impact on SME profitability.
• The current ratio, which is often used as a tool defining and measuring liquidity,
is negatively related to SME profitability, the objectives and policies of liquidity
should be linked to those of profitability. High current ratios tend to high liquidityand low profitability. However, this does not mean the current ratio should be
continuously lowered to raising profitability because such actions will adversely
affect liquidity. The trade-off between liquidity and profitability as indicated by
Van Horne (1986) and demonstrated in this study should be flexibly applied
depending on particular circumstances. Wise policies on financial management
achieve both liquidity and profitability objectives. Unless both these objectives
are achieved, what financial managers should do is to maintain an “appropriate”
current ratio so that the profitability of SMEs will not be adversely affected.
When an enterprise is forced to maintain a relatively high current ratio because of
liquidity problems, the adverse effects of this current ratio on profitability should
be identified and reduced. Short-time investment of the temporary cash surplus
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for profitable purpose is often considered actions to reduce the adverse effects of
maintaining relatively high liquidity ratios.
• In contrast to the current ratio, total asset turnover is positively related to SME
profitability. High total asset turnover leads to higher profitability for SMEs. In
general, actions increasing total asset turnover will positively impact on
profitability. Total asset turnover is defined as the ratio between net sales and total
assets. Therefore increasing net sales or decreasing total assets will cause total
asset turnover to increase. Selling assets that are not necessary for business
operations is a typical example of efforts to increase the efficiency of utilizing
total assets and increase total asset turnover. In addition, efforts of marketing,
sales management, and new product development and the likes will increase net
sales and, as a result, increase total asset turnover and profitability.
Implication 3: Raising the efficiency of financial management practices to improve SME
profitability.
The model of SME profitability indicates that SME profitability is positively related to
the efficiency of financial management practices. Therefore raising the efficiency of
financial management is considered an effective tool for improving and increasing profitability of SMEs. Specifically, the model indicates the efficiency of the following
financial management components are positively correlated to SME profitability:
• working capital management and short-term planning practices including cash
management, receivable management, inventory management and short-term
financial planning regarding working capital
• fixed asset management and long-term financial planning practices consisting of
managing fixed assets, evaluating capital investment projects, and long-term
financial planning regarding capital investments
• financial and accounting information systems practices including systems for
accounting reports and financial reporting and analysis.
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6.3.2 Contribut ions to knowledge of this research into financial
management for SMEs
This research study has made a number of contributions to knowledge in the fields of
SME financial management.
• The model of SME profitability is considered a most significant and important
contribution of this study to knowledge of financial management for SMEs. This
model, in one hand, evaluates the financial management theories provided by
previous researchers by using empirical evidence from an emerging country. On
the other hand, it provides knowledge of simultaneous impacts of financial
management practices and financial characteristics on SME profitability, which
has not investigated previously.
• This model also indicates relationships between variables used to measure
financial characteristics. Specifically, it indicates the negative relationship
between profitability and liquidity and the positive relationship between
profitability and activity.
• A contribution is the use of statistical techniques to identify some relationships
not previously emphasized by researchers – linkages between current ratios and profitability, linkages between financial leverage and profitability, and linkages
between total asset turnover and profitability.
• This study provides details of the relationships between financial management
practices, financial characteristics and profitability of SMEs in developing
nations. Previous research provided a large number of descriptive findings of
financial management and financial characteristics whereas the associative
findings have rarely been investigated. This study supplements the gap by
investigating the association between profitability and financial management
practices, and financial characteristics of SMEs.
• Through the study’s model, testing of the model and revision of the model, the
research demonstrates how field data from an emerging nation (Vietnam) can be
applied to modify theoretical model to reflect the business environment of SMEs.
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Given difficulties in data collection, data related to financial characteristics in this
study were only derived from current financial statements. In consequence, data
collection only provided cross-sectional data related to financial characteristics while the
longitudinal data was not available for this research study. Also, for the purpose of
encouraging and support for the local and private SME development, this study only
focuses on the domestic private sector but does not capture the foreign-owned and state
sectors.
In terms of scope of the study, more specific limitations imposed by the approach
adopted in the investigation include:
• In considering significant aspects of the financial management practices, this
study concentrated on internal factors of SMEs but did not capture much external
environment factors. The internal business functions of the greatest concern in
this study were financial management while other functions such as production
management, marketing management, and personnel management were omitted.
• This study indicates current ratios are negatively related to profitability and
positively related to liquidity and maintaining the appropriate current ratio will
improve SME profitability while the liquidity was not affected. However, this
study could not specify what the appropriate current ratio should be because theappropriate current ratio is dependent on characteristics of each industry. This
requires further research with surveys to indicate appropriate current ratios
corresponding to each industry. Unfortunately, such extended research was
beyond scope of this thesis.
6.5 IMPLICATIONS FOR THE FURTHER RESEARCH
This study was designed to examine relationships between financial management
practices, financial characteristics and SME profitability. Its limitations were examined in
section 6.4. These limitations suggest further research to expand and supplement what
could not be captured in this research. Descriptive findings of financial management
practices, financial characteristics, and SME profitability and conclusions related to the
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Purpose of the survey: The purpose of this survey is to obtain in-depth
information on financial management practices of SMEs located in HoChi Minh City. This information is linked to a project of improving financial
management practices and profitability of SMEs.
Businesses to be surveyed: All small and medium enterprises (SMEs) including stock
companies, limited liabilities companies and private enterprises which have less than 500employees and total capital of less than VND 10 billion will be interviewed in this
survey. Large companies, foreign-invested companies, joint-venture companies and state-
owned enterprises are not included in this survey.
Respondents: We ask that this questionnaire should be answered by the owner or keymanager (e.g., financial manager or chief-accountant) who is responsible for financial
function in your business. We would like you to answer each question from the perspective of the business unit that you manage rather than from the general ideas or
views and please add any additional comments that you believe are appropriate.Non commercialization and confidentiality: Data collected from the survey will be
used to test the model relating to a theory developed as a part of a doctoral thesis. It does
not involve any commercial activities and all information will be treated in strictestconfidence.
How to answer the questions: To answer the questions you simply circle the most
appropriate numbers, which are listed, excepting of some cases you are requested to fill
the appropriate number into the blanks. For example, to answer the following question, ifyour position is “owner” you will circle number 1 as follows:
1.1 What is your position in your business (Please circle one that applies)?
Joint stock company .............................................3
State company ......................................................4Others ..................................................................5, please specify ……………………………….
2.3 How long has your business been established (Please circle one that applies)?
Less than 2 years ..................................................12 – 5 years ............................................................2
6 – 10 years ..........................................................3More than 10 years ...............................................4
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1.3 Does your business ever utilize computers in accounting (Please circle number that applies)? Never ...................................................................1Rarely ..................................................................2
Sometimes ...........................................................3
Often ....................................................................4
4.4 In managing receivables, which areas are computers applied (Circle one that applies)?Managing receivables ..........................................1
Managing bad debts ............................................2
Both .....................................................................3Others ..................................................................3, please specify ………………………………….
4.5 Efficiency of receivable management (Circle one number applies for each scale)
Here are some statements which describe how owner/manager might feel about the efficiency of receivable
management practices. Please indicate the most appropriate number that describes your business position
on the scale.
1 – Extremely negative
5 – Neither negative nor positive
9 – Extremely positive
There are no right or wrong answers to these questions. Just give your opinion about your business.
Low regard High regard
1. How does your business regard to receivables management
practices?
1 2 3 4 5 6 7 8 9
Not regularly at all Very regularly
2. How regularly does your business review debtors’ credit period?
1 2 3 4 5 6 7 8 9
Not reasonable at all Very reasonable3. How reasonable is debtors’ credit period in your business? 1 2 3 4 5 6 7 8 9
Not regular at all Very regular
4. How regular does your business review debtors’ discount
policy?
1 2 3 4 5 6 7 8 9
Not reasonable at all Very reasonable
5. How reasonable is debtors’ discount policy in your business 1 2 3 4 5 6 7 8 9
Not regular at all Very regular
6. How regular does your business review percentage of bad 1 2 3 4 5 6 7 8 9
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6.3 Which area is computer used in managing fixed assets (Circle one that applies)?Assessing capital investment projects .................1Managing fixed assets .........................................2
Both .....................................................................3
No goal or policy .................................................7
7.3 What type of budget does your business regularly prepared? (May circle more than one).Sales budget ........................................................1
7.4 Who is responsible for preparing budgets (Circle one that applies)?Owner ..................................................................1Financial manager ...............................................2
The Socialist Republic of Vietnam is a one-party communist state, extending 1 600 kmfrom latitude 23 degrees north to 9 degrees north along the western rim of the South
China Sea. Occupying 331 114 sq. km. and bordering China to the north, Laos to thewest and Cambodia to the south-west,Vietnam is marked by two delta regions ateither end of the country (the Songkoi - orRed River - in the north, the Mekong in thesouth), which are separated by the narrowregion of the Central Highlands. Theextensive Annamite Mountains dominatethe north-west. Around 16% of Vietnam'sland mass is under cultivation, with theremaining areas either mountainous orforested. Vietnam has substantial territorialclaims in the South China Sea andoccupies a number of reefs and islands. Itscapital, Hanoi, lies on the Red River.
Eighty percent of Vietnam's population of 78 million (1998 official estimate) are ethnic Vietnamese. Significantethnic minorities include the Tai and Hmong in the north and west, the Cham in thecentre, and the Chinese and Khmer in the south. Vietnam has a Buddhist majority, itsreligious minorities including the Cao Dai, the Hoa Hao, and most notably the RomanCatholic, Protestant and Muslim religions.
Vietnam is a member of the UN, ASEAN, ARF, ASEM, APEC and the Non-Aligned Movement. It is currently seeking accession to the WTO.
Historical Overview
After a millennium as a Chinese province, the northern region of Vietnam gainedindependence in 938, following the dissolution of the Tang empire. Under succeedinglocal dynasties ruling from Hanoi over the next five centuries, Vietnam fought off severalattempts to reintegrate it into China and also expanded its reach southward, graduallyannexing the central kingdom of Champa.
Dynastic struggles led to civil wars during the sixteenth, seventeenth, eighteenthcenturies. During this period, Vietnam gained control over the Mekong delta and the first
Christian missions arrived. It was not until 1802 that the present Vietnam was unitedunder a single ruler, Nguyen Anh, whose court was located at the central coastal city ofHue.
Despite the continuation of the Nguyen dynasty, Vietnam saw increasing Frenchintervention from the 1850s. Spurred by Hue's persecution of French Christianmissionaries and their Vietnamese converts and by a desire not to lose eastern markets tothe British, France annexed the southern Cochin-China region, their possession of which
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was recognised by Hue in a 1874 treaty. A treaty of protection over Vietnam followed in1883. By 1901, Vietnam, Cambodia and Laos had fallen collectively under a centralFrench administration, forming the Union Indochinoise.
In the decades before the Second World War, a number of groups opposed tocolonial rule emerged. Following the suppression in the 1900s of early nationalist
movements led by Phan Chau Trinh and Phan Boi Chau and the restriction ofconstitutionalist movements in the 1910s to the Cochin-China region, Vietnamesenationalism adopted a revolutionary flavour during the 1920s. The Communist Party ofIndochina (CPI) was established in 1930. Although suppressed by the French military in1931, the CPI took advantage of an amnesty for political prisoners in 1936 and enjoyedincreasing support from Moscow during the late 1930s. The outbreak of war in 1939 ledto a ban on left-wing activity and the development of secret CPI networks which weremaintained throughout the war. In 1941, the Revolutionary League for the Independenceof Vietnam (Viet Minh) was formed under the leadership of Ho Chi Minh.
Despite the Japanese advance into Vietnam in 1941, a Vichy Frenchadministration maintained authority until early 1945, when it was deposed by the
Japanese and a pro-Japanese government was appointed by Emperor Bao Dai. Followingthe Japanese surrender, the Viet Minh took effective control of a number of provinces,mostly in the north. After the abdication of Bao Dai, Ho Chi Minh declared independenceand the founding of the Democratic Republic of Vietnam on 2 September 1945. But withthe division of Vietnam at the 16th parallel between British forces in the south andChinese forces in the north agreed at the Potsdam Conference, France was able to regaincontrol over the south by the end of 1945 and negotiated the withdrawal of Chinesetroops from the north by March 1946.
Relations between the French and Viet Minh completely broke down by late1946, leading to a protracted guerrilla war which ended with the French defeat at DienBien Phu in May 1954, the Viet Minh being aided to a large extent by Chinesecommunists. A cease-fire agreement at Geneva in the same month provided for a singleVietnam divided at the 17th parallel. Vietnam was to be administered in the north fromHanoi by the government of the Democratic Republic of Vietnam and in the south fromSaigon by the government of the State of Vietnam, which had been founded by theFrench under Bao Dai in 1949. The agreement also provided for the possibility in 1956 ofnational elections which never eventuated. The following decade saw economic andsocial restructuring in the north under the Vietnam Workers' Party (formerly the CPI) andthe dominance of Ngo Dinh Diem in the south.
A Roman Catholic, Diem overthrew Bao Dai to become President in 1955. Untilhis assassination in the 1963 military coup, due in part to increasing Buddhistdissatisfaction with his Catholic-dominated government, Diem took South Vietnamincreasingly into the US sphere, his conflict with communists in South Vietnamdeveloping a cold-war dynamic. Accordingly, the Kennedy and Johnson Administrationscommitted themselves to defending South Vietnam, first with military advisers and thenfollowing the Gulf of Tonkin incident in August 1964 with US military force. Australia, New Zealand, Thailand, South Korea and the Philippines also contributed forces. After aseries of coups in South Vietnam, the constitutional reforms in 1967 led to thegovernment of General Nguyen Van Thieu, which survived until 1975.
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Although enjoying military superiority and seriously disrupting economic life in North Vietnam through aerial bombardment from 1965 to 1968, the domestically beleaguered United States entered into informal negotiations with North Vietnam in1968. With the advent of the Nixon Administration in 1969, the same year as Ho ChiMinh's death, formal negotiations commenced in Paris. Despite Nixon's intention to
reduce US involvement and "Vietnamise" the conflict, a campaign to disrupt communistsupply lines led to the expansion of the conflict into Cambodia and Laos. The ParisAgreement was concluded in March 1973, which provided for the withdrawal of US butnot North Vietnamese troops. Although the agreement notionally provided for SouthVietnam's security, this security was not enforced effectively. Following a final swiftcampaign in early 1975, North Vietnamese forces entered Saigon on 30 April andrenamed it Ho Chi Minh City. Formal reunification took place on 2 July 1976 with thefoundation of the Socialist Republic of Vietnam and in December with the foundation ofthe Communist Party of Vietnam.
In the late 1970s, relations with China soured over border disputes, the plight ofsouthern Vietnam's Chinese, China's support for the hostile Pol Pot regime in Cambodia,
and Vietnam's orientation towards the USSR. Following the Vietnamese-Cambodiaconflict in late 1978 and the imposition of a pro-Vietnamese government, tension withChina increased leading to full-scale conflict in February and March 1979. Sporadicclashes continued throughout the 1980s. Although the USSR-China rapprochement in thelate 1980s and the withdrawal of Vietnamese troops from Cambodia in 1989 helped easeconflict, tensions between Vietnam and China over competing claims in the South ChinaSea continue to the present.
Changing global circumstances and desperate economic conditions within thecountry during the late 1980s forced Vietnam to make its first tentative steps towards political and economic doi moi (renovation). (See political and economic overviews.) In1994, the United States lifted its economic embargo against Vietnam, imposed afterVietnam and Cambodia war. In 1995, Vietnam became the seventh member of ASEAN.In the same year, the United States and Vietnam established full diplomatic relations, thetwo countries signing an agreement to normalise trading relations in July 2000.
Political Overview
Vietnam is one of the world's five remaining one-party communist states. Decisionmaking in Vietnam is shared by national and provincial government and agencies,slowing the political process and encouraging a cautious approach to major policy issues.Political power lies with the Communist Party of Vietnam. Its peak organ, the eighteenmember Politburo, is elected by the Party's Central Committee, of 170 members, andholds authority over the implementation of social, economic, labour, defence, securityand foreign policy. The Party is led by the General Secretary, currently Le Kha Phieu.
Party Congresses are held every five years to ratify major policy changes. The ninthCongress will take place in early 2001. Between Congresses, Central Committee Plenaare convened three or four times per year to decide on important policy issues.
Although still conservatively communist, Vietnam has undertaken some reformsin recent years. In 1986, at a time of economic crisis following years of economicstagnation resulting from the effects of the war and unsuccessful collectivisation programs, the Party embarked upon a program of limited market-based economic
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reforms. These reforms were known as doi moi (renovation) and were aimed at a shifttowards "market economy with socialist orientation". Under doi moi, the private sectorwas permitted to exist in a limited capacity. There was also greater decentralisedeconomic planning and a greater acceptance of market forces as the determinant of pricesand production. Foreign investment was encouraged, and agriculture was deregulated to
allow individual family farms again. Vietnamese living standards rose appreciably, particularly in urban areas.However, the potential benefits of past reforms are now close to being exhausted
and further reform is needed to stimulate the Vietnamese economy. While Vietnam'ssigning in July 2000 of the Bilateral Trade Agreement with the United States indicates acommitment to continued economic reform, the Party remains equally committed to aneconomy which is led by the public sector, dominated by state owned enterprises (SOEs)and protected by government regulation. The prospect of inequitable development andsocial disintegration, which some elements of the Party attribute to market forces, hasalso been a source of considerable debate within the Party. The Party's collectiveambivalence towards reform is reflected in Vietnam's current leadership, representing a
reformist and conservative mix.The Party is presently faced with a conjunction of difficult issues such asincreasing unemployment, growing income disparities between urban and rural areas,social problems (including drug abuse, prostitution and increasing levels of HIV),occasional pockets of provincial unrest, corruption and declining Party membership. Itsoverriding concern is to maintain political and economic stability, which will ensure itscontinued existence in the face of a more open economic environment.
Since the end of 1997, there have been a number of instances where members ofthe Party and the general population have been prepared to express dissent. The Party hasresponded by introducing measures to address the concerns of the general population(such as seeking to channel more of the benefits of economic reform to the rural areasand pursuing administrative reform within the Party) and by projecting itself as the protector of Vietnamese culture. The August 1999 Central Committee Plenum reflectedthese themes, acknowledging that ineffective organisation and a cumbersome politicalstructure, particularly in state administrative management, had been "responsible forreducing the efficiency of the [Party] leadership and management". The Party alsolaunched a campaign of criticism and self-criticism in May 1999, designed to "purify"itself and to stem internal corruption and mismanagement. The dismissal of formerDeputy Prime Minister Ngo Xuan Loc by the National Assembly in December 1999represents the most prominent outcome of this campaign.
Although political reform has never been articulated as an objective, and the paramount position of the Party has never been under challenge, the National Assemblytook some cautious steps in 1998 away from complete dominance by the Party, withunexpectedly heated debate over key provisions of legislation relating to land andcitizenship. The release of a number of leading dissidents in successive Presidentialamnesties, including many prisoners on the Australian Government's list of cases ofconcern who are believed imprisoned for the peaceful expression of their political orreligious beliefs, was taken as an indication of greater political openness.
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President Tran Duc LuongVice-President Nguyen Thi BinhPrime Minister Phan Van KhaiDeputy Prime Minister Nguyen Tan Dung
Deputy Prime Minister Nguyen Manh CamDeputy Prime Minister Nguyen Cong TanDeputy Prime Minister Pham Gia KhiemMinister of Agriculture and Rural Development Le Huy NgoMinister of Construction Nguyen Manh KiemMinister of Culture and Information Nguyen Khoa DiemMinister of Defence Pham Van TraMinister of Education and Training Nguyen Minh HienMinister of Finance Nguyen Sinh HungMinistry of Fisheries Ta Quang NgocMinister of Foreign Affairs Nguyen Dy Nien
Minister of Health Do Nguyen PhuongMinister of Industry Dang Vu ChuMinister of Justice Nguyen Dinh LocMinister of Labour, War Invalids and Social Affairs Nguyen Thi HangMinister of Planning and Investment Tran Xuan GiaMinister of Public Security Le Minh HuongMinister of Science, Technology and Environment Chu Tuan NhaMinister of Trade Vu KhoanMinister of Transport and Communications Le Ngoc HoanGovernor of the State Bank Le Duc ThuyMinister, Committee for Ethnic Minorities and Mountainous Areas Hoang Duc Nghi
Minister, Government Committee of Organization and Personnel Do Quang TrungMinister, State Inspectorate Ta Huu ThanhMinister, Office of Government Doan Manh GiaoMinister, Committee and Physical Culture and Sport Ha Quang DuMinister, National Committe for Population and Family Planning Tran Thi Trung ChienMinister, National Committee for Protection and Care of Children Tran Thi Thanh Thanh Politburo of the Communist Party of Vietnam
Le Kha Phieu* (General Secretary)Tran Duc Luong* (President)Phan Van Khai* (Prime Minister)
Nong Duc Manh* (Chairman of the National Assembly)Pham The Duyet* (Former Chairman of the Hanoi Party Committee, President of theVietnam National Fatherland Front) Nguyen Phu Trong* (special member assisting Mr Duyet) Nguyen Manh Cam (Deputy Prime Minister) Nguyen Duc Binh Nguyen Van An
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Pham Van Tra (Minister of Defence) Nguyen Thi Xuan MyTruong Tan Sang (Head, Economic Commission of the CPV Central Committee)Le Xuan TungLe Minh Huong (Minister of Public Security)
Nguyen Tan Dung (Deputy Prime Minister)Pham Thanh Ngan Nguyen Minh Triet (Party Secretary, Ho Chi Minh City)Phan Dien
Economic Overview
Key Indicators
Population (1998) :78.1 millionExchange rate (15/3/2000) :7636 dong/A$GDP per capita (1999) :approx. US$360GDP growth (1999) :4.8%
The Vietnamese economy is currently in transition from a centrally planned to a market- based economy. However, the economy is still largely centrally planned, with state
ownership still the predominantform of ownership. The
government is committed to statesector dominance as a key featureof the Vietnamese economy. Thisis effected through measures suchas price controls, production planning and access to credit.However, there has been somedevelopment of monetary, fiscaland trade policy as tools ofeconomic management within thecontext of maintaining a "socialist
economy with a marketorientation". The financial sectoris in poor shape, Moody's ratings agency recently giving Vietnam a B1 rating. Vietnamhas a controlled exchange rate which is allowed to fluctuate within a very narrow band.While the dong has been gradually depreciating as permitted by this band, it is stillgenerally regarded to be overvalued.
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The state owned sector is not only protected from international competition, butalso from the domestic private sector. However, as part of broader efforts to improve theinvestment climate for domestic and foreign investors alike, as well as provideemployment opportunities for Vietnamese, the government has recognised the legitimacy
of the private sector and the
inherent disadvantages it facesvis-a-vis the state owned sector.The government is undertaking a privatisation process(equitisation) to improve theoverall performance of the stateowned sector and allow the private sector to operate in moresectors. The Enterprise Law, passed in 1999, was the first stepin providing a legal platform for
private sector development.Equitisation has not proceeded asquickly as the government has expected, in part because many state assets are notattractive investment options. Key sectors, such as aviation, power supply,telecommunications and post are among industries which will remain monopolised bylarge SOEs, and subject to central planning management mechanisms.
Vietnam has committed to global economic integration through its participation inAFTA and APEC, its WTO accession negotiations and most recently its signing in July2000 of the US-Vietnam Bilateral Trade Agreement. However, global integration is along-term objective and the Government has recently introduced a number of policieswhich appear to contradict the spirit of trade liberalisation. Although activelyencouraging exports, Vietnam is pursuing an import substitution industrialisation policywhich affords disproportionate protection to the predominant state owned sector, andrestricts imports in an ad hoc manner to protect its currency.
Recent Economic Performance
The Vietnamese Government's underlying objective is to achieve stable and higheconomic growth and development. Such growth was achieved in the early to mid 1990s,with real growth averaging 8% annually. However, the combined effects of the stallingreform process, the regional economic crisis, falling demand, including declining foreignand domestic investment, have slowed growth. According to official figures, GDP growthdeclined from 9.5% and 9.3% in 1995 and 1996 to 4.8% in 1999. The IMF estimatedgrowth at 3.5% and the World Bank at around 4% in 1999. With an official growth rate
of 6.2% for the first half of 2000 (partly the result of the recently improved value of itscrude oil exports), Vietnam is expected to meet the government's growth target for 2000of around 6%. The government has attempted to stimulate growth through a combinationof fiscal and monetary policy measures. However, these have yet to prove fruitful. In1999, unemployment was estimated at 7.4% by the World Bank. This is a major preoccupation for the Vietnamese government in its efforts to maintain economic and political stability. The economy does not generate enough jobs to accommodate the
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