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Southern Cross University

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2001

Financial management and protability of smalland medium enterprises

Kieu Minh NguyenSouthern Cross University

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http://epubs.scu.edu.au/

http://epubs.scu.edu.au/theses

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http://epubs.scu.edu.au/theses

http://epubs.scu.edu.au/



A THESIS SUBMITTED TO THE GRADUATE COLLEGE OF MANAGEMENT IN PARTIAL

FULFILLMENT OF REQUIREMENTS FOR THE DEGREE OF

DOCTOR OF BUSINESS ADMINISTRATION

AT SOUTHERN CROSS UNIVERSITY, N.S.W., AUSTRALIA



Certificate

I certify that the substance of this thesis has not already been submitted for any degree

and is not currently being submitted for any other degree or qualification.

I also certify that, to the best of my knowledge, any help received in preparing this thesis,

and all sources used have been acknowledged in this thesis.

Signature: Kieu Minh Nguyen ______________________

Date: ___________________________________________

ii



Acknowledgements

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



I would particularly like to thank the following friends for their support related to

data collection: Mr. Doan Thanh Tuan, Ms. To Ngoc Huong, and Mr. Bui Hai Binh from

Truong Doan Company Limited, Mr. Hoang Trong from Ho Chi Minh City University of

Economics, Mr. Vo Sy Nhan from Ho Chi Minh City Department of Investment and

Planning, and all my students who worked as fieldworkers for data collection.

Finally, to my parents and my wife, I wish to extend my loving thanks for their

encouragement. My greatest debt of gratitude is to my wife, Mrs. Que Thi Tran, who was

patiently waiting me during my study in Australia. This thesis could not have been

written without her daily encouragement.

iv



Abstract

After a decade of reforming policy, building and developing the multi-sector market

economy, Small and Medium Enterprises (SMEs) in Vietnam have developed strongly

and contributed to creating employment, increasing GDP, and raising the nation’s volume

of exports. However, SMEs have found difficulties on the way to development due to

lack of management experience and financial resources, and due to uncertainty within the

business environment. As a result, SMEs often faced obstacles during their operations.

This thesis examines the relationship between financial management and profitability of

SMEs to determine whether financial management practices and financial characteristics

impact on SME profitability.

Objectives of the thesis are (1) to investigate and describe features of financial

management practices and financial characteristics of SMEs in Vietnam, (2) to develop

and test a model of SME profitability, and (3) to contribute knowledge of the

relationships between financial management and characteristics to improve SME

profitability by using tools of efficient financial management.

In terms of structure, the thesis has six chapters. The thesis begins by defining the

research problem and questions, and providing a justification for the research study.

Chapter one also reviews the research background, and presents definitions of terms,

significance and scope of the study. Chapter two examines the economic background,

business structure and the development of SMEs in Vietnam. This chapter also reviews

previous research related to financial management for SMEs in Vietnam to identify gaps

between financial management for SMEs in Vietnam and financial management for

SMEs worldwide.

Chapter three reviews financial management including financial management

practices, financial characteristics and profitability of SMEs around the world, especially

in the developed economies such as the United States of America (USA), the United

Kingdom (UK), Australia and Canada. This review emphasizes profitability and the

impact of financial management practices and financial characteristics on SME

profitability. Objectives of this chapter are to review previous research related to the

areas of financial management practices, financial characteristics, and profitability of

v



SMEs and to build a model of the impact of financial management practices and financial

characteristics on SME profitability.

Chapter four discusses aspects of the research methodology including research

design, data collection and data analysis methods, and hypothesis testing to support the

model. Objectives of this chapter are: (1) to justify the research methodology of this

study, (2) to explain research methodology used in the study, and (3) to demonstrate how

research design, and data collection and analysis can be utilized in this study to answer

the research questions outlined in the chapter 1.

Data analysis and findings are presented in chapter five. This chapter presents

descriptive findings of financial management practices, financial characteristics and SME

profitability and findings of the research study related to testing the model of SME

profitability. Objectives of this chapter are (1) to systematically present the descriptive

findings of the research study, (2) to interpret significance of these findings based on data

analysis, (3) to present the results of testing the model of SME profitability, and (4) to

explain how the model, developed from a literature review, was supported by data

analysis. Finally, the thesis ends with chapter six where conclusions are summarized and

applications of the research findings are indicated for the financial management

practitioners.

The thesis provides descriptive findings of financial management practices and

financial characteristics and demonstrates the simultaneous impact of financial

management practices and financial characteristics on SME profitability. In addition, the

research study provides a model of SME profitability, in which profitability was found to

be related to financial management practices and financial characteristics. With the

exception of debt ratios, all other 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

found to be significantly related to SME profitability.

With the findings as presented above, this research study provides many

implications for financial management practices and contributes to knowledge of

financial management of SMEs. The model of SME profitability can be used as guidance

for actions to improve the profitability of SMEs in Vietnam.

vi



Glossary of terms and abbreviations

AFTA ASEAN Free Trade Agreement

ANOVA Analysis of variance

APEC Asia Pacific Economic Cooperation

ASEAN Association of South East Asian Nations

CED Committee of Economic Development

CF Cash flows

CUR Current ratio

DER Debt ratio

E.q Equation

EBT Earning before tax

EBIT Earning before interest and taxes

EFF Efficiency of financial management practices

EOQ Economic order quantity

FAIS Financial and accounting information system

FALP Fixed asset management and long-term planning practices

FDI Foreign direct investment

FSSB Financial Studies of the Small Business

GDP Gross domestic products

GSO General Statistical Office

IFC International Financial Corporation

IRR Internal rate of return

MIRR Modified internal rate of return

MPDF Mekong Project Development Facilities

NOI Net-operating-income

NPV Net present value

PRO Profitability

RE Retained earnings

ROA Return on assets

vii



ROE Return on equity

ROI Return on investment

ROS Return on sales

SBA The Small Business Administration (United State of America)

SBV The State Bank of Vietnam

SME Small and medium enterprise

SMENET Small and Medium Enterprise Net

SPSS The Statistical Package for Social Science

TA Total assets

TAT Total asset turnover

UK United Kingdom

USA United States of America

USM Unlisted Securities Market

VCCI Vietnamese Chamber of Commerce and Industry

VIDB Vietnam Investment and Development Bank

VN Vietnam

VND Vietnam dong

Vietcombank Vietnam Bank for Foreign Trade

WTO World Trade Organization

WCSP Working capital management and short-term planning practices

viii



Table of Contents

CERTIFICATE.......................................................................................................................................... ii

ACKNOWLEDGEMENTS ....................................................................................................................... iii

ABSTRACT .............................................................................................................................................. v

GLOSSARY OF TERMS AND ABBREVIATIONS ................................................................................ vii

TABLE OF CONTENTS .......................................................................................................................... ix

LIST OF TABLES..................................................................................................................................... xiii

LIST OF FIGURES .................................................................................................................................. xvii

CHAPTER ONE: INTRODUCTION TO THE STUDY

1.1 INTRODUCTION ...................................................................................................................1

1.2 RESEARCH BACKGROUND .................................................................................................3

1.3 RESEARCH PROBLEM .........................................................................................................4

1.3.1 Research questions ...................................................................................................6

1.3.2 Research objectives ..................................................................................................6

1.4 METHODOLOGY....................................................................................................................7

1.5 JUSTIFICATION FOR THE STUDY.......................................................................................8

1.6 DEFINITIONS OF TERMS USED IN THE STUDY ................................................................10

1.7 SIGNIFICANCE AND SCOPE OF THE STUDY ....................................................................13

1.8 ANALYTICAL MODEL FOR THE STUDY..............................................................................13

1.9 STRUCTURE OF THE STUDY ..............................................................................................15

1.10 CONCLUSIONS .......................................................................................................................16

CHAPTER TWO: THE ECONOMIC STRUCTURE AND SMEs IN VIETNAM

2.1 INTRODUCTION ....................................................................................................................17

2.2 VIETNAM: BACKGROUND INFORMATION..........................................................................19

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



2.4 SMALL AND MEDIUM ENTERPRISE FINANCE IN VIETNAM.............................................51

2.4.1 Types of finance.........................................................................................................52

2.4.2 Use of finance............................................................................................................53

2.4.3 Financial management for SMEs...............................................................................54

2.4.4 Problems in financial management............................................................................55

2.5 BUSINESS STRUCTURE AND SMEs IN HO CHI MINH CITY .............................................56

2.6 CONCLUSIONS......................................................................................................................58

CHAPTER THREE: FINANCIAL MANAGEMENT AND PROFITABILITY OFSMEs

3.1 INTRODUCTION ....................................................................................................................59

3.2 DEFINITIONS OF SMEs.........................................................................................................61

3.2.1 Qualitative definitions.................................................................................................61

3.2.2 Quantitative definitions ..............................................................................................64

3.2.3 The forms of ownership of SMEs...............................................................................65

3.3 FINANCIAL MANAGEMENT FOR SMEs...............................................................................67

3.3.1 Defining financial management .................................................................................68

3.3.2 Objectives of financial management..........................................................................69

3.3.3 Major decisions of financial management .................................................................71

3.3.4 The specific areas of financial management .............................................................72

3.4 FINANCIAL MANAGEMENT PRACTICES.............................................................................76

3.4.1 The context of financial management practices ........................................................76

3.4.2 Accounting information systems................................................................................77

3.4.3 Financial reporting and analysis ................................................................................83

3.4.4 Working capital management ....................................................................................89

3.4.5 Fixed asset management ..........................................................................................95

3.4.6 Capital structure management...................................................................................100

3.5 FINANCIAL CHARACTERISTICS OF SMEs .........................................................................104

3.5.1 Identifying financial characteristics ............................................................................104

3.5.2 Measuring financial characteristics............................................................................107

3.5.3 Previous findings related to financial characteristics.................................................111

3.6 SME PROFITABILITY.............................................................................................................119

3.6.1 Importance of profitability...........................................................................................119

3.6.2 Defining and measuring profitability...........................................................................120

3.6.3 Factors influencing profitability ..................................................................................123

3.7 RELATIONSHIPS BETWEEN FINANCIAL MANAGEMENT AND SME PROFITABILITY....126

3.8 MODEL OF THE IMPACT OF FINANCIAL MANAGEMENT ON SME PROFITABBILITY....128

x



3.9 CONCLUSIONS......................................................................................................................131

CHAPTER FOUR: RESEARCH METHODOLOGY

4.1 INTRODUCTION ....................................................................................................................132

4.2 APPRAISAL OF PRIOR RESEARCH METHODOLOGIES ...................................................134

4.3 RESEARCH DESIGN .............................................................................................................137

4.3.1 Classification of research design...............................................................................137

4.3.2 Selecting research design or paradigm .....................................................................140

4.3.3 Selecting research methods or techniques ...............................................................141

4.4 VARIABLE DEFINITIONS, SURVEY INSTRUMENT AND MODEL DEVELOPMENT..........144

4.4.1 Variable measurements and survey instrument ........................................................144

4.4.2 Model development....................................................................................................162

4.4.3 Hypothesis statements ..............................................................................................165

4.5 DATA COLLECTION METHODS ...........................................................................................168

4.5.1 Secondary data collection..........................................................................................169

4.5.2 Primary data collection ..............................................................................................170

4.6 DATA TRANSFORMATION ..................................................................................................174

4.7 DATA ANALYSIS METHODS.................................................................................................175

4.7.1 General consideration................................................................................................175

4.7.2 Descriptive statistics ..................................................................................................176

4.7.3 Bivariate analysis .......................................................................................................177

4.7.4 Multivariate analysis...................................................................................................178

4.8 CONCLUSIONS......................................................................................................................183

CHAPTER FIVE: DATA ANALYSIS AND FINDINGS

5.1 INTRODUCTION ....................................................................................................................184

5.2 LINKS BETWEEN DATA ANALYSIS AND RESEARCH OBJECTIVES AND QUESTIONS.186

5.3 DESCRIPTIVE FINDINGS OF THE RESEARCH STUDY.....................................................187

5.3.1 Sample descriptions and SME characteristics ..........................................................187

5.3.2 Descriptive findings of financial management practices............................................190

5.3.3 Descriptive findings of financial characteristics .........................................................206

5.3.4 Descriptive findings of profitability of SMEs...............................................................211

5.4 ASSOCIATIVE ANALYSIS AND FINDINGS OF THE RESEARCH STUDY..........................215

5.4.1 Factor analysis and principal components of financial management practices ........216

5.4.2 Bivariate analysis and findings ..................................................................................221

5.4.3 Multiple regression analysis and findings ..................................................................225

xi



5.4.4 Test for the difference of average profits between efficient and inefficient financial

management groups of SMEs....................................................................................234

5.5 CONCLUSIONS......................................................................................................................236

CHAPTER SIX: CONCLUSIONS AND IMPLICATIONS

6.1 INTRODUCTION ...................................................................................................................237

6.2 CONCLUSIONS RELATED TO RESEARCH QUESTIONS AND TESTING THE MODEL..239

6.2.1 Conclusions related to financial management practices ...........................................239

6.2.2 Conclusions related to financial characteristics.........................................................247

6.2.3 Conclusions of SME profitability ................................................................................249

6.2.4 Summary of research question answers ...................................................................255

6.3 IMPLICATIONS OF THE RESEARCH STUDY.....................................................................258

6.3.1 Implications for financial management practices of SMEs........................................258

6.3.2 Contributions to knowledge of this research into financial management for SMEs ..262

6.4 LIMITATIONS OF THE RESEARCH STUDY .......................................................................263

6.5 IMPLICATIONS FOR THE FURTHER RESEARCH.............................................................264

Bibliography ......................................................................................................................................266

Appendix 1

Appendix 2

Appendix 3

Appendix 4

xii



List of tables

Table Page

2.1 Changes in economic structure, 1986 – 1991............................................................27

2.2 State-budget revenue, 1986 – 89................................................................................28

2.3 State-budget revenue, 1991 – 93................................................................................29

2.4 Financial institutions in Vietnam, 1995.....................................................................30

2.5 GDP index by economic sector and rate of inflation.................................................31

2.6 Index of exchange rate of USD/VND........................................................................32

2.7 GDP index by economic industry..............................................................................32

2.8 Agriculture development over the years ....................................................................33

2.9 Industry development over the years.........................................................................34

2.10 Export and import value by major countries..............................................................35

2.11 Population by sex and areas.......................................................................................38

2.12 Population growth rates and structure........................................................................39

2.13 Labor force by economic sector.................................................................................39

2.14 Labor force by the state and non-state sector.............................................................40

2.15 Unemployment rate of labour force in 1998..............................................................40

2.16 Number of businesses by economic sector and average capital ................................43

2.17 Number of businesses and employees on July 1, 1995..............................................44

2.18 Definitions of SMEs in Asian countries ....................................................................46

2.19 Number of enterprises in manufacturing industry by scale of employees and total

capital.........................................................................................................................49

2.20 Business operation problems of SMEs in Vietnam ...................................................50

2.21 The kind of SME support programs...........................................................................51

2.22 Some financial characteristics of SMEs in Vietnam..................................................54

2.23 Business structure of SMEs in Ho Chi Minh City.....................................................57

2.24 Size of businesses in Ho Chi Minh City....................................................................57

3.1 Summary of the quantitative definitions of small business .......................................65

3.2 Forms of SME ownership in the USA .......................................................................65

3.3 Legal status of small firms in the UK ........................................................................66

xiii



3.4 Summary of advantages and disadvantages of each form of ownership ...................67

3.5 Responsibility for the bookkeeping and accounting task ..........................................78

3.6 Responsibility for preparation and use of financial information ...............................78

3.7 The results of survey of computer software application............................................79

3.8 The most important applications of computer software ............................................79

3.9 The most important applications of computers..........................................................80

3.10 Percentage of awareness and utilization of costing systems......................................81

3.11 Evaluate the adequacy of accounting records............................................................82

3.12 Accounting information prepared externally or internally ........................................82

3.13 Summary of research areas related to the accounting system practices of SMEs .....83

3.14 Use of financial statement techniques by small manufacturers in Quebec................84

3.15 Responsibility for financial statement interpretation.................................................85

3.16 Proportion of respondents indicating use of selected financial ratios........................86

3.17 Percentage of use of financial ratios..........................................................................87

3.18 Percentage of preparing accounting information both internally and externally.......88

3.19 Summary of the main research areas related to the financial reporting and analysis89

3.20 Cash surplus investment practices .............................................................................90

3.21 Instruments of short-term investment used................................................................91

3.22 Awareness and utilization of credit control systems..................................................92

3.23 Methods used by small and large enterprises to determine inventory level ..............92

3.24 Working capital management: Frequency (%) of using or reviewing.......................93

3.25 Summary of working capital management practices.................................................95

3.26 Percentage of firms using capital project selection methods.....................................96

3.27 The extent of use of formal methods of the capital investment evaluation ...............96

3.28 Primary method of investment analysis.....................................................................97

3.29 Percentage use of different methods by small, medium, and large enterprises .........97

3.30 Percentage of kinds of screening rate used to evaluate the capital projects ..............98

3.31 Methods of determining the required rate of return as using discounted cash flow..99

3.32 Summary of fixed asset management practices.........................................................99

3.33 Viewpoint guiding firms’ financing decisions...........................................................102

3.34 Factors influencing percentage of bank debt usage ...................................................103

xiv



3.35 Summary of literature review of financial characteristic variables ...........................106

3.36 Summary of measurement of financial characteristic variables ................................110

3.37 Financial ratios used in the study of Meric and Meric (1997)...................................117

3.38 Comparison of liquid ratios between Korean and USA firms...................................118

3.39 Summary of measurement of SME profitability........................................................123

4.1 Classification of research designs..............................................................................139

4.2 Summary of advantages and disadvantages of the most typical surveys...................143

4.3 Model classification...................................................................................................163

4.4 Number and percentage of SME sample and population...........................................174

4.5 Summary of multivariate techniques for the analysis of dependence........................181

5.1 Structure of SMEs in the sample by type of industry and form of ownership...........187

5.2 Sample distribution by form of ownership within industry.......................................189

5.3 Business characteristics of SMEs in the sample........................................................189

5.4 Characteristics of accounting system organization....................................................190

5.5 Responsibility – accounting information system.......................................................191

5.6 Using computer in accounting information system ...................................................192

5.7 Kinds of financial statements prepared......................................................................193

5.8 Frequency of preparing and analyzing financial statements......................................193

5.9 Responsibility – preparing and analyzing financial statements.................................194

5.10 Kinds of financial analysis and ratios used................................................................194

5.11 Preparing cash budgets ..............................................................................................196

5.12 Cash balance determination .......................................................................................196

5.13 Cash surplus or shortage ............................................................................................197

5.14 Sales on credit and credit polices...............................................................................198

5.15 Frequency of reviewing receivable levels and bad debts...........................................199

5.16 Percentage of bad debts compared to sales................................................................199

5.17 Frequency of reviewing inventory levels and preparing inventory budgets..............200

5.18 Basis of determining inventory levels and using EOQ Model ..................................201

5.19 Frequency of evaluating investment projects and reviewing efficiency of using

fixed assets after investing.........................................................................................202

5.20 Methods used to evaluate investment projects...........................................................203

xv



5.21 Frequency of preparing and reviewing financial budgets..........................................204

5.22 Kinds of financial budgets prepared ..........................................................................204

5.23 Responsibility – preparing financial budgets.............................................................205

5.24 Frequency of comparing between budgeted and actual results .................................205

5.25 Descriptive statistics of financial ratios.....................................................................207

5.26 Test for difference of means of financial ratios between two groups........................208

5.27 Comparison of current ratios .....................................................................................208

5.28 Descriptive findings of SME current ratios ...............................................................209

5.29 Descriptive findings of SME debt ratios....................................................................210

5.30 Descriptive findings of SME activity ratio................................................................211

5.31 Overview of SME profitability..................................................................................213

5.32 Relationship between profitability and types of business..........................................213

5.33 Relationship between profitability and business characteristics................................214

5.34 Total variance explained and three principal components of financial management

practices .....................................................................................................................217

5.35 Factor analysis results for measuring financial management practices .....................219

5.36 Three principal components of financial management practices...............................218

5.37 Correlation matrix of PRO, ROS, ROA, and ROE....................................................222

5.38 Correlation matrix of PRO and independent variables..............................................223

5.39 Correlation matrix of ROS and the independent variables ........................................224

5.40 SME profitability regression model using profitability as dependent variable .........226

5.41 Descriptive finding of relationship between profitability and current ratio ..............227

5.42 Relationship between SME profitability and the efficiency of financial

management practices................................................................................................230

5.43 Regression model of SME profitability after removing debt ratio ............................231

5.44 SME profitability regression model using return on sales as dependent variable .....232

5.45 Descriptive statistics of profitability of two groups of SMEs....................................235

5.46 Independent group test of mean profit difference......................................................235

6.1 Summary of conclusions related to financial management practices ........................246

6.2 Summary of conclusions related to financial characteristics of SMES .....................249

6.3 Summary of research questions and answers.............................................................257

xvi



List of figures

Figure Page

1.1 Structure of chapter 1.................................................................................................2

1.2 Fields of the research problem...................................................................................5

1.3 Analytical model for the research..............................................................................14

1.4 Structure of the study.................................................................................................15


2.2 Political structure of Vietnam ....................................................................................23

2.3 Business structure in Vietnam ...................................................................................41

2.4 Breakdown of business by size..................................................................................42

2.5 SME financial management practices and the gap ....................................................56


3.2 The central position and role of financial management.............................................68

3.3 The relations among objectives of financial management.........................................70

3.4 A model of financial management.............................................................................74

3.5 Interaction between theories and practices of financial management .......................75

3.6 Financial ratios linked to return on equity .................................................................125

3.7 Model of the impact of financial management on SME profitability........................130


4.2 Survey instrument for measuring accounting information system ............................148

4.3 Survey instrument for measuring financial reporting and analysis ...........................150

4.4 Survey instrument for measuring cash management practices..................................152

4.5 Survey instrument for measuring receivable management practices.........................154

4.6 Survey instrument for measuring inventory management practices..........................156

4.7 Survey instrument for measuring fixed asset management .......................................157

4.8 Survey instrument for measuring financial planning.................................................159

4.9 Analytical model for the research study ....................................................................165

4.10 Structure of SMEs in Vietnam and the target population..........................................171

4.11 A classification of multivariate methods ...................................................................179

xvii




5.2 Distribution of sample by industry ............................................................................188

5.3 Distribution of sample by ownership.........................................................................188

5.4 Relationship between profitability and debt ratio......................................................229


6.2 The revised model of SEM profitability ....................................................................254

xviii



Chapter One:

Introduction to the Study

1.1 INTRODUCTION

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.



Chapter One: Introduction to the Study

Figure 1.1: Structure of chapter 1

1.3 Research problem

1.3.1 Research questions 1.3.2 Research objectives

1.4 Methodology

1.5 Justification for the study

1.6 Definitions of terms used in the study

1.9 Structure of the study

1.10 Conclusions

1.8 The analytical model for the study

1.7 Significance and scope of the study

1.2 Research background

1.1 Introduction

Source: Developed for the thesis




1.2 RESEARCH BACKGROUND

In the mid-1980s, Vietnam could be characterized as having a strong command-

economy system. However, difficulties from 30 years of war and the inefficiency of

the command-economy system had led the national economy to the brink of disaster.

Faced with stagnant growth, a severe shortage of food, deficit budgets, increases in

inflation and chronic trade imbalances, the Government of Vietnam initiated an

economic renovation policy in December 1986.

Economic reform has taken place in many areas but typically has focused on

four main areas (Le, 1992). The first was to change from a centrally planned and

controlled economy to a market economy regulated by the government. The second

involved a shift from the policy of giving priority to the state and collective sectors to

the policy of developing multi-sector businesses and promoting private businesses.

The third was to change investment policy that had formerly emphasized heavy

industries into policies of priority for development of food and consumer goods

production, and goods production for exports. In terms of international economic

relations, the government has encouraged all economic sectors to diversify exporting

products and markets instead of focussing on the traditional ones such as the former

Soviet Union and Eastern European countries (Le, 1992).

It is apparent that since the government introduced the series of economic

reforms known as doi moi (renovation), the private sector has rapidly grown in terms

of the number of businesses, capital and employees. From the base of zero in 1991,

the number of private businesses and limited companies had quickly risen to 28,811 in

1998 (Tran, 1998, p. 54) and almost all are small and medium enterprises (SMEs).

SMEs have contributed considerably to growing GDP and creating jobs for labour-

age people. Vu (1998, p. 18) summarizes SME contributions as follows:

• providing a large number of diversified products, occupying 26 percent of

GDP and 30 percent of industrial outputs,

• creating jobs for 4.5 million people,

• mobilizing temporarily unused resources such as land, capital, labour and

management skills to develop production, and

• increasing export volume and lessening trade deficits.




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


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




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





1.3.1 Research questions

Research questions involve the research translation of “problem” into the need for

inquiry (Zikmund, 1997, p.88). The research problem defined above leads to the

following research questions:

• How important are SMEs in Vietnam and are they profitable? (answered in

chapters 2 and 5)

• How have researchers in the literature review, identified the context of

financial management practices and financial characteristics, and how have

they proposed to measure SME profitability? (answered in chapter 3)

• How important are financial management practices and financial

characteristics to SME profitability? (answered in chapter 3)

• What are the relationships between financial management practices, financial

characteristics and SME profitability? (answered in chapters 4 and 5)

• How do financial management practices and financial characteristics affect

SME profitability? (answered in chapters 4 and 5)

• What action can improve financial management and profitability of SMEs in

Vietnam? (answered in chapters 5 and 6)

1.3.2 Research objectives

A research objective is the researcher’s version of a business problem. Objectives

explain the purpose of the research in measurable terms and define standards of what

the research should accomplish (Zikmund 1997, p. 89). In solving the research

problem and answering the research questions mentioned previously, this study has

the following objectives:

to collect descriptive evidence on financial management practices, financial

characteristics and profitability of SMEs in Vietnam

•

•

•

to develop a model of the impacts of financial management practices and

financial characteristics on SME profitability

to contribute to knowledge of the relationships of financial management

practices, financial characteristics and SME profitability.




1.4 METHODOLOGY

In choosing a research design, Zikmund (1997, p. 37) discusses three types of

business research: exploratory, descriptive and causal research.

• Exploratory research is usually conducted to clarify and define the nature of a

problem.

• Descriptive research is designed to describe characteristics of a population or

phenomenon.

• Causal research is conducted to identify cause-and-effect relationships among

variables where the research problem has already been narrowly defined.

Choosing a type of research depends upon the research questions that the researcher

wants to answer. This research study is designed to describe characteristics of

financial management practices of SMEs and investigates the impact of the financial

management practices and financial characteristics on SME profitability. Thus,

“descriptive” was viewed as an appropriate research type. Also, this research is

designed to identify the cause-and-effect relationships between efficient financial

management practices and profitability of SMEs. Thus causal research was also

implemented in combination with descriptive research. In summary, a combination of

descriptive and causal research has been chosen for this research.

Selecting research design is the next step after choosing type of research. There

are four types of research design from which to select: survey, experiments,

observation and secondary data (Zikmund, 1997). Selection of research design is

based on the advantages and disadvantages of each kind of research designs and

circumstances in which the research problem is defined. In this research, both survey

and secondary data methods are used in combination.

Survey was chosen as a research technique in this study to investigate and

describe financial management practices of SMEs in Vietnam. Questionnaires were

designed and directly delivered to SMEs to collect data related to financial

management practices. The argument for choosing survey was twofold. Firstly,

surveys provide quick, efficient and accurate means of assessing information about

the population. Secondly, surveys are more appropriate in cases where there is lack ofsecondary data.




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.




• 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




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




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,




fixed asset management and financial planning. The extent of efficiency of each

financial management component is measured by the sum of points of eight items on

the nine-point scale (1 = not efficient at all, 9 = very efficient). If the sum of points of

a financial management component of a business is greater than the average point of

40 (8 x 5 point average), the business is said to be “efficient” in practising that

financial management component. Conversely, if that sum is less than the average

point of 40, the business is said to be “not efficient” or “inefficient” in practising that

financial management component. Lastly, a business is said to be “efficient” in

financial management practices, if all components of financial management practices

are efficient, that is, all sums of points of components are greater than the average

point of 40.Manager refers to the person who is hired to run and manage the business

whereas owner-manager refers to the person who plays the role of both owner and

manager.

Financial characteristics of the enterprise are represented by financial ratios,

derived from financial statements. This information can be used to quantify the

position of SMEs in terms of their profitability, liquidity, and leverage and to compare

them with other or large enterprises (McMahon et al. 1993). In this study, financial

characteristics are measured by three variables including liquidity, financial leverage

and business activity, which are derived from financial statements.

SME profitability is an abstract concept. There are many different ways to

measure profitability. This research limits the measures of SME profitability at the

following ratios: (1) return on sales, (2) return on assets, and (3) return on equity. This

limitation is necessary to narrow the scope of the study and is suitable for financial

management practices for SMEs in Vietnam. In addition, in this study, the concept of

profitability is defined as a comparative concept. A business is said to be “profitable”

if it produces annual average returns (average of return on sales, return on assets and

return on equity) that are greater than the free-risk rate of interest, which was

estimated as 5.4% percent at the middle of the year 2000 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”. The arguments for the concept of

profitability will be explained in chapters 4 and 5.




1.7 SIGNIFICANCE AND SCOPE OF THE STUDY

Completing this study brings together aspects of theory and practice. For theory, this

study is an expansion of previous studies on financial management practices and

financial characteristics of SMEs by focussing on examining the simultaneous

impacts of financial management practices and financial characteristics on SME

profitability. In addition, utilizing data from Vietnam, one of the emerging economies,

contributes to the literature of SME financial management, which traditionally

concentrates on SMEs of developed economies rather than SMEs in other economies.

Using data from Vietnam to test theories of financial management helps to confirm

and expand the scope of theoretical applications.

In practice, this study is significant for financial management practices in

Vietnam. Results will indicate relationships between financial management practices,

financial characteristics and SME profitability and will assist owner-managers and

financial managers to improve performance and profitability of their businesses by

managing financial matters efficiently and effectively.

1.8 ANALYTICAL MODEL FOR THE STUDY

The analytical model for this research, which is developed and justified in the

literature review chapters, and which ultimately provides structure to the empirical

chapters, is illustrated in figure 1.3 (page 14). This analytical schema represents the

model of the effects of financial management practices and financial characteristics

on SME profitability. The model demonstrates that SME profitability is expected to

be positively influenced by efficient financial management practices and financial

characteristics.This analytical schema presented in Figure 1.3 can be expressed in

mathematical notation as follows:

Pm = f(As, Fa, Wo, Fi, Cs, Ls, FLa, ACo) (Eq. 1.1)

where:

Pm = SME profitability ratios, viewed as dependent variables




management, capital structure management, and financial planning. In addition, the

model of simultaneous effects of financial management practices and financial

characteristics on SME profitability will be developed from the literature review in

chapter 3 and with variables defined in chapter 4 of the study.

1.9 STRUCTURE OF THE STUDY

This research is structured into 6 chapters. Chapter 1 introduces the research including

research background, research problem, research questions, research objectives and

justifications for the research. Chapter 2 examines the economic structure, and the

current practices and role of SMEs in Vietnam. Chapter 3 provides a literature review

of financial management practices, financial characteristics and SME profitability.

Chapter 4 discusses methodology utilized in the research. Chapter 5 analyses the data

collected and presents the findings of the research. Chapter 6 points out conclusions

and the implications of the research in the world of business administration. Figure

1.4 (page 15) illustrates the structure of the study and the relationships between

chapters.

Figure 1.4: Structure of the study

Chapter 1: Introduction to the Study

Chapter 2: The Economic Structureand SMEs in Vietnam

Chapter 3: Financial ManagementPractices, Financial Characteristics and

Profitabilit of SMEs

Chapter 4: Research Methodology

Chapter 6: Conclusions and Implications

Chapter 5: Data Analysis and Findings





1.10 CONCLUSIONS

This research examines the simultaneous impacts of financial management practices

and financial characteristics on SME profitability using evidence from Vietnam. To

date, there is no significant research related to financial management practices and

financial characteristics of SMEs conducted in Vietnam and there is also no research

that examines the simultaneous impact of financial management practices and

financial characteristics on SME profitability. This research is designed as a

combination of descriptive and explanatory research in which a sample of 160 SMEs

are drawn from a list of over 14,000 SMEs in Ho Chi Minh City for personal

interview.

Gathered data will be processed by computer and the Statistical Package for

Social Science (SPSS) is the main computer software utilized in data analysis. In term

of data analysis, this study applies both descriptive and inferential statistics.

Descriptive statistical techniques will be applied to describe characteristics of

financial management practices and financial characteristics of SMEs in the sample.

Inferential statistical techniques such as bivariate analysis for measuring the

association, bivariate analysis for testing the difference, factor analysis, and

multivariate analysis will be applied to test the hypotheses of association and

differences (chapter 5). Findings of this study will be applied to increase efficiency of

financial management practices and improve profitability of SMEs in Vietnam

(chapter 6). To provide an in-depth picture of business environment in which SMEs

operate, chapter 2 will respectively examine and present information on background

of the economy, business structure and SMEs in Vietnam whereas chapter 3 reviews

the literature of financial management for SMEs around the world.



Chapter Two:

The Economic Structure and

SMEs in Vietnam

2.1 INTRODUCTION

As of 2000, Vietnam, a country suffering from 30 years of war and 10 years of

economic mismanagement, stands on the threshold of a new era – an era of

international relations and economic development. After a decade of strong efforts, its

economy and finance have been substantially reformed, and is integrating into the

world economy. Vietnam has made substantial progress in rearranging its foreign debt

arrears and started to benefit from financial assistance and foreign direct investment

(FDI) since the end of 1980s. Although challenges remain, Vietnam’s achievements

over the past years foretell its capacity to prevail. This chapter provides an overview

of Vietnam’s economy and performance of small and medium enterprises (SMEs) in

Vietnam. Objectives of the chapter are (1) to provide a literature review of economic

background, business structure and the development of SMEs in Vietnam, and (2) to

identify gaps in financial management for SMEs in Vietnam compared with financial

management for SMEs worldwide.

This chapter is structured into 6 main sections. Section 2.1 provides a general

introduction to the chapter, including the objectives and structure of the chapter.

Section 2.2 examines information on Vietnam such as geographic location, history,

political structure, the process of economic and financial development, and its

population and labour force. Section 2.3 concentrates on examining Vietnam business

structures with special emphasis on SMEs and the support policy for SME

development. Section 2.4 analyzes all aspects of SME finance in Vietnam including

types of finance, use of finance and financial management. Section 2.5 provides an

overview of business structure of SMEs in Ho Chi Minh City where SMEs are

considered the largest groups in term of numbers and are representative of SMEs in

the whole country. Section 2.6 summarizes the conclusions drawn from reviewing the

background of economy and SME performances in Vietnam. Figure 2.1 (page 18)

provides a visual outline of the structure of the chapter.



Chapter Two: The Economic Structure and SMEs in Vietnam


2.1 Introduction

2.2 Vietnam: background information

2.2.1 Overview of the country

2.2.2 Vietnam economy

2.2.3 Vietnam population

2.2.4 Vietnam labour force

2.3 Vietnam business structure

2.3.1 Type of business 2.3.3 Small and medium enterprises

2.3.4 Policies for supporting SMEs2.3.2 Overview of enterprises in VN

2.4 SME finance in Vietnam


2.5 Business structure and SMEs inHCM City

2.4.3 Financial management for

SMEs

2.4.1 Types of

finance

2.4.2 Use of

finance

2.6 Conclusions




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.




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.




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




Chamber of Vietnam in USA, 1998; Australian Department of Foreign Affairs and

Trade, 2001).

Figure 2.2: Political structure of Vietnam

The National Assembly

Source: Adopted from the Commercial Chamber of Vietnam in the U.S.A. and Australian Department of Foreign Affairs and Trade

2.2.2 The Vietnam economy

Since unification of the north and south, the process of the Vietnam economy

development can be divided into three main periods: the central-planned economy

period (1976 – 1986), the policy reform period (1986 – 1990) and the transition

economy period (1990 – present). This subsection reviews the development of

Vietnam economy throughout each period with a special emphasis of the effects of

the government’s economic policy. Its purpose is to review the background in which

SMEs operate and develop because the process of SME development is linked to the

process of economic policy reform.

Supreme People’s Court Supreme People’s Procuracy

Prime Minister

President

Ministry of Interior Ministry of ForeignMinistry of Defense

Ministry of Planningand Investments

Ministry of

Transportation andCommunications

Ministry of Trade Ministry of Finance

Ministry of Technologyand Environment

Ministry of Educationand Training

Ministry of Agriculture

and Rural Development

Ministry of Industry

Ministry of Fishery and

Aquatic Products

Ministry of Health Ministry of Construction Ministry of Information

State Bank of Vietnam Ministry of Justice Government Office




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.




For this reason, the budget deficits and foreign debt would have increased

along with any increase in outputs.

Such policies were not conductive to motivating individuals and companies to boost

enterprising economic activities. The economic institutions had no room for private

individual’s creativity and business dynamism. Thus, although income distribution

was egalitarian and all members of society were assured the basic necessities of life,

there was, however, no incentive for individuals to use their talents or assiduity in

work to make larger contributions to the country. This is demonstrated by failure of

the 1976 – 80 five-year plan. In 1980 food production attained only 69 percent of its

target; coal, 52 percent; electricity, 72 percent; cotton fabric, 39 percent; paper, 37 percent (Vu, 1994). The economy’s growth was seriously hampered by the centrally

planned system.

2.2.2.2 The pol icy reform period (1986 – 1990)

The policy reform period is characterized by the changes in management mechanisms

of the economy. After ten years, the practical results proved that the central-planned

economic system was not efficient and effective. In 1986 the Government recognized

that policy reform was the survival goal. The year of 1986 was viewed as the year of

beginning policy reform. Vu (1994, p. 7) confirmed the path taken by Vietnam’s

economic reform was marked by the important conclusions on the system of concepts

regarding economic renovation drawn up by the Sixth National Congress of the

Communist Party of Vietnam in December 1986. In this congress the following

changes in policies were mapped out:

•

confirmation of the long-term development of the multi-sector economy,

eliminating the former discrimination against the private economy, allowing

private sector to compete with other sectors on an equal footing in a healthy

competitive environment,

• confirmation of the importance of market relations in the economy,

• renovating the economic structure, using available resources to meet the main

objectives: developing agriculture, promoting the production of consumer




goods, increasing the export of goods and services, and enlarging its external

economic relations,

•

stabilizing the socio-economic environment by reducing the inflation rate, the

budget deficits, and excessive government expenditure, and improving the

living standard of people, and

•

carrying out an open-door policy in relations with foreign countries.

Policy reform mentioned above opened opportunities for changes in activities of the

economy including changes in economic structure, financial and banking system, and

price and market relations.

Changes in economic structure

Developing a multi-sector economy led to change in economic structure. In Vietnam’s

economic ideology, the national economy could be divided into several economic

sectors based on the form of ownership and means of production. Before policy

reform, the economy consisted of two sectors: state-owned and collective. Since

policy reform, the following main sectors were officially recognized (Le, 1992):

• state sector, based on the state ownership,

• collective sector, based on the voluntary contribution of capital by a group of

people to set up joint units and use labour forces of the collective’s members

and their relatives,

• private sector including the family or household businesses and private

companies, and

•

joint sector between state and other sectors.

Table 2.1 (page 27) demonstrates changes in economic structure during the period

1986 – 1991 in which the non-state sector had increasingly risen in terms of national

income, labour and labour in industry. For example, labour force working for state

sector declined to 10.4 percent in 1991 from 14.7 percent in 1986 whereas labour

force working for private sector increased to about 90 percent in 1991 from 85 percent

in 1986. This showed that private sector played a major role in creating employment.




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




• readjusting the revenue and expenditure policy of the state budget to step by

step reduce deficits and control the rate of inflation.

Taxation reform was the second change in the financial system. Before 1989, taxes

were collected from non-state economic sectors. The two main kinds of taxes were

the agricultural tax, based on quantity and quality of land used, and the industrial and

trade tax, based on turnover of collective and private businesses (Table 2.2).

Table 2.2: State-budget revenue, 1986 - 89 (million dong)

1986 1987 1988 1989

Revenue from state sector 60,349 284,801 1,184,945 2,085,838Net sales 56,908 270,220 1,027,627 1,616,870Depreciation 893 4,911 3,724 71,300Others and service revenue 2,548 9,670 78,634 144,000

Taxes on commercial export and import - - 74,960 253,668Revenue from non-state sector 23,277 97,489 573,216 1,505,988Industry and trade tax 8,325 38,055 184,084 427,949

Agriculture tax 3,834 12,176 136,456 308,093Non-commercial export and import tax 6,171 17,441 56,368 108,715Others 4,947 29,817 196,308 661,231

Total 83,626 382,290 1,758,161 3,591,826

Source: Statistical Yearbook, 1991

The state sector did not pay any tax but had to transfer most of its profit and turnover

to the state budget. Therefore, one of the most important tasks of taxation reform was

to eliminate the administrative supply-withdraw system of state enterprise finances

and to build a new tax system applicable to every business. The new tax laws

promulgated including the following kinds of taxes: agricultural tax, turnover tax,

profit tax, special commodity consuming tax (cigarettes, alcoholic products,

automobiles), import-export tax, tax on the use and exploitation of natural resources,

tax on housing and the use of land, and personal income tax.

After reforming tax systems, not only discrimination between the state and

non-state sectors was eliminated but also the state-budget revenue was increased.

Table 2.3 (page 29) shows changes in terms of sources and amounts of tax revenue

compared with table 2.2, which shows the sources and amounts before reforming tax

policy.




Table 2.3: State-budget revenue, 1991-93 (billion dong)

1990 1991 1992 1993

Tax collected from state enterprises 2,080 3,817 5,887 8,878 Tax collected from joint ventures 1,091 1,942 4,242 5,104

Industry and trade tax 667 941 1,821 2,942 Agriculture tax 298 707 1,294 1,350Export and import tax 732 1,099 2,194 6,398Housing and land tax 2 5 18 241Income tax - 62 154 181Fees and others 1,036 1,271 2,905 4,138Depreciation 247 239 1,660 1,939

Total 6,153 10,083 20,175 31,171


The third change was to restructure the national financial apparatus andmanagement. Formerly, Vietnam’s financial system had operated at two levels:

central and local. At the local level there were three sub-levels: provincial, district and

village in the countryside or residential in urban areas. During the Vietnam War and

central-planned economy period, financial and fiscal decision-making had been

strictly concentrated at the central level. With policy reform, it was to be

decentralized and liberalized to grant more powerful decision-making in finance and

fiscal issues for the lower (province and district) levels.

Changes in banking systems

Until 1988 there were only three state-owned banks in Vietnam: the State Bank of

Vietnam (SBV), the Vietnam Investment and Development Bank (VIDB), and the

Vietnam Bank for Foreign Trade (Vietcombank). Unlike other countries, in Vietnam

the SBV played both roles of central and commercial banks (The World Bank Group,

1997). This was never seen in countries based on a market economy. The VIDB and

Vietcombank basically operated as commercial banks. The VIDB was in charge of

providing funds and loans for the state long-term investment projects while the

Vietcombank specialized in providing loans and banking services for all international

economic activities.

Reform in the banking system was initiated in 1988 by issuing the Decree

53/HDBT to divide the banking system into two categories: the State Bank played the

role of central bank and the specializing banks played the role of commercial banks.




In addition, two other state-owned commercial banks: the Vietnam Industrial and

Commercial Bank and the Vietnam Bank for Agricultural Development were

established. Four state-owned banks were allocated primary funds from the state

budget and operated as commercial banks (The World Bank Group, 1997). At the end

of 1990, the Government started liberalizing the banking system. Since 1990 the non-

state sectors have been allowed to establish commercial banks. Dozens of joint stock

banks were established in cities such as Hanoi, Hai Phong, and Ho Chi Minh City.

Some were based mainly on the participation of state units, others on mixture of state

and private operations, while the rest were entirely private (Vu, 1994).

Banking system reform quickly changed the banking system in Vietnam to

comprise development and investment banks, state-owned commercial banks, foreign banks’ branches, joint-venture banks, joint stock banks, credit co-operatives, and

financial companies (Table 2.4). All the banks are self-managed and operate as

business organizations. Gradually the system of state subsidization providing low-

interest-rate credits was removed, and interest rates were stabilized at higher levels

than the rate of inflation.

Table 2.4: Financial institutions in Vietnam, 1995

Institution Number of InstitutionsState Bank of Vietnam 1State commercial banks 4

Joint stock banks 46 Joint venture banks 4Foreign banks 17Financial companies 2Financial leasing company 1Insurance company 1Credit co-operatives 120

Total 198

Source: Australia and New Zealand Banking Group, 1996

Changes in price systems

Vietnam’s transition to the market economy started alongside price reform (Vu, 1994,

p.26). Since 1989, prices have not been fixed by the state, except in the case of items

such as electricity, water, coal, and cement used for the major state construction

projects. The decentralization of the price decision-making process and the

introduction of a free-market price system have given rise to a better balance between

total demand and supply in the entire economy and between different regions, as well




as encouraging economic exchange. The system of price management changes from

one extreme of total state-monopolized control to the other extreme of prices set by

free market forces without state intervention (Vu, 1994). These changes created a

substantial foundation for the economy in the transition period.

2.2.2.3 The transition economy period (1990 – 2000)

The transition economy period has been characterized by the high growth rate in GDP

and stabilization of price and financial system. Unlike Russia and Eastern European

countries, Vietnam’s transition from a centralized to a market economy was smooth

(Dana, 1994). The economic achievements and changes in the economic and social

life have only started in 1990 though the innovation policy had been initiated since

1986.

At the beginning of 1990s, the Vietnam economy has been known as one of

the economies that achieved high growth rates (Le, 1997). Le (1997) summarized the

Vietnam’s recent economic achievements as follows:

•

GDP growth rate has annually averaged 8.0 percent since 1991 whereas rate of

inflation, once in triple digits 1980s, has been brought down to a single digit

level at the end of 1990s (Table 2.5).

Table 2.5: GDP index by economic sector and rate of inflation (%)

1991 1992 1993 1994 1995 1996 1997 1998 1999

Rate of inflation 67.5 17.5 5.2 14.4 12.7 4.5 3.6 9.2 0.1

GDP growth rate 6.00 8.60 8.10 8.80 9.54 9.34 8.15 5.8 4.8State sector 8.60 12.40 11.60 12.80 9.42 11.28 9.67 5.60 4.3Non-state sector 4.70 6.80 6.20 6.70 n/a n/a n/a n/a n/a

Collective n/a n/a n/a n/a 4.48 3.56 2.64 3.5 3.6

Private n/a n/a n/a n/a 9.30 14.39 9.80 7.9 6.2Household n/a n/a n/a n/a 9.78 6.58 5.63 3.4 3.9Foreign-invested n/a n/a n/a n/a 14.98 19.42 20.75 9.1 13.4Others n/a n/a n/a n/a 12.68 8.06 3.54 4.1 -1.3

Source: Statistical Yearbook, 1994, 1998 and 1999

•

Per capita income has risen from about USD140 in 1991 to USD300 in 1995.

• The exchange rate, which strongly fluctuated in 1980s, has been fairly stable

in recent years (Table 2.6, page 32)




Table 2.6: Index of exchange rate of USD/VND (%)

1996 1997 1998 1999

January 100.00 100.88 103.68 99.81February 100.02 101.41 98.39 99.79

• The country has benefited from significant expansion and diversification of

external trade (Table 2.10, page 35).

Vietnam Embassy in the USA (1999) provided an overview of Vietnam economy

since the country started the transition economy in 1990. Major industries such as

agriculture, oil, gas and mining, manufacturing, and international trade have

considerably grown in recent years. Agriculture is currently the dominant economic

sector, accounting for nearly 30% of GDP and employing 70% of the work force.

Agricultural growth has averaged about 4.25% per annum from 1991 to 1998 (Table

2.7), laying a solid base for growth in related industries, particularly in food

processing.

Total food output reached a record 27.4 million tons in 1995. Vietnam was the

world’s third largest exporter of rice, with 85% of cultivated land devoted to rice

growing. Besides rice, the main agricultural products are corn, tropical vegetables and

Table 2.7: GDP index by economic industry (%)

1991 1992 1993 1994 1995 1996 1997 1998 Agriculture 2.20 7.10 3.80 3.90 4.43 4.44 4.71 3.44Industry 9.00 14.00 13.10 14.00 13.55 13.59 12.82 11.00

Trade and services 8.30 7.00 9.20 10.20 11.30 9.74 6.93 4.43 Total 6.00 8.60 8.10 8.80 9.54 9.34 8.15 5.80

Source: Statistical Yearbook, 1994 & 1998

March 99.99 100.94 100.35 100.30 April 100.04 101.12 98.70 100.16May 100.01 100.53 99.59 100.00

June 100.01 99.56 100.15 100.06 July 100.11 99.98 100.58 100.41 August 100.06 100.36 100.26 99.87September 99.99 100.54 108.09 100.06October 100.42 100.25 101.30 100.21November 100.58 106.12 97.16 100.02December 100.38 102.92 99.73 100.14





fruits, cassava, potatoes, sugarcane, cashew nuts, soybeans, groundnuts, coconuts,

coffee, tea and rubber (Vietnam Embassy in the USA, 1999).

Vietnam’s S-shaped coastline is over 3,200 km long and supports a vibrant

seafood industry. In 1994, of the 1.5 million tons of fishery products, some 70% came

from the ocean and the remainder from fish farms and fresh-water sources. Fishery

production reached 1.5 million tons in 1995, making seafood become one of the

country’s major exports. Earnings from seafood exports reached US$ 580 million in

1995 and are expected to top US$ 1 billion by the year 2000. Table 2.8 summarizes

the achievements of agriculture in recent years.

Table 2.8: Agriculture development over the years

Unit 1990 1992 1994 1996 1998

Gross output value billion dong 20,667 49,061 64,877 92,006 107,517Cultivation " 16,394 37,540 49,921 71,589 87,618Livestock " 3,701 10,152 13,113 17,792 17,551Service " 572 1,369 1,843 2,625 2,348Labour force 1000 people 21,895 23,208 23,548 24,725 25,124Growth rate % 2.20 7.10 3.90

Vietnam’s oil reserves, estimated at 1.7 billion barrels, are among the largest

in the world. The country started to produce oil in 1986 through a joint venture with

the former Soviet Union. Oil production reached nearly 7 million tons in 1994 and 7.7

million tons in 1995. The government plans to raise production to 22 - 25 million tons

per year by the year 2000 (Asia Business Network, 1997).

Vietnam’s oil sector is on a path of rapid growth. Since 1986, 29 production-

sharing contracts have been signed between PetroVietnam, the state-owned oil

company, and various foreign oil companies. In addition to the White Tiger field, the

country’s only oil source prior to 1995, two more fields – Dai Hung (Big Bear) and

Rong (Dragon) – are now also producing oil. All of the current oil production is for

export, with most crude oil destined for Japan. However, the government is planning

and seeking foreign investment for two refinery projects with a capacity of six million

tons each.

Natural gas reserves, estimated at 100 billion cubic meters, represent another

huge potential export. A pipeline was recently completed to harness gas potential

instead of burning it off. The development of gas-related industries is being

considered by the government of Vietnam as well as by foreign companies.

4.44 3.44Source: Statistical Yearbook 1994, 1998




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




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

Asia 1,663 2,719 3,911 6,339 8,613 9,086 8,970Europe 420 692 1,020 1,083 1,540 1,726 1,637

America 25 30 73 170 304 306 390 Africa 5 0 3 8 13 24 16 Australia and ocean 20 33 69 104 156 218 298 Trade balance 215 -789 -1,390 -2,443 -3,800 -2,404 -2,003

Source: Statistical Yearbook 1994, 1998




Deploy its resources effectively – Vietnam needs to utilize its scare resources

efficiently, through raising productivity in the agricultural sector, utilizing the

entrepreneurial flair of southern business owners, encouraging overseas

Vietnamese to invest locally, merging viable state enterprises with private

investors and utilizing overseas development assistance effectively.

•

•

•

•

•

•

•

•

Create equitable wealth – Vietnam needs to narrow the gap between the poor

and rich people during the process of economic development.

Control the rate of population growth – Vietnam is a relatively poor country

that is likely to remain impoverished until it is able to control the growth of

the population. Annual increase in population puts further strain on the limited

resources of the country and puts severe pressure on the nation’s resources.

Create employment – The abilities to maintain political stability and the

formation of a consumer class providing the foundations for further

industrialization will require the government to bring about the creation of

jobs across the broad spectrum of society, ranging from peasant farmers to

university graduates.

Maintain sound economic management of the economy – Attainment of a

stable macro-economy is a key prerequisite for further development of theeconomy, as clearly evidenced by the experiences of the dynamic economic

neighbours. This will create the necessary environment for the market-based

economy.

Invest in human capital and physical infrastructure – There will be a pressing

need for Vietnam to invest in the education of its people and also in its

physical infrastructure. Whilst Vietnam has an abundance of cheap labour, this

will not be enough when it eventually hits shortages in trained and skilledworkers.

Create strong and efficient institutions – Vietnam lacks the necessary

institutions to support a market-oriented economy. It needs to develop a

modern central bank, an independent judiciary, a modern banking system and

supportive capital market for the fledgling private sector.

Reduce its reliance on primary exports (oil, rice and seafood) – Vietnam

remains exposed by fluctuations of world commodity prices and heavily

dependent upon exports of crude oil, sea products and rice.




Prevent the North/South, and rural-urban split from widening – A gulf

between the north and south of Vietnam, as a result of history, politics, and

economics, threatens to become even more pronounced as free market reforms

take root. Ho Chi Minh City is destined to become Vietnam’s leading

commercial centre and international focal point. In order to prevent regional

disparities the government needs to divert more investment to the north and

other underdeveloped provinces.

•

• Maintain political stability – Whilst economic reform has been a key

component of the developmental program, political reform is not on the

agenda.

Recently, Mekong Project Development Facilities (MPDF), a multi-donor program

managed by International Financial Corporation (IFC) examined the current state and

indicated four big problems that Vietnam economy has to face including:

•

GDP growth rates have been falling – That growth has slowed significantly in

Vietnam is scarcely a matter of debate. GDP growth has fallen from a high of

9.3 percent in 1996 to 4.8 percent in 1999. Growth rates have roughly halvedacross all major sectors: industrial growth has dropped from a high of 16

percent in 1995 to 8 percent in 1999, and growth in services has fallen from

8.8 percent in 1996 to 2.5 percent in 1999 (MPDF, 1999).

• Both unemployment and underemployment are rising – Unemployment in

urban areas was officially estimated at 7.4 percent for 1999 and the

underemployment rate for rural was reported at 28.2 percent (MPDF, 1999).

• Foreign direct investment has sharply declined since 1998 – The number of

new foreign-invested projects was estimated to total 252 in 1999, a seven-year

low from a high of 411 projects in 1995 (MPDF, 1999)

• Growth in exports has fell precipitously in 1998 – Seventy two percent and 65

percent of Vietnam’s exports in 1996 and 1997, respectively, were shipped to

Asian countries. Monetary crises of Asian countries caused Vietnam’s exports

sharply declined in 1998 and 1999 (MPDF, 1999).




In recent years, the financial and monetary crises of Asian countries have remarkably

affected the process of economic development in Vietnam and made these problems

and challenges become more serious. Vietnam was affected by the East Asian crisis,

although the consequences were not as severe as in neighbouring countries. The crisis

had in particular an impact on the external trade of Vietnam. East Asia accounted for

70% of Vietnam’s exports and foreign investment. As a result of the crisis, the exports

of Vietnam to these countries stagnated and fell by respectively 5% and 20% in 1997

and 1998 (Pool, 2000).

2.2.3 The Vietnam population and labour

This subsection examines the population and labour and their potential effects on the

economic and SME development in Vietnam.

2.2.3.1 Population

Vietnam is a small country but very crowded with city population, and the population

growth rate is relatively high. At the beginning of 1980s, the population of Vietnam

was about 53 million. Its population has risen to 76 million at the end of 1990s, an

increase of 43 percent after 20 years (Table 2.11).

Table 2.11: Population by sex and areas (in thousands)

1980 1985 1990 1995 1999

Total 53,722 59,872 66,233 73,962 76,327By sex

In recent years, the government has recognized that a population boom in poor

countries like Vietnam will threaten development and stability of the economy.

Therefore the government has carried out strong measures to restrict population

growth. As a result, population growth rate of Vietnam has declined to 1.7 percent at

the end of 1990s (Table 2.12, page 39) from 2.3 percent at the beginning of 1990s.

Male 26,018 29,285 32,327 36,095 37,581Female 27,704 30,587 33,906 37,867 38,829

By areas

Urban 10,301 11,360 13,281 14,575 17,918Rural 43,321 48,512 52,952 59,387 58,409Source: Statistical Yearbook 1994, 1999




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).

1990 1992 1994 1996 1998

Population growth rate 2.30 2.41 2.09 1.88 1.75Population structure 100.00 100.00 100.00 100.00 100.00

Male 48.80 48.70 48.80 48.80 49.00Female 51.20 51.30 51.20 51.20 51.00Urban 20.40 19.40 19.90 20.30 21.30Rural 79.60 80.60 80.10 79.70 78.70


Table 2.13: Labour force by economic sector (in thousands)

1980 1985 1990 1995 1997Industry 2,250.0 2,800.0 3,392.0 3,586.6 3,656.0Construction 1,008.0 832.0 817.7 995.6 976.5

Agriculture and forest 15,301.1 18,979.0 21,895.0 24,121.7 25,443.4 Transportation 417.1 484.0 513.0 781.0 856.0 Trade and services 1,180.2 1,162.0 1,711.2 2,394.3 3,190.2

Education and health 877.5 960.0 1,105.5 1,252.6 1,294.8Others 649.6 808.0 860.2 1,457.2 1,577.3

Total 21,683.5 26,025.0 30,294.6 34,589.0 36,994.2

Source: Statistical Yearbook 1994, 1998 and Vietnam data bank




Table 2.14: Labour force by the state and non-state sector (in thousands)

1980 1985 1990 1995 1997

State sector

Although foreign investor views labour-force as a key potential factor and

labour costs are quite low, the rate of unemployment is still high, especially in the

north of Vietnam. Table 2.15 shows the rate of unemployment in 1998. The rate of

unemployment of the whole country was 6.85 percent while Hanoi and Ho Chi Minh

City account for 9.09 and 6.76 percent respectively.

In summary the details of Vietnam’s background as reviewed above provides

an overview of the business environment in Vietnam. Generally, the business

environment has significantly improved since the government introduced its reform

policy. Policy on development of the multi-sector economy which was mapped out

since 1986 and transition to the market economy in recent years brought about

significant achievements in developing the economy, improving business

environment, encouraging the private sector and integrating into the regional and

world economy.

2.3 VIETNAM BUSINESS STRUCTURE

The previous sections provided an overview of the Vietnam economy with a special

focus on policy reform. This section will examine business structure in Vietnam

including types of business, development of SMEs and the government policy to

support for SMEs.

3,315.8 3,859.2 3,421.4 3,053.1 3,266.9Non-state sector 18,367.7 22,165.8 26,837.2 31,535.9 33,727.3

Total 21,683.5 26,025.0 30,258.6 34,589.0 36,994.2

Source: Statistical Yearbook 1994, 1998 and Vietnam data bank

Table 2.15: Unemployment rate of labour force in 1998 (%)

Over 15 years old Working age

Total Female Total Female Whole country 6.60 6.25 6.85 6.55Hanoi 8.86 8.91 9.09 9.30Hai Phong 7.98 7.20 8.43 7.68Da Nang 6.17 7.50 6.35 7.79Ho Chi Minh City 6.58 7.03 6.76 7.25

Source: Statistical Yearbook 1998




2.3.1 Types of business in Vietnam

With the policy of developing a multi-sector economy and attracting foreign

investment, the Vietnam business structure has currently diversified consisting of

many different economic sectors. The business structure in Vietnam can be classified

into many different types depending upon the breakdown basis.

Based on form of ownership, the business structure in Vietnam includes two

main sectors: domestic and foreign-invested. The domestic sector can be further

divided into the state and non-state sectors. There are five types of business in non-

state sector: private enterprises, limited liability companies, joint stock companies,

collectives or co-operatives and individual households. Figure 2.3 illustrates all types

of business in Vietnam by form of ownership. However, this research only

concentrates on private enterprises, limited liabilities companies, and joint stock

companies – the main types of non-state business in Vietnam. Other sectors such as

foreign-invested companies, state companies, co-operatives and individual households

are beyond scope of the study.

Figure 2.3: Business structure in Vietnam

Business structure in VN

(*) Target population of this research

Source: Developed for this research

Foreign-invested sector

Private enterprises* Central

Domestic sector

State sectorNon-state sector

Limited liability companies*

Joint stock companies*

Co-operatives

Individual households

Local




A second way to breakdown the business structure in Vietnam is based on size

of the businesses. Based on size of the businesses, the business structure in Vietnam

can be classified into three types: small, medium and large enterprises (Figure 2.4).

This study only focuses on examining small and medium enterprises whereas the

large enterprises are beyond the scope of this study. These definitions below vary

from the VCCI definitions explained on page 10.

• Small enterprise was defined as business having less than 50 employees and/or

a total capital of less than VND 1 billion (Document 681/CP-KTN issued by

the government in 1998).

•

Medium enterprise was defined as business having from 51 to 200 employeesand/or a total capital ranging from 1 to VND 5 billion (Document 681/CP-

KTN issued by the government in 1998).

•

Large enterprise was defined as enterprise with more than 200 employees

and/or a total capital of more than VND 5 billion in capital (Document

681/CP-KTN issued by the government in 1998).

Figure 2.4: Breakdown of business by size

Business structure


A third way to break-down the business structure in Vietnam is based on

industry. Based on the characteristics of industry, the business structure in Vietnam

can be classified into businesses operated in the following major industries:

agriculture and forestry, fishery, mining, manufacturing, electricity, construction,

trade and services, hotels, and finance and banking. In scope, this study only

considers small and medium businesses operating in manufacturing and trading

- Labour: 51 – 200- Capital: 1 – dong 5 bil.

Medium enterprise

- Labour: > 200- Capital: > dong 5 bil.

Large enterpriseSmall enterprise

- Labour: < 50- Capital: < dong 1 bil.




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

Private sector 19,436 0.40 6,845 0.28 25,754 0.41 6,318 0.41

Private enterprises

In accordance with the Decision 115/TTg issued by the Prime Minister on

March 13, 1995, the General Statistical Office (GSO) and other relevant ministries

had carried out a survey of businesses and enterprises in Vietnam’s territory. The

results of survey published in 1997 by GSO revealed that there were 23,708

14,052 0.16 5,088 0.13 18,243 0.17 4,191 0.21

Limited companies 5,258 0.83 1,730 0.59 7,346 0.78 2,088 0.63

Stock companies 126 9.76 27 8.60 165 10.33 39 10.38State sector 5,835 8.29 338 41.72 6,310 12.31 475 61.63

Central management 1,678 19.42 96 131.35 1,847 30.76 169 143.36

Local management 4,157 3.80 242 6.16 4,463 4.67 306 16.49

Total 25,271 2.16 7,183 2.19 32,064 2.68 6,793 4.62





enterprises in Vietnam on July 1, 1995, broken down as follows: 5,873 state

enterprises, 10,916 private enterprises, 4,242 limited liability companies, 118 stock

companies, 1,867 collective businesses and 692 foreign-invested companies. These

businesses and enterprises created employment for by 1.3 million people (Table 2.17).

The number of businesses provided by the result of the survey is not compatible with

that of Statistical Yearbook because the Yearbook did not subtract the number of

businesses, which did not operate due to bankruptcy.

Table 2.17: Number of businesses and employees on July 1, 1995

Percentage Type of businesses Number of Percentage Number ofbusinesses employees

93.91%Domestic sector 23,016 97.08% 1,263,439

State enterprises

Table 2.17 shows that the domestic sector was the major sector which

accounted for 97.08% of enterprises, and the private enterprises were the biggest

(47.04%), the next were state enterprises (24.77%), limited liability companies and

stock companies were respectively 17.89 and 0.50%. Although the number of state

enterprises is less than that of private enterprises, they employed up to 65.93 percent

of employees.

2.3.3 Small and medium enterprises in Vietnam

This subsection reviews the background, role, current status, difficulties and problems

of SMEs in Vietnam in recent years. The main objective of this subsection is to

address the current status and problems that SMEs face.

2.3.3.1 Background

In recent years, promotion of small and medium enterprises (SMEs) has been given

more attention (Nguyen, 1999). The eighth National Congress and the fourth session

of the Central Conference of the Vietnam Communist Party confirmed promotion

5,873 24.77% 886,985 65.93%Collectives 1,867 7.87% 87,771 6.52%

Private enterprises 10,916 46.04% 127,819 9.50%

Limited liability companies 4,242 17.89% 147,792 10.98%

Stock companies 118 0.50% 13,072 0.97%

6.09%Foreign-invested sector 692 2.92% 81,964100.00% Total 23,708 100.00% 1,345,403

Source: Size and Effectiveness of 1.9 Million Businesses in Vietnam’s Territory, GSO 1997




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




− 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




• mobilized unused resources such as land, capital, labour, and management

skills into development of the economy and contributing to increase of export

volume.

Nguyen (1999) found that SMEs annually contribute approximately 31 percent of the

total industrial output and create jobs and income for 4.2 – 4.5 million people.

According to Vuong (1998), during the period of 1991 – 1997, the private sector

capitalized almost USD3 million, created 3.5 million jobs and made a significant

contribution to Vietnam’s GDP growth, in which 90 percent come from SME

contribution, and only 10 percent from large firms.

2.3.3.4 The current status

It is difficult to gain reliable facts from a literature review regarding the current status

of SMEs in Vietnam. This is for two main reasons. Firstly, there is little research

undertaken related to this field. Secondly, most research, especially the research

conducted by the local researchers, is not reliable and very poor in term of scientific

and academic methods. In Vietnam, there have recently been some surveys on the

current status of enterprises conducted by both local and foreign organizations.

Typical surveys are listed below:

• enterprises census taken by the General Statistics Office (GSO) on July 1,

1995

• survey on small and medium enterprises conducted by Ebashi, Sakai and

Takada in March 1997

• survey on Vietnamese private sector conducted by Mekong Project

Development Facilities (MPDF) in May 1999.

Of these surveys, only the survey conducted by Ebashi, Sakai and Takada (1997)

concentrated on considering the current status of SMEs in Vietnam. The survey

conducted by MPDF only focused on larger private enterprises. Regarding the number

of enterprises and number of SMEs in Vietnam, there are many different opinions.

Based on the census conducted by GSO on July 1, 1995, Ebashi, Sakai and

Takada (1997) concluded that 96.7% of manufacturing enterprises in Vietnam are




SMEs. Some 96.7% of enterprises have no more than 500 employees and 91.3% have

less than VND10.0 billion in total capital (Table 2.19, page 49). According to Nguyen

Tien Quan (1999), Director of Non-state Economic Development Centre, there are

5,960 state enterprises in which medium and small enterprises account for 65.9%. Of

1,396 foreign invested enterprises, medium and small enterprises account for 33.6%

and of 19,480 cooperatives and united cooperatives, medium and small cooperatives

account for 65.9%. Also, of 34,000 business establishments having registered under

company and private enterprise law, medium and small enterprises of responsibility

limited companies account for 94.6% and of private enterprises account for 99.4%.

2.3.3.5 Difficul ties and problems

Small and medium enterprises in Vietnam are faced with many problems irrespective

of their process of development. In their interview of 14 SME manufacturers (5 in

Hanoi, 4 in Ho Chi Minh City, 2 in Dong Nai and 3 in Binh Duong), Ebashi, Sakai

and Takada (1997) found the main problems that SMEs in Vietnam have to face as

listed below by the order of serious concern.

• Funding rising – A large number of the interviewed SME owners saw

financial shortfalls as one of the biggest problems. They needed funds

primarily to finance plant and equipment investment and for securing working

capital to cover expenses involved in exporting their products until they could

receive payments from exporters.

• Export licenses – Companies who wanted to export goods directly to foreign

countries were required to obtain a direct export license. Companies who were

not eligible for the license had no choice except to export goods on

consignment through government enterprises. Even those who had the license

were required to visit Hanoi every year to renew their licenses.

• Industrial land – Interviews also found that in cities such as Hanoi and Ho Chi

Minh City, there was increasing concern for pollution problems because of the

mixture of residential and industrial areas. Moreover, urban areas were

increasingly and seriously short of industrial estates.




• Business administration – SME managers were deeply aware of the

importance of acquiring more sophisticated management skills. Many owners

have recently attended seminars and training sessions for managers.

•

Other problems such as human resource development, quality control,

smuggle effect were less serious than the four problems listed above.

Additionally, Ebashi, Sakai and Takada (1997) conducted a questionnaire survey to

identify management practices and problems, and the needs of SMEs for government

support program. Table 2.20 below shows the result of the survey. This result

demonstrated that 51 percent, the highest percentage, of SMEs faced with financial

issues.

Table 2.20: Business operation problems of SMEs in Vietnam

Problems Percentage of interviewees faced with problems (%)

Financing 51.0 Tax 32.3

2.3.4 Policies for support ing SMEs

Countries around the world have policies to support small and medium enterprises.

The objectives of SME support policy are different depending on the country’s stage

of economic development (Ebashi, Sakai and Takada, 1997). In Vietnam, the

necessity of policies to support SMEs has been supported with the following

objectives:

• expand export and improve the living standard of the residents

• raise capital and labour productivity

•

create jobs for residents

Production investment 26.7 Technology development 20.3Recruiting 17.9Sales 17.5Raw material supply 16.7

Regulation 13.5Production 9.2Export 7.6Information access 4.8Distribution 3.6Outside manufacturers 2.0

Source: Survey conducted by Ebashi, Sakai and Takada, 1997




• 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




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




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

Company, Ann’s Tourist and Trading Ltd, Autec Ltd, Hunsan Ltd, Orient Plastic

Company, Saigon Private Garment Ltd, and Vien Thang Ltd) obtained bank loans

after establishment. The other SMEs had financed their business after the

establishment by using profits, long supplier credits, customer payments in advance,

co-operation with foreign companies and networks consisting of relatives and friends.

The main reasons they did not use bank loans were (1) lack of assets to offer as

collateral, (2) lack of good relations and stipulations with the banks, and (3) high

interest rate charged on bank loans.

Kack and Lindgren (1999) also found there are several “misfits” regarding

distribution of capital in Vietnam. Firstly, according to general regulations,




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

Equity/total assets 25% 61. % 90%Short-term ratio n.a 67% n.aSource: Vietnam Investment Review, 1998




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.




Figure 2.5: SME financial management practices and the gap

Literature review of financial management

practices of SMEs in Vietnam

Difficulties in obtaining bank loans High risk business environment

Results: Framework of:

•

High equity ratio/low debt ratio •

Financial leverage

•

High current ratio •

Liquidity•

Using short-term loans tofinance non-current assets.

•

Profitability

The gap

Research problem:How does the gap impact on SME profitability?


2.5 BUSINESS STRUCTURE AND SMEs IN HO CHI MINH CITY

Section 2.3 and 2.4 respectively reviewed business structure and SMEs in Vietnam.

However, because of constrain of time and funding, this research only focuses on

investigating SMEs in Ho Chi Minh City where SMEs are considered to be

representative of the country. This section examines business structure of SMEs in Ho

Chi Minh, which is defined as the target population for this research.

According to the Ho Chi Minh City Department of Investment and Planning,

at the present time, there are 14,806 businesses (consisting of 4,909 private

enterprises, 8,030 limited liability companies, 322 joint stock companies and 1,545

businesses belonging other sectors) operating in Ho Chi Minh City with over VND18




billion in total capital, and over 280,000 employees (Table 2.23). This figure accounts

for all businesses that have been established since 1990, the year of commencing the

transition economy period.

Table 2.23: Business structure of SMEs in Ho Chi Minh City

In terms of business size, almost all of these businesses are small and medium

enterprises with the average total capital of VND327 million for private enterprises,

VND1, 617 million for limited liability companies and VND11, 257 million for joint

stock companies. In term of number of employees, these businesses have an average

number of employees of 3 for private enterprises, 33 for limited liability companies

and 18 for joint stock companies (Table 2.24).

With an average total capital and number of employees as mentioned earlier,

most businesses in Ho Chi Minh City are considered small and medium enterprises.

These businesses satisfy the criteria of SME definition as indicated in chapter 1.

Table 2.24: Size of businesses in Ho Chi Minh City

Forms of business Number ofbusiness

Capital (Million VND) Number of employees

Total Average Total Average

Private enterprises 4,909 1,609,785 327.93 14,043 3Limited companies 8,030 12,989,401 1,617.61 267,452 33 Joint stock companies 322 3,625,031 11,257.86 5,679 18Others 1,545 111,027 71.86 n/a n/a

Total 14,806 18,335,244 1,238.37 287,174 19

Source: Ho Chi Minh City Department of Investment and Planning (2000)

Year Private enterprise Limited company Joint stock Others Totalcompany

1991 - 3 - - 31992 66 330 28 - 4241993 197 557 21 - 7751994 656 508 10 - 1,1741995 565 632 7 1 1,2051996 487 667 18 - 1,1721997 518 637 14 8 1,177

1998 542 813 23 5 1,3831999 712 1,868 65 11 2,6562000 1,166 2,015 136 1,520 4,837

Total 4,909 8,030 322 1,545 14,806





2.6 CONCLUSIONS

Vietnam is in transition to a market-oriented economy and has achieved stability and

relatively high growth rates. Its policy of developing the multi-sector economy has

created a substantial and attractive foundation for enterprises in all economic sectors.

Based on this policy reform, SMEs in Vietnam have had opportunities to develop and

create employment. However, as of 2000, there are still differences in policy between

the state and non-state enterprises as well as between large and small enterprises.

These differences in policy mean small and medium enterprises have many problems

in the process of development.

Financing is one of the most difficult issues faced by SMEs (Ebashi, Sakai and

Takada, 1997). SMEs cannot easily obtain bank loans for establishment and further

expansion. This leads SMEs to use equity as a major source of finance and use short-

term loans to finance non-current assets. Moreover, different rules for different banks

and different rules from time to time lead to negative impacts on financial policy for

SMEs. As a result, they often maintain relatively high current ratios to respond to the

regularly changing business situations. Probably, financial management practices of

SMEs as mentioned above, have adversely affected profitability.

In addition, operating in an uncertain business environment probably makes

the financial characteristics of SMEs in Vietnam differ from that of SMEs in other

countries. As a result, financial characteristics may adversely affect SME profitability.

These conclusions are viewed as the foundation for conducting research on the impact

of financial management practices and financial characteristics on SME profitability

in Vietnam. Chapter 3 will review the literature on financial management practices

and financial characteristics of SMEs around the world as a framework for

comparisons with financial management practices of SMEs in Vietnam.



Chapter three:

Financial Management and

Profitabil ity of SMEs

3.1 INTRODUCTION

This chapter follows from chapter 2 as a review of the literature on financial

management. Chapter 2 provided an overview of the economic development and

performance of SMEs in Vietnam. Chapter 3 reviews financial management including

financial management practices, financial characteristics and profitability of SMEs

around the world, especially in the developed economies such as the United States of

America (USA), the United Kingdom (UK), Australia and Canada. It emphasizes

profitability and the impact of financial management practices and financial


The objectives of this chapter are to review previous research related to the areas

of financial management practices, financial characteristics, and profitability of SMEs

and to build a model of the impact of financial management practices and financial


This chapter is structured into nine main sections (Figure 3.1, page 60). Section

3.1 introduces the general purpose and objectives of the chapter. Section 3.2 reviews

definitions of SMEs, both qualitative and quantitative. Section 3.3 defines the objectives,

major decisions and the specific areas of SME financial management. Section 3.4, 3.5

and 3.6 respectively review the previous studies on financial management practices,

financial characteristics and SME profitability conducted by previous researchers in the

developed economies. Section 3.7 concentrates on examining the relationships between

financial management practices, financial characteristics and SME profitability. Section

3.8 develops a model of the impact of financial management practices and financial

characteristics on SME profitability. Lastly, section 3.9 provides the conclusions that are

drawn from the literature review and figure 3.1 (page 60) provides a visual outline of the

structure of the chapter where the sections are combined as a whole.



Chapter Three: Financial Management and SME Profitability



3.8 The model of impact of financialmanagement on SME profitability

3.9 Conclusions

3.7 Relationships between financialmanagement and SME profitability

3.6 SME profitability

3.6.1 Importanceof profitability

3.6.2 Defining andmeasuring profitability

3.6.3 Factors influencing on profitability

3.5 Financial characteristics

3.5.1 Identifying

financialcharacteristics

3.5.2 Measuring

variables of financialcharacteristics

3.5.3 Previous findings related to financial

characteristics

3.4 Financial management practices

3.4.2 Accounting information system

3.4.3 Financial reporting and analysis

3.4.4 Working capital management

3.4.5 Fixed asset management

3.1 Introduction

3.2 Definition of SMEs

3.3 Financial management for SMEs

3.3.1 Defining financial management

3.3.2 Objectives of financial management 3.3.4 Specific areas of financial management

3.3.3 Major decisions of financial management

3.4.1 The context of financial management

3.4.6 Capital structure management

60




3.2 DEFINITIONS OF SMEs

This section reviews the definitions of small and medium enterprises (SMEs) from the

literature. Obtaining a definition is the starting point for reviewing literature on the

aspects of SME financial management. There is no universal definition of small

enterprise (Scarborough and Zimmerer, 1984; Back, 1985 and Meredith, 1993). In theory

and practice, there are many terms used to refer to SME including “small business”,

“small enterprise”, “small firm”, “small company”, “small and medium enterprise”, and

“small and medium-sized enterprise”. They all are somewhat different in meaning but

distinguishing differences among these terms is not the purpose of this study. In this

study all these terms are used as if having the same meaning.

Although there are several definitions of small and medium enterprises,definitions are basically classified into two types: those based on qualitative

characteristics and those based on quantitative characteristics of small and medium

enterprises (Back, 1995).

3.2.1 Qualitative definitions

Qualitative definitions define small and medium enterprises based on their qualitative

characteristics. The great advantage of these definitions is that they attempt to capture the

essential nature of small business. However, the problem is that they vary from country to

country and from industry to industry. This study mainly reviews the definitions of small

business in the developed countries such as the United States of America (USA), the

United Kingdom (UK), Australia and Japan.

In the USA, based on four key factors identified by the 1947 Committee of

Economic Development (CED), the authorities define a small firm to be one which:

1)

has independent management

2) has capital supplied and ownership held by an individual or small group

3) has an area of operation which is localized in one community, and

4) is small in relation to other firms in the industry.

61




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.

62




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.

63




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.

64




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)

65




In the UK the Bolton (1971) reported that the legal forms of small firms consists

of sole proprietorships, partnerships, quoted and non-quoted companies, limited and

unlimited companies. Of these forms, the majority is the unlimited companies while the

quoted companies are not significant (Table 3.3).

Table 3.3: Legal status of small firms in the UK

QuotedCo.

Non-quoted

limited Co.

UnlimitedCo.

Partner-ships

Sole proprietor-

shipsManufacturing

In summary, there are several legal forms of ownership for SMEs. Three of the

most popular forms are proprietorships, partnerships and company. Each form of

ownership has both advantages and disadvantages. Table 3.4 (page 67) lists all these

advantages and disadvantages by the forms of ownership (Scarborough and Zimmerer,

1984). Legal forms of ownership also have a certain influence on the financial

management practices and financial characteristics. This will be examined in more detail

in the next sections (section 4 and 5) where financial characteristics of many different

kinds of SMEs are compared. Related to the legal forms of ownership, as indicated in

chapter 2, state enterprises, private enterprises, limited companies, joint stock companies,

cooperatives and households are the popular legal forms of ownership of SMEs in

Vietnam. However, as indicated in chapter 1, this study only focuses on private

enterprises, limited companies and joint stock companies.

1 – 24 employees 0.0 77.4 2.6 7.4 12.625 – 99 employees 1.0 94.6 1.1 2.3 1.0100 – 199 employees 5.4 91.8 1.6 0.7 0.7

Non-manufacturing

Catering 0.0 6.5 0.0 24.7 68.8Constructions 0.0 72.4 0.2 9.1 18.3Motor trades 0.0 46.7 0.3 21.4 31.5Retail distribution 0.4 34.5 0.6 22.6 41.8Road transport 0.8 35.2 0.0 19.5 44.5 Wholesale distribution 0.7 82.7 1.8 4.6 10.2

Source: Adopted from Report of the Committee of Inquiry on Small Firms, Bolton (1971)

66




Table 3.4: Summary of advantages and disadvantages of each form of ownership

Form ofownership

Advantages Disadvantages

Proprietorship – A

business owned andmanaged by anindividual.

• Simplicity in creation

•

Least costly form ofownership to start up

3.3 FINANCIAL MANAGEMENT FOR SMEs

This section provides a general framework of financial management for SMEs from the

literature. At the same time, it points out the specific areas of financial management in

the literature that will be reviewed. This section is structured into four subsections.

Subsection 3.3.1 reviews the definitions of SME financial management. Subsection 3.3.2

discusses the objectives of financial management. Subsection 3.3.3 examines the major

decisions that the financial managers or owner-managers have to make in financial

• The owner receives all theprofit

• The owner has totaldecision making authority

• There are no special legalrestrictions

• Unlimited personal liability

•

Limited skills and capability• Limited access to capital

• Lack of continuity of thebusiness

Partnership – Anassociation of twoor more persons who engage inbusiness inbusinesses co-owners for thepurpose of making aprofit

• Easy to establish

• Division of profits

• Larger pool of capital

•

Large pool of talent• Ability to attract limited

partners

• Little governmentregulation

• Flexibility

• Taxation

• Unlimited liability of least onepartner

• Capital accumulation

•

Difficulty in disposing ofpartnership interest withoutdissolving the partnership

• Potential for personality andauthority conflicts

• Partners are bound by the law ofagency

Corporation – Aseparate legal entityapart from itsowners and it mayengage in business

make contracts, sueand be sued and paytaxes.

• Limited liability of the

stockholders

• Ability to attract capital

• Ability of the corporationto have “perpetual life”

•

Transferable ownership

• Large pool of skill,

expertise, and knowledge

• Potential for economies

of scale

• Cost and time involved in the

incorporation process

• Taxation

• Potential for diminishedmanagerial incentives

•

Legal restrictions and regulatoryred tape

• Potential loss of control by the

founder(s) of the corporation.

Source: Adopted from Effective Small Business Management, Scarborough & Zimmerer, 1984

67




management. Finally, subsection 3.3.4 summarizes the specific areas of financial

management that will be more particularly discussed in the next sections.

3.3.1 Defining financial management

The main objective of this study is to review financial management and its impact on

profitability of small and medium enterprises. Before reviewing the relations between

financial management and SME profitability, the concept of financial management needs

to be clarified. According to Meredith (1986) financial management is one of several

functional areas of management but it is the central to the success of any small business.

This definition emphasizes the central role and position of financial management in

relation to the other specific areas of business management. Figure 3.2 describes the

central role and position of financial management in relation to specific areas of business

management.

Figure 3.2: The central position and role of financial management

Source: Adopted from the Central Role of Financial Management (Meredith, 1986)

Financialmanagement

Salesmanagement

Personnelmanagement

Customermanagement

R & Dmanagement

Marketingmanagement

Qualitymanagement

Engineeringmanagement

Productionmanagement

68




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

69




comparing and evaluating the efficiency and effectiveness of financial management. The

final goal of financial management is to maximize the financial wealth of the business

owner (McMahon, 1995). This general goal can be viewed in terms of two much more

specific 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. This objective is also consistent with

the goal of most businesses.

•

• Liquidity management, on one hand, ensures that the business’s obligations

(wages, bills, loan repayments, tax payments, etc.) are paid. The owner wants to

avoid 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. On the

other hand, liquidity management minimizes idle cash balances, which could be

profitable if they are invested (McMahon, 1995).

In addition to the two objectives mentioned by McMahon, English (1990) viewed growth

as another objective of financial management. He also emphasizes the relationships

between the three objectives by putting them on a triangle as illustrated in figure 3.3

below.

Figure 3.3: The relations among objectives of financial management

Liquidity

Growth

Profitability

Source: Adopted from Financial Management for Small Business, English (1990)

70




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.

71




McMahon (1995) suggested another way of identifying the major decisions of financial

management is to look at the balance sheet of a business. There are many decisions

regarding items on the balance sheet. However, they are classified into three main types:

investment decisions, financing decisions and profit distribution decisions (McMahon,1995).

• Investment decisions: (1) relate to the amount and composition of a business’s

investment in short-term assets (cash, stock, debtors, etc.) and fixed assets

(equipment, premises, facilities, etc.), and (2) relate to the achievement of an

appropriate balance between the two classes of assets.

• Financing decisions: (1) relate to the types of finance used to acquire assets, and

(2) relate to the achievement of an appropriate balance between short-term and

long-term sources, and between debt and equity sources.

• Profit distribution decisions: (1) relate to the proportion of profit earned that

should be retained in a business to finance development and growth, (2) and the

proportion, which may be distributed to the owner (McMahon, 1995).

These major decisions of financial management will be discussed in more detail in the

next section where the specific areas of financial management are respectively clarified.

3.3.4 The specific areas of financial management

Most authors and researchers approach the specific areas of financial management in

different ways depending upon their emphasis. This section reviews the specific areas of

financial management, which have regularly been raised and discussed by the recent

authors and researchers such as Walker and Petty (1978), Barrow (1984), Meredith

(1986), Cohen (1989), English (1990) and McMahon (1995).

Walker and Petty (1978) define the main areas of financial management including

planning (cash planning and control, asset-required forecasting, profit planning), financial

leverage, investment decision-making, working capital management (cash, receivable and

inventory management) and sources of financing (short-term and long-term financing,

72




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

73




• 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

influencing financial management practices. Figure 3.5 (page 75) illustrates interaction

74




between theoretical and practical aspects with influence of objectives and decisions of

financial management.

Figure 3.5: Interaction between theories and practices of financial management

Specific areas of financial management:

•

•

•

•

•

•

•

Current asset management

Fixed asset management

Funding management

Financial budgeting and planning

Leverage and capital structure

Financial analysis and evaluating performance

Profit distribution


Figure 3.5 presents the relationship between specific areas of financial

management and financial management practices. However, the purpose of this study is

not to cover all areas of financial management but only to examine the areas of financial

management practices such as accounting information system, financial reporting and

analysis, working capital management practices, fixed asset management practices,

capital structure management practices, financial planning and financial characteristics

Financial management practices:

•

•

•

•

•

•

Accounting information system practices

Financial reporting and analysis practices

Working capital management practices

Fixed asset management practices

Capital structure management practices

Financial planning practices

Profitability

Objectives of financial management:

•

•

•

Liquidity

Profitability

Growth

Decisions of financial management:

•

•

Investment decisions

Financing decisions

• Profit distribution decisions

75




including liquidity, financial leverage, and activity. Section 3.4 and 3.5 respectively

review financial management practices and financial characteristics.

3.4 FINANCIAL MANAGEMENT PRACTICES

The previous section provides a review of SME and financial management. This section

reviews SME financial management practices in the developed economies such as the

USA, Canada, the UK and Australia. Firstly, the context of financial management

practices should be defined and then the aspects of financial management practices,

which may affect SME profitability, will be reviewed and discussed in more detail.

3.4.1 The context of financial management practices

Financial management practices in the SME sector have long attracted the attention of

researchers. Depending on different objectives, researchers emphasize different aspects

of financial management practices. McMahon, Holmes, Hutchinson and Forsaith (1993)

and McMahon (1998) summarize their review of financial management practices in

Australia, the UK and the USA. In their review the context of financial management

practices includes the following areas:

1. Accounting information systems – the nature and purpose of financial records,

bookkeeping, cost accounting, and use of computers in financial record keeping

and financial management

2. Financial reporting and analysis – the nature, frequency and purpose of

financial reporting, auditing, analysis and interpretation of financial performance

3. Working capital management – non-financial and financial considerations in

asset acquisition, quantitative techniques for capital project evaluation, investment

hurdle rate determination and handling risk an uncertainty in this context

4. Financial structure management – financial leverage or gearing, accounting to

lenders, knowledge of sources and uses of finance, non-financial and financial

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considerations in financial structure decisions and non-financial and financial

considerations in profit distribution decisions

5. Financial planning and control – financial objectives and targets, cost-volume-

profit analysis, pricing, financial budgeting and control, and managementresponsibility centers

6. Financial advice – internal and external sources and types of financial advice and

use of public accounting services

7. Financial management expertise – informal and formal education, training and

experience in financial management, relevant qualifications, and overall financial

management expertise.

However, the purpose of this study is not to cover all the contexts of financial

management practices as indicated above but to review selected financial management

practices that affect on or are related to SME profitability. These include accounting

information systems, financial reporting and analysis, working capital management, fixed

asset management, and capital structure management.

3.4.2 Accounting information systems

In the developed economies such as the USA, Canada, the UK and Australia, accounting

system practices in SMEs have long attracted the considerations of many researchers.

This section examines the accounting system practices and computer utilization in

accounting. In these fields, D’Amboise and Gasse (1980), Raymond and Magnenat-

Thalmann (1982), Cheney (1983), Raymond (1985), DeThomas and Fredenberger

(1985), and Farhoodman and Hryck (1985) are considered key researchers in the USA

and Canada. Further research in the 1990’s was carried out by Gul (1991), Chen (1993)

Palmer (1994), and Gorton (1999).

D’Amboise and Gasse (1980) studied the utilization of formal management

techniques in 25 small shoe manufacturers and 26 small plastic manufacturers in Quebec,

Canada and found that 88 percent of the businesses used a cost accounting system.

Regarding accounting standards, DeThomas and Fredenberger (1985), in a survey of over

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360 small enterprises in Georgia, found that the standards of financial record keeping was

very high. In addition to cheque and deposit receipts, around 92 percent of respondents

had some form of record keeping. Over 50 percent of respondents used an in-house

bookkeeper for recording transactions, whereas preparing financial statements wascarried out by external accountants (Table 3.5).

Table 3.5: Responsibility for the bookkeeping and accounting task

Percentage of response (%)Recording transactions Preparing financial statements

Owner-manager 21 17In-house bookkeeper 54 40Outside accountant 25 53

Source: Adapted from DeThomas and Fredenberger (1985)

Regarding the use of financial information, DeThomas and Fredenberger’s

(1985) study indicated that 96 percent of the respondents had financial statements

prepared, the responsibility for evaluating and using the information was within the

business itself and only four percent relied on an outside accountant (Table 3.6).

Table 3.6: Responsibility for preparation and use of financial informationPercentage (%)

Responsibility for interpreting financial statement information:No specific responsibility

For computer software applications in accounting, Raymond and Magnenat-

Thalmann (1982) conducted a survey of 129 small manufacturing businesses, whose

number of employees totaled between 20 and 250 and sales varied from $0.5 to $ 25

million, in 1982. Another survey of 464 small businesses was carried out by Raymond in

1985 in the province of Quebec. The results of the two surveys are summarized in Table

3.7 (page 79). In the 1990’s, Chen (1993) found that accounting still was the most

important and widely software in the small business studied.

Owner/manager responsibilityIn house bookkeeperOutside accountant

0

82144

Specific use of financial statement information:

Not used at allCursory use

089

Formal use 11Source: Adapted from DeThomas and Fredenberger (1985)

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Table 3.7: The results of survey of computer software application Applications Raymond and Magnenat-Thalmann (1982) Raymond (1985)

Percentage use Percentage use Accounts receivable 85 58.5

Accounts payable 77 80.6General ledger 75 78.8Billing 68 72.6Sales analysis 75 68.5Inventory 54 56.4Order entry 42 47.3Cost accounting 43 43.0Budgeting n.a 35.4Purchasing n.a 31.5Forecasting n.a 31.3Production control 11 29.6Production scheduling 14 16.8 Word processing 10 15.8Personnel n.a 15.1Payroll 79 n.aOthers 9 5.8

Source: Adapted from Raymond and Magnenat-Thalmann (1982) and Raymond (1985)

In the USA, researchers conducted many surveys of the most important

applications of computers in accounting. Cheney (1983) reports on a survey of 30 small

and medium-sized businesses in a variety of industries in Georgia. In his survey, the

respondents were asked to indicate the most important applications of computer software

in use and the results are summarized in Table 3.8. The results revealed that the most

important applications of computer software are in the areas such as payroll, accounts

receivable, accounts payable and general ledger.

Table 3.8: The most important applications of computer software Application Number of respondents Percentage usePayroll 30 100 Accounts receivable 26 87 Accounts payable 24 80General ledger 22 73Inventory 12 40Sales analysis 11 37Order entry 9 30Bill of materials 3 10

Source: Adapted from Cheney (1983)

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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

80




importance of sound costing systems but they lacked the time and expertise to install such

systems.

Table 3.10: Percentage of awareness and utilization of costing systemsSize category (employees) Awareness (%) Utilization (%)11 – 50 91 4551 – 100 100 66101 – 200 91 63201 – 500 100 80

Source: Adapted from Murphy (1978)

Lovett (1980) found that many businesses either had no costing system at all or

relied on periodic attempts to estimate the cost of a product through a rough calculation

of the labor and materials content plus a mark up for overhead and profit.

In Australia Peacock (1985, 1987, and 1988), Williams (1986), Holmes (1987)

and Holmes and Nicholls (1988) are typical researchers who published results of studies

of accounting information system practices. Peacock (1985) investigated the effects and

causes of more 1,000 proprietary company failures in South Australia during ten years

and found that 4.6 percent of failures had inadequate or no accounting records. In another

study of company failures in South Australia, Peacock (1987) reviewed the bankruptcy

reports of 418 unincorporated businesses for four years (from 1981 to 1985) and found

that 50.5 percent of these used single entry systems, 32.8 percent used bank and taxation

records whereas only 2.1 percent utilized double entry systems. In a more recent study,

Peacock (1988) found a significant element in the failure of many of the businesses was

inefficient or absence of accounting records. More than half of the businesses failed were

found to have no records or only basic bank and taxation records. Peacock’s (1985, 1987,

and 1988) findings are very important as examining the impact of accounting system

practices on performance of SMEs.

Williams (1986) evaluated the adequacy of accounting records for 10,570 failed

and surviving small enterprises operating throughout Australia. The results, which are

summarized at Table 3.11 (page 82), are compatible with Peacock’s (1986, 1987,1988)

findings in that a significant proportion of owner-managers kept inadequate accounting

records.

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Table 3.11: Evaluate the adequacy of accounting recordsStandard Percentage (%)Excellent 9.33Good 22.93

Average 43.88Inadequate 21.58

Holmes (1987) conducted a survey of accounting information requirements of 928

small enterprises operating in Sydney, Melbourne and Brisbane. Fifty-seven percent of

respondents indicated they used the journal/ledger (double entry) systems. This finding is

rather in contrast to Peacock’s (1987) findings of types of records maintained by failed

enterprises, where only 2.1 percent of respondents were found to use double entry

systems. In a more recent study, Holmes and Nicholls (1987) analyzed the use of

accounting information by Australian small firms. The owner-managers were asked to

indicate the accounting information prepared at least once a year by either business or an

external accountant. The responses are listed in Table 3.12.

Poor/ non-exist 2.28Source: Adapted from Williams (1986)

Table 3.12: Accounting information prepared externally or internallyInternally prepared Externally preparedInformation

Statutory Tax return 7.7 88.8Statutory accounts 9.7 51.7

An inspection of the data in Table 3.12 suggests that a significant difference exists

between the internal and external preparation of accounting information. In order to

check this hypothesis, tests of equality of proportion were carried out and the testing

results supported the conclusions that statutory information is sought mainly from

external accountants, whereas additional management information tends to be prepared

within the business.

Financial statements 14.5 69.3Budget Profit/Loss 17.0 26.6

Cash flow 20.6 16.3 Additional Ratio analysis 7.4 5.0

Manufacturing statement 6.0 2.6Source & application of funds 10.0 7.7

Break-even analysis 12.3 4.2Cash flow statement 20.5 8.1

Production reports 10.3 4.3 Job costing reports 18.4 2.4

Source: Adapted from Holmes and Nicholls (1987)

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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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Table 3.15: Responsibility for financial statement interpretationResponsibility Percentage of responseOwner-manager 82In-house bookkeeper 14

Outside accountant 4Source: Adapted from DeThomas and Fredenberger (1985)

DeThomas and Fredenberger also found that 61 percent of respondents felt the financial

statements provided the information they required for planning and decision-making.

Nevertheless, only 11 percent of respondents reported that they had used financial

statement information formally as part of managerial evaluation, planning and decision-

making, 2 percent of businesses utilized financial ratio analysis, and few made even

simple historical comparisons.

Thomas and Evanson (1987) studied 398 small pharmacies (in Michigan, North

Carolina, Nebraska, Rhode Island and Washington) to examine the extent to which

financial ratios were used in a specific line of small retail business and tested for a

relationship between use of financial ratios and business success. The proportion of

respondents using financial ratios in Thomas and Evanson’s (1987) study of small

pharmacies is summarized in Table 3.16 (page 86).

Thomas and Evanson (1987) used regression analysis to examine the relationship

between financial ratio usage and SME profitability. However, they could not

demonstrate any significant relationship between earnings-to-sales and the number of

financial ratios used by the owner in operational decision-making. When efforts were

made to include the effects of other managerial practices and variations in business

environments, no association between use of individual ratios and total earnings or total-

to-sales was found. They explained the lack of association between financial ratio usage

and either survival or profitability, may also indicate that the level of sophistication in use

of ratios has not reached a high enough level among pharmacies to make a discernible

difference between those which use and those which do not use financial ratios.

However, Thomas and Evanson (1987)’s study only examined the association between

SME profitability and the number of financial ratios, while the relationship between SME

profitability and the efficiency as the result of using the financial ratios was not studied.

85




Table 3.16: Proportion of respondents indicating use of selected financial ratiosPercentage of each kind of pharmacies using

financial ratiosClosed

(%)

Changes of

ownership (%)

Ongoing

( %)

Total

(%)Cost of goods sold to sales 64.4 66.7 71.6 68.5Inventory turnover 64.4 68.4 69.5 68.0Gross margin to sales 64.4 64.0 69.5 61.9Net profit to net sales 43.7 52.6 45.3 47.1Net profit to inventory 37.9 49.1 34.2 39.4Current assets to current liabilities 41.4 38.6 38.4 39.1Net sales to inventory 40.2 42.1 32.1 36.8 Accounts receivable collection period 23.0 31.6 33.7 30.7 Total liabilities to net worth 28.7 28.9 23.2 26.1Return on equity or investment 26.4 29.8 23.2 25.8Days accounts receivable outstanding 21.8 23.7 27.4 25.1

Days accounts payable outstanding 19.5 23.7 22.1 22.0Inventory to net working capital 28.7 28.9 23.3 21.5

Source: Adapted from Thomas and Evanson (1987)

Palmer (1994) interviewed 36 small independent retail owners to determined if

timely and accurate financial information is really all that important to small businesses

and found that the more knowledgeable the owner-managers were about the financial

position of these businesses, the more successful the businesses appeared to be.

The key researchers of financial reporting practices in the UK include Ray and

Hutchinson (1983), Hankinson (1982, 1983), Arnol-McCullock and Lewis (1986), and

McMahon and Davies (1994). Ray and Hutchinson (1983) studied the type and frequency

of financial reporting in the super-growth enterprises and found that there was a clear

tendency towards more frequent financial reporting as the business grew and became

public companies. Hankinson (1982, 1983) studied making investment decisions in 52

small engineering businesses in southwest England between 1979 and 1982 and found

that only one business in the sample used financial ratio analysis. Conversely, in their

survey of 102 growth enterprises operating in the northeast region of England, McMahon

and Davies (1991) found that 80 percent or more of the participants employed financial

ratio analysis. Related to the kind of financial ratios used, Arnold-McCulloch and Lewis

(1986) examined 52 recently established businesses. Their findings are summarized in

Table 3.17 (page 87), which revealed that the percentage of use of financial ratios such as

debtors/creditors, acid test, sales to debtors and cash, inventory turnover, return on

86




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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Table 3.18: Percentage of preparing accounting information both internally and externallyIn 1986 In 1988

Internally prepared

(%)

Externally prepared (%)

Internally prepared

(%)

Externally prepared (%)

Taxation returns 3.6 92.7 7.7 88.8Statutory accounts 7.3 61.8 9.7 51.7Balance sheet/ profit and loss n.a n.a 14.5 68.3Manufacturing statements n.a n.a 6.0 2.6Funds statements 18.2 12.7 10.0 7.7Cash-flow statement 27.3 14.5 20.5 8.1Production reports 25.5 1.8 10.3 4.3 Job costing reports 23.6 1.8 18.4 2.4Source: Adapted from Holmes (1986), Holmes and Nicholls (1988)

A common tendency is that relatively complicated accounting reports such as taxation

returns, statutory accounts, balance sheets, and profit and loss statements are usually

prepared by external experts.

McMahon (1998) examined which enterprises and financial management

characteristics seem to most influence financial reporting practices adopted in small and

medium-sized manufacturing enterprises in Australia and what impact these financial

reporting practices appear to have on achieved business growth and performance. The

research results showed that development orientation, extent of owner-management,

technological complexity, degree of reliance upon external financial advice, and financial

reporting climate significantly influence on the comprehensiveness of financial reporting

practices in Australian small manufacturing enterprises. According to McMahon (1998)

the relationship between financial reporting practices and business growth and

performance is difficult to identify, describe and explain. The reason explained for this is

that management is a complex activity affected by a myriad of interacting internal and

external factors. Recently, McMahon (1999) reported new empirical evidence on

financial reporting to financiers by small and medium-sized enterprises and found a

significant relationship exists in the study sample between enterprise size in employment

terms and provision to financiers of a business plan or future-oriented financial

statements or annual historical financial statements or periodic historical financial

statement. However, no statistically significant relationship exists in the study sample

88




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)




In contrast to Grablowsky and Rowell’s (1978) and Cooley and Pullen’s (1979)

survey, Murphy’s (1973) study indicated that active cash management in small

enterprises in the UK was unusual, and that there was little inclination to invest surplus

cash on a short-term basis.Evidence on the cash management practices of 123 small enterprises across a

variety of industries in the Canadian provinces of Quebec and Ontario was provided by

Anvari and Gopal (1983). Generally, 53 percent of the sample businesses indicated that

they prepared cash forecasts, substantially higher than the 30 percent figure reported by

Grablowsky (1978, 1980). Respondents were also asked the basis for determining the

level of their cash balances. Only 26 percent of respondents indicated they used formal

techniques, using a fixed percentage of sales or expenses, for determining the level of

their cash balances. Fifty-five percent of respondents claimed to have had a short-term

surplus of cash and 26 percent of businesses had generated what they considered to be

long-term surplus funds in the previous year. The instruments of short-term investment

used by these firms are shown in Table 3.21.

Table 3.21: Instruments of short-term investment usedInstrument PercentageChecking account 1.5Saving account 9.1

Treasury bills 3.0Bankers acceptance 28.8 Term deposits 56.1Commercial paper 1.5

Source: Adapted from Anvari and Gopal (1983)

Regarding accounts receivable management practices, Grablowsky (1976) and

Grablowsky and Rowell (1980) found generally low standards. Approximately 95 percent

of businesses that sold on credit tended to sell to anyone who wished to buy. Only 30

percent of respondents subscribed to a regular credit reporting service. Most had no credit

checking procedures and guidelines, and only 52 percent enforced a late-payment charge.

Thirty-four percent of businesses had no formal procedure for aging accounts receivable.

Bad debts averaged 1.75 percent of sales, with a high of 10 percent in some concerns.

Murphy (1978) revealed a very high level of awareness and utilization of credit control

systems in the UK, even in the smallest businesses (Table 3.22, page 92).

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Table 3.22: Awareness and utilization of credit control systemsSize category (Employees) Awareness (%) Utilization (%)

11 – 50

On inventory management practices, D’Amboise and Gasse (1980) studied the

utilization of management techniques in small shoe and plastic manufacturing industries

in Canada and found 64 percent of shoe and 65.4 percent of plastic businesses employed

formal inventory control systems. While Grablowsky and Rowell (1980) found that most

of the respondents had in excess of 30 percent of their capital invested in inventory, the

general standard of inventory management was poor. Only six percent of businesses in

their survey used a quantitative technique such as economic order quantity for optimizing

inventory and 54 percent had systems which were unable to provide information on

inventory turnover, reorder points, ordering costs or carrying costs. Related to the

methods used to determine inventory level, Grablowsky (1984) compared methods used

by a sample of 94 small enterprises with those used by large enterprises and found the

results as in Table 3.23.

Unlike the researchers mentioned above, Peel and Wilson (1996) studied working

capital management practices of small firms based in the North of England without any

Table 3.23: Methods used by small and large enterprises to determine inventory levelSmall enterprises Large enterprises

Method Percentage use (%) Percentage use (%) ABC 2 -Economic order quantity (EOQ) 2 63Inventory turnover ratio - 55Linear programming - 24Statistical methods - 10Safety stock 7 50 Anticipation stock 32 -Executive judgement 6 66

Sales projections 9 -Past experience 15 -No method 27 -

Source: Adapted from Grablowsky (1984)

100 9151 – 100 100 100

101 – 200 100 91201 – 500 100 100

Source: Adapted from Murphy (1978)

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separation of cash management, receivable, payable and inventory management but

dealing with working capital components. In their research, respondents were requested

to indicate the frequency with which they used or reviewed various methods or

components pertaining to the management of working capital. Table 3.24 reports theresearch results conducted by Peel and Wilson (1996).

Table 3.24: Working capital management: Frequency (%) of using or reviewingNever Some-

timesQuiteoften

Often Veryoften

Cash budgeting (use) 8.5 11.0 20.7 23.2 36.6Debtors’ credit period (review) 8.6 9.9 22.2 35.8 23.5Debtors’ discount policy (review) 30.0 22.5 23.8 13.8 10.0Bad debt (review) 4.9 13.6 13.6 29.6 38.3Doubtful debts (review)

In general, depending upon their objectives, in examining working capital

management practices, previous researchers emphasized specific aspects of working

capital management. Burns and Walker (1991) examined working capital management as

a whole. In their survey of working capital policy among small manufacturing firms in

the USA, the following aspects of working capital were considered:

• working capital policy,

• managing working capital components, including cash, receivable, payable and

inventory management, and• relationships between working capital management practices and profitability.

Probably this survey was one of the most comprehensive surveys of working capital

management practices where almost all aspects of working capital management were

3.7 13.6 19.8 37.0 25.9

Customer credit/risk standing (review) 8.6 18.5 22.2 25.9 24.7Creditors’ payment period (review) 12.2 22.0 36.6 15.9 13.4Factoring (use) 78.0 4.9 4.9 3.7 8.5 Working capital financing requirements 12.2 22.0 36.6 15.9 13.4Stock turnover (review) 38.5 16.7 24.4 12.8 7.7Stock level (review) 34.6 10.3 17.9 23.1 14.1Stock re-order levels (review) 40.3 10.4 20.8 16.9 11.7Economic order quantity model (use) 73.8 8.8 12.5 2.5 2.5

Source: Adapted from Peel and Wilson (1996)

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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

(% use) (% use) (% use)Small 61 35 11Medium 29 47 24Large 45 35 45

Source: Adapted from Corner (1967)

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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.

Table 3.33: Viewpoint guiding firms’ financing decisionsResponse

percentagea. Raise/use money in the following order: 31.8

1. Use internal funds as much as possible2.

Issue short-term debt, long-term debt3. Issue convertible securities4. Issue common stock

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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Other empirical evidence on capital structure was provided by Peterson and

Shulman (1987). Peterson and Shulman (1987) analyzed the empirical data collected for

1984 International Small Business Congress. Approximately 130 questions were asked

in 4,000 interviews conducted in 12 countries including Brazil, Colombia, Spain,Kenya, Cameroon, Indonesia, USA, Canada, West Germany, United Kingdom,

Netherlands, and Japan. The survey questionnaire contains information regarding the

source of funds, including traditional debt, internal equity, friends/relatives, and trade

suppliers. The actual percentage of each source that a firm employs varies depending on

such factors as (1) age of firm, (2) location of the firm, (3) cost of the source, (4)

availability of the source, (5) profitability of the firm, (6) growth level of the firm, and

(7) information flows.

The results of the study show that a life cycle of capital structure among small

growing firms depend on age, size, and economic development. Most firms appear to be

initially dependent on relatives/friends and personal equity for expansion/working

capital needs and over time are able to rely on more heavily on traditional source of

bank debt for financial support. Since firm managers/owners will attempt to minimize

the overall cost of capital, the firm is seen as having a rising level of debt as it becomes

available.

Using debt finance seems to be dependent on size, profitability of the firm and the

development of the economy. This conclusion is supported by the evidence shown in

Table 3.34.

Table 3.34: Factors influencing percentage of bank debt usagePercentage of bank debt use

Number of employeesUnder 10 4410 – 50 63Over 50 73

Firm profitabilityProfitable firms 71Unprofitable firms 43

Development of the economyDeveloped countries 68Developing countries 42

Source: Adapted from Peterson and Shulman (1987)

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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

researchers. Stevens (1973), Burns (1985), Hutchinson, Meric and Meric (1988), Jaggi

and Considine (1990), Davidson and Dutia (1991), Laitinen (1992), Hutchinson and

Mengersen (1993), McMahon et al. (1993), and Meric et al. (1997) are viewed as the key

researchers who study financial characteristics. In defining financial characteristics,

McMahon et al. (1993, p. 177) states:

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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

Jaggi andConsidine (1990)

73 owner controlled Profitability, liquidity, leverage and dividendacquired firm payment capability

Laitinen (1992) Newly-founded Profitability, dynamic liquidity, quick ratio,firms indebtedness or static solidity, dynamic solidity,

logarithmic net sales, and capital intensiveness.

McMahon et al.(1993)

General Profitability, liquidity and leverage

Hutchinson andMengersen(1993)

Growth small firm Profitability, liquidity, and leverage

Meric et al.(1997)

87 Japanese and 87 Operating profit margin, total asset turnover, returnUS chemical firms on assets, return on equity, fixed charge coverage,

common equity ratio, long-term debt ratio, currentratio, quick ratio, inventory turnover


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3.5.2 Measuring financial characteristics

Subsection 3.5.1 discussed financial characteristic identified by previous researchers in

their studies. Subsection 3.5.2 examines how to measure financial characteristics.

However, the purpose of this study is not to examine all variables but only discusses

measuring four variables: liquidity, leverage, activity and profitability, which are the

most popularly used to identify financial characteristics and meet the objectives of the

study.

3.5.2.1 Liquidity

Most researchers view liquidity as one of the variables to define financial characteristics.

Liquidity refers to the overall level of cash and near cash assets (such as debtors and

stock) held and cash inflows and outflows that add to and subtract from the sum of these

assets (McMahon and Stanger, 1995, p.24). When used for determining financial

characteristics, liquidity is often measured as ratios. There are two kinds of ratios used by

most researchers such as Stevens (1973), Burns (1985), Jaggi and Considine (1990),

Hutchinson and Mengersen (1993), Meric et al (1997):

1.

Current ratio = Current assets / Current liabilities

2. Quick ratio = (Current assets – Inventory) / Current liabilities

In general, previous researchers strongly agreed in the use of these two ratios as measures

of liquidity and to determine financial characteristics of small enterprises.

3.5.2.2 Financ ial leverage

Leverage is the next variable often used by most researchers to determine financial

characteristics of the small enterprises. Walker and Petty (1978, p.145) defined financial

leverage to be the process of using senior (debt or equity capital with a fixed return)

capital to increase the rate of return on junior securities. Brigham (1995, p. 429) indicated

that financial leverage is the extent to which fixed-income securities (debt and preferred

107




stock) are used in a firm’s capital structure. Similarly, Ross, Westerfield and Jaffe (1999,

p.33) said that financial leverage is related to the extent to which a firm relies on debt

financing rather than equity.

When financial leverage is used to identify financial characteristics of the firm, itis often measured by the following ratios:

1. Equity ratio = Equity/Total asset: used by Hutchinson, Meric and Meric (1988),

Meric et al (1997)

2. Long-term debt ratio = Long-term debt/Total capital: used by Burns (1985), Meric

et al (1997)

3.

Lon-term debt to equity ratio = Long-term debt/Common stock equity: used by

Jaggi and Considine (1990)

4. Debt ratio = Total debt/Total assets: used by Brigham (1995) and Ross,

Westerfield, and Jaffe (1999).

5. Debt-to-equity ratio = Total debt/Total equity: used by Brigham (1995) and Ross,


3.5.2.3 Activity

A ratio of activity is considered the third variable to determine financial characteristics of

the firm. Hutchinson, Meric and Meric (1988) measure activity by the following ratios:

1. Inventory ratio = Inventory/Sales

2. Receivables ratio = Accounts receivable/Sales

3. Fixed assets ratio = Fixed assets/Sales

4. Total asset turnover = Sales/Total assets

Meric et al (1997) only used two ratios of activity: total asset turnover (Sales/Total

assets) and inventory turnover. Noticeably, Ross, Westerfield, and Jaffe (1999) and Meric

et al. (1997) used inventory turnover instead of inventory ratio. Inventory ratio is

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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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Table 3.36: Summary of measurement of financial characteristic variables

Researcher(s) Financial Measurementand year characteristic

variables

Burns (1985) Liquidity Current ratio and quick ratioProfitability Return on total assets, return on net assets and return

on equityLeverage Gearing ratio and long-term debt ratioLiquidity ratios Current assets/Current liabilities

(Current assets – Inventory)/Current liabilitiesCurrent assets/Total assets(Current assets – current liabilities)/Total assets

Hutchinson,Leverage ratios Owners’ equity/Total assets

Current liabilities/Total assetMeric and Meric(1988)

Activity ratios Inventories/SalesSales/Total assets

Profitability ratios Net profit after tax/SalesEarnings before interest and tax/Total assetsNet profit after tax/Owners’ equity

Growth ratios Average annual assets growth rate Average annual sales growth rate

Profitability Operating profit/Total assets Jaggi andConsidine (1990)

Liquidity Cash/Current liabilities(Cash + accounts receivable)/Current liabilitiescurrent assets/Current liability

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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3.5.3 Previous findings related to financial characteristics

This subsection reviews findings of previous researchers, related to financial

characteristics. Its objective is to identify the gap in knowledge of financial

characteristics of SMEs.

During the three decades of 1960’s, 1970’s and 1980’s, Anderson (1967), Singh

and Whittington (1968), Gupta (1969), Bolton (1971), Bates (1971), Elliott (1972),

Stevens (1973), Walker and Petty (1978), Wilson (1979), Chen and Balke (1979), Tamari

(1980), the US Small Business Administration (1984), Burns (1985), Storey et al. (1987),

and Hutchinson, Meric and Meric (1988) are the well-known researchers who completed

numerous studies related to financial characteristics of SMEs. In recent years, the key

researchers who have contributed to studying financial characteristics of SMEs include

Jaggi and Considine (1990), Davidson and Dutia (1991), Laitinen (1992), Hutchison and

Mengersen (1993) and Meric et al. (1997). The findings and contribution of researchers

as mentioned above can be classified into three categories:

• findings of factors influencing financial characteristics of SMEs

• findings of comparisons (large versus small enterprises, owner versus non-owner

controlled acquired firms, quoted versus unquoted firms, floated versus non-

floated firms, country versus another country) of financial characteristics of

SMEs, and

• findings of the impact of financial characteristics on SME performance.

The next subsections will review details of these findings. Its objective is to identify a

gap in the literature on financial characteristics of SMEs.

3.5.3.1 Findings of factors influencing financial characteristics of SMEs

Researchers in the literature found many factors influencing financial characteristics of

SMEs in which growth and size are two of these factors. According to McMahon et al.

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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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reflected by four financial characteristics: profitability; liquidity; leverage and dividend

payment capability was weak for non-owner controlled firms and it was strong for

owner-controlled firms.

Quoted versus unquoted small firms

Differences in financial characteristics of quoted and unquoted small firms were

examined by Hutchinson, Meric and Meric (1988). In their study, they examined whether

financial characteristics of small firms, which are quoted on the Unlisted Securities

Market (USM) in the UK, are different from small firms not listed.

Based on multivariate variance analysis, they indicated that the overall financial

characteristics of these firms are significantly different from those which have not

achieved USM quotation. The most important differences between these two groups of

firms are in terms of sales growth rates, the use of debt financing, and the level of liquid

assets. Small firms, which had achieved USM quotation, appeared to have higher growth

rates, use more debt financing, and invest less in current assets than small firms, which

have not achieved USM quotation.

Floated versus non-floated small firms

While Hutchinson et al. (1988) provided an analysis of financial characteristics of small

firms which achieved quotation on the USM, Hall and Hutchinson (1995) examined how

financial characteristics of small firms entering the USM between 1980 and 1983

inclusive differed from those that remained non-floated. Their results provide useful

insights into some aspects of the operation of the USM with respect to small firms. Those

small firms, which did seek flotation, are not necessarily the fastest growing; and the

establishment of the USM would not appear to have made any difference to the

relationship between the growth of a small firm and its profitability in achieving flotation.

Similarly, whilst small firms that were floated on the USM in 1980 to 1983 were clearly

usually more profitable than those that were not, profitability would not appear to have

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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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By using the multivariate analysis of variance method to compare financial

characteristics of Japanese chemical firms, and USA chemical firms, Meric and Meric

(1997) found that the overall financial characteristics of these two groups are

significantly different. Particularly, the differences in financial characteristics of twogroups of firms included:

• All profitability ratios were higher in USA chemical firms compared with

Japanese chemical firms.

• Japanese firms were able to use a significantly higher level of financial leverage

compared with USA firms to boost their return on equity.

•

The liquidity level as measured by the quick ratio was not significantly different

for USA and Japanese chemical firms; however, the current ratio was

significantly higher for USA chemical firms than for Japanese chemical firms.

• The inventory turnover ratio was also significantly lower for USA chemical firms

than for Japanese chemical firms.

Another international comparison of financial characteristics was a financial comparison

between Korean and USA firms provided by Van Auken, Doran and Yoon (1993). By

using canonical correlation analysis, they found the differences in financial

characteristics between Korean and USA firms to be as follows:

• The Korean firms were shown to have greater relative level of cash and fixed

assets and small levels of inventory than USA small and large firms.

• Korean firms were less liquid compared to USA businesses. A comparison of the

current and quick ratios of two groups is given in Table 3.38.

•

Another difference between Korean and USA businesses was that Korean

businesses depend heavily on the use of current debt.

Table 3.38: Comparison of liquid ratios between Korean and USA firmsKorean firms USA firms

Small LargeCurrent ratio 0.70 1.70 2.00Quick ratio 0.47 0.52 1.00

Source: Adapted from Van Auken, Doran and Yoon (1993)

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3.5.3.3 Findings of impact of financial characteristics on performance

Subsection 3.5.3.1 provided a review of the factors influencing financial characteristics of

SMEs. Subsection 3.5.3.3 reviews the findings related to the impact of financial

characteristics on SME performance. Unfortunately, studies on these effects are few in

the literature. While there is much research on factors affecting financial characteristics

and many comparative studies of financial characteristics of SMEs, it appears there is

little research on the impact of financial characteristics on SME profitability. This is a

gap in previous studies, which needs to be met by this research.

3.6 SME PROFITABILITY

Sections 4 and 5 review the literature of financial management practices and financial

characteristics of SMEs, two of three main issues in this research. Section 3.6 reviews the

literature on profitability of SMEs. This section is structured into three subsections.

Subsection 3.6.1 examines the importance of profitability to survival and development of

SMEs. Subsection 3.6.2 reviews measures of profitability. Lastly, subsection 3.6.3

analyses factors influencing SME profitability.

3.6.1 Importance of profitabili ty

Profitability is one of the most important objectives of financial management because one

goal of financial management is to maximize the owner’s wealth (McMahon, 1995).

Thus, profitability is very important in determining the success or failure of a business.

At the establishment stage, a business may not be profitable because of investment and

expenses for establishing the business. When the business becomes mature, profits have

to be produced.

Due to the importance of profitability, Edmister (1970) among other researchers

have suggested that small firms need to concentrate on profitability. Jen (1963) found

profitability to be a significant determinant of a small firm’s credit risk. Thomas and

Evanson (1987) stress the aim of a business is not only the generation of sales, but also

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generation of profits. Profit is especially important because it is necessary for the survival

of a business. Low profitability contributes to under-capitalization problems because it

leads to fewer dollars as retained earnings and therefore to a reliance on external capital

(Davidson and Dutia, 1991).

3.6.2 Defining and measuring profitabili ty

One of the most difficult attributes of a firm to conceptualize and measure is profitability

(Ross, Westerfield and Jaffe, 1999). In a general sense, accounting profits are the

difference between revenues and costs. However, the problem with accounting-based

measures of profitability is that they ignore risk. In the economic sense, a firm is

profitable only if its profitability is greater than investors can achieve independently in

the capital market. In their text, Ross et al. (1999) suggest some methods to measure

profitability including profit margin or return on sales, return on assets, and return on

equity.

• Profit margins are computed by dividing profits by total operating revenue and

thus express profits as a percentage of total operating revenue.

•

Return on assets is the ratio of income to average total assets, both before tax andafter tax, and measures managerial performance.

• Return on equity is defined as net income divided by average stockholders’

equity, and shows profit available for stockholders.

Cohen (1989) stated measures of profitability are essential in any business. In his text, he

indicated many different ratios to measure profitability of the business. They included

asset-earning power, return on the owner’s equity, net profit on sales, and return on

investment.

• Asset earning power is determined by the ratio of earnings before interest and tax

to total assets. It indicates how much operating profit each dollar of total assets

earns.

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• Return on the owner’s equity is computed by dividing net profit by average

equity, and shows return that the business received in exchange for investment.

• Net profit on sales is determined by the ratio between net profit and net sales, and

measures the difference between what the business takes in and what it spends inthe process of doing business.

• Return on investment is simply computed by dividing net profit by total assets.

This measure is very useful for measuring profitability. There are several different

ways of calculating return on investment depending upon the purpose of measure:

1. A measure of earning power in operating efficiency (Cohen, 1989)

=Rate of earning on total

capital employed Net income + Interest + Tax

Total liabilities and capital

2. A measure of earning power of the borrowed invested capital (Cohen, 1989)

=Rate of earnings on

invested capital Net income + Income taxes

Proprietary equity and fixed liabilities

3. A measure of the yield on the power’s investment (Cohen, 1989)

=Rate of earnings on proprietary capital

Net income

Total capital including surplus reserves

4. A measure of the attractiveness of common stock as a source of income

(Cohen, 1989)

=Rate of earnings on

stock equity Net income

Stock equity

5. To indicate the desirability of common stock as a source of income (Cohen,

1989)

=Rate of dividends oncommon stock equity

Common stock dividends

Common stock equity

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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


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productive than other employees. However, in his study family member’s productivity

did not increase profitability. Results showed the opposite, as paid family labor increases,

profitability decreases. As family member participation increases, wage and salary

expense increase as a percentage of revenue, thereby causing profit as a percentage ofsales to decline.

McDonald (1999) provided new evidence on the determinants of profitability of

Australian manufacturing firms by analyzing an unique firm level data-set of firm

performance over the period 1984 – 93. Determinants of firm profitability were found to

be generally consistent with previous Australian industry-level results and overseas

studies. Firm profitability was found to be negatively affected by union density and by

import penetration, and positively affected by industry concentration. In addition, there

was a strong degree of persistence in firm profit margins over time. Real wage inflation

was negatively related to profit margins, which suggests that firms do not immediately

pass on increases in real wages by raising current prices. Firm market share was generally

not found to be a significant determinant of profit margins, although this result is

sensitive to the econometric method used.

Generally, there are many factors affecting SME profitability. However, from the

viewpoint of financial management, DuPont analysis is considered a standard model to

analyze the factors affecting on SME profitability. According to Eisemann (1997), a

virtue of DuPont analysis is its simplicity. Three fundamental ratios derive one summary

ratio: return on equity (ROE). Their relationships are illustrated by the following

equations:

Return on equity = (Net profit margin) x (Total asset turnover) x (Leverage) (Eq. 6.1)

Net income/equity = (Net income/sales) x (Sales/assets) x (Assets/equity) (Eq. 6.2)

The ratios that determine ROE reflect three major performance dimensions of

interest to all loan analysts: income statement management, or how much profit a

company can generate per sales dollar; and two aspects of balance sheet management,

how well assets can generate sales and the amount of solvency risk. The ratios also

indicate that there are several paths that a business can use to gain a return for its owners:

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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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Net income/equity = (operating income/sales) x (EBT/operating income) x

(Net income/EBT) x (sales/assets) x (assets/equity) (Eq.6.3)

Equation 6.3 provides new insights into profit margin and leverage. The first of the three

new ratios, operating margin, relates operating income to sales. Because operating

income is before any deduction for interest, this ratio measures the underlying

profitability of the business and, except for the impact of leasing, is independent of how

the firm is financed. The second ratio divides earnings before taxes by operating income.

This ratio measures the income statement effect of financial leverage. As financial

leverage and interest expense increase, this ratio decreases. To see this, consider a

situation where there is no interest expenses or non-operating income. Earnings before

taxes and operating income would be identical and the value of the ratio would be one.

The last new ratio is net income divided by earnings before taxes. This measures the

effect of taxes and is actually equivalent to one minus the effective tax rate.

3.7 RELATIONSHIPS BETWEEN FINANCIAL MANAGEMENT AND SME

PROFITABILITY

This section reviews the relationships between financial management and SME

profitability based on the literature by reviewing findings that were investigated by

previous researchers. Unfortunately, these findings are not clear because most previous

researchers only focus on examining and describing financial management practices and

financial characteristics but do not focus on examining the impact of financial

management practices on SME profitability. Concerned with the relationships between

working capital management practices and SME profitability, only Burns and Walker

(1991) provide some relevant findings as follows:

• profitable firms reviewed their working capital policies on monthly and quarterly

bases

• profitable firms used an ROI (return on investment) criterion in looking at

changes in the management of certain working capital components

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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

128




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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Figure 3.7: Model of the impact of financial management on SME profitability

Financialmanagement

practices

a) General model

b) Detailed model

Source: Developed for this study

Financialmanagement

Financialcharacteristic

SME profitability

Financial management practices:

•

•

•

•

•

•

Accounting information system

Financial reporting and analysis

Efficientfinancial

management

Working capital management


Capital structure management

Financial lannin

SME profitability:

•

•

•

Return on sales

Return on assets

Return on equity

Financial characteristics:

•

•

•

Liquidity ratios

Financial leverage ratios

Activity ratios

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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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Chapter Four:

Research Methodology

4.1 INTRODUCTION

Chapter 3 reviewed relevant literature on financial management practices, financial

characteristics, SME profitability and the relationships between financial management

practices and SME profitability. At the end of chapter 3, a model of the impact of

financial management practices and financial characteristics on SME profitability was

created based on the literature. Chapter 4 discusses aspects of the research methodology

including research design, data collection and data analysis methods, and hypothesis

testing to support the model.

The objectives of this chapter are: (1) to justify the study’s research methodology,

(2) to explain the research methodology used in the study, and (3) to demonstrate how

research design, and data collection and analysis can be utilized in this study to answer

the research questions outlined in the chapter 1. This chapter is structured into eight

sections.

Section 4.1 generally introduces the chapter including the main contents,

objectives and structure of the chapter. Section 4.2 provides a brief review of research

methods used by prior researchers. The objective of this section is to justify the research

methodology applied in this study. Section 4.3 discusses and explains how the research

design can be appropriately utilized in this study to answer the research questions.

Section 4.4 concentrates on defining and measuring the variables, and developing the

model, which will be tested by empirical data. Section 4.5, 4.6 and 4.7 respectively

present methods of data collection, data transformation, and data analysis, which will be

conducted in chapter 5 of the study. Finally, section 4.8 summarizes the conclusions

drawn from the chapter and Figure 4.1 (page 133) provides a visual picture of the chapter

outline and the links among sections as indicated earlier.



Chapter Four: Research Methodology


4.3 Research design

4.4 Variable definition, surveyinstrument and model development

4.5 Data collection methods

4.2 Appraisal of prior research methodologies

4.1 Introduction

4.7 Data analysis methods

4.6 Raw data transformation methods

4.8 Conclusions

Source: Developed for this thesis

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4.2 APPRAISAL OF PRIOR RESEARCH METHODOLOGIES

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

al. (1972), Grablowsky and Burns (1980), Pattillo (1981), Block (1997), Corner (1967),

Taylor Nelson Investment Services (1970), Stevens (1973), Burns (1985), Hutchinson,

Meric and Meric (1988), Jaggi and Considine (1990), Davidson and Dutia (1991),

Laitinen (1992), Hutchinson and Mengersen (1993), McMahon et al. (1993), and Meric et

al. (1997).

In methodology, studies and surveys conducted by previous researchers have the

features drawn from the review of literature in chapter 3 as follows:

1. Examining the variables of financial management practices including accounting

information system, financial reporting and analysis, working capital

management, fixed-asset management, and capital structure management was

often conducted in separate studies. While prior studies provide interesting

insights into each separate aspect of financial management practices, very few

attempts have been made to link all variables to performance. As a result, the

simultaneous impact of many variables (accounting information system, financial

reporting and analysis, working capital management, fixed asset management,

134




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

135




conducting comparative studies but did not consider the impact of financial

characteristics on SME performance in general and SME profitability in

particular.

In terms of methodology, McMahon (1998) summarized criticism of the most significant

methodological problems identified in published reviews and surveys of prior SME

research as follows:

too much focus on exploratory research•

•

•

•

•

•

•

a narrow focus with reliance on a single paradigm or disciplinary frameworks and

insufficient learning from other fields in terms of both content and process

too many cross-sectional surveys, and far too few longitudinal and field research

studies

use of small and/or non-representative and/or poorly selected samples

reliance on data from surveys with poor response rates, and failure to adequately

test for response and non-response bias – thus creating serious misgivings about

the external validity or generalization ability of findings

poor reporting of definitions used, sampling frames and samples employed, and

other methodological details – so that it becomes difficult to validly compare

research findings and/or replicate them

reporting with largely descriptive but statistically simplistic and with limited use

of more sophisticated techniques of statistical analysis, and widespread disregard

for the circumstances in which particular forms of analysis may be validly

employed.

In this study, the limitations, as indicated earlier, in terms of research methodology will

be overcome by selecting research designs, incorporating variable definitions and

measurements, developing models, and using appropriate data collection and analysis

methods. These will be examined in the next sections.

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4.3 RESEARCH DESIGN

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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Based on the summary of research classifications as presented in Table 4.1 (page

139), subsection 4.3.2 explains how the most appropriate research design was selected for

this study.

4.3.2 Selecting research design or paradigm

Subsection 4.3.1 reviewed the classification of research types. This subsection explains

how the research paradigms are appropriately selected and utilized in this study. There

are two main research paradigms labeled positivist and phenomenological (Hussey and

Hussey, 1997). Selection of research type or paradigm is based on the theoretical

framework of research design and methodological appraisal of prior research examined in

subsection 4.3.1 and section 4.2 (page 134)

As indicated by Zikmund (1997), 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. According to Emory (1985),

the essential difference between descriptive and causal studies lies in their objectives. If

the research is concerned with finding out who, what, where, when, or how much, then

the study is descriptive. If it is concerned with learning why, that is, how one variable

affects another, it is causal. Chapter 1 states the main research questions that this study is

seeking to answer include:

• How important are financial management practices and financial characteristics to

SME profitability?


characteristics and SME profitability in Vietnam?

•

How do financial management practices and financial characteristics affect onSMEs profitability?

In seeking answer to these questions, the characteristics of financial management

practices and financial characteristics of SMEs in Vietnam has been investigated and

described. As such, descriptive research is more appropriate than exploratory research

140




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

141




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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High participation – The presence of an interviewer generally increases the

percentage of people willing to complete the interview. As a result, response rate

is high.

•

In addition to using “personal interview” to obtain primary data related to financial

management practices, 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 were derived from financial statements. These

financial statements were available from taxation departments of Vietnam and sometimes

from businesses.

4.4 VARIABLE DEFINITION, SURVEY INSTRUMENT, AND MODEL

DEVELOPMENT

This section discusses variable definitions and measurements, and develops a model

representing the relationships between variables.

4.4.1 Variable measurements and survey instrument

This study is designed to develop a model and test the hypotheses of association between

financial management practices, financial characteristics and SME profitability. Before

developing the hypotheses to test these associations, variables had to be defined and

measured clearly. Pedharzur and Schmelkin (1991, p. 177) defined a variable as any

attribute or property in which organisms (objects, events, people) vary.

In developing a causal model and testing the hypotheses of association, there are

two kinds of variables involved: dependent and independent variables. An independent

variable is the presumed cause, whereas a dependent variable is the presumed effect

(Pedharzur and Schmelkin, 1992, p.177). Following is a more detail consideration of the

dependent and independent variables, which are defined and utilized in this study.

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4.4.1.1 Dependent variables

Zikmund (1997, p.87) defines a dependent variable as a criterion or a variable that is to

be expected or explained. This study examines the impact of financial management

practices and financial characteristics on SME profitability. Generally, profitability is

viewed as the dependent variable. However, profitability is an abstract concept and a

latent variable, it cannot be measured directly. To overcome this obstacle, researchers

often use indicated variables to indirectly measure profitability.

Chapter 3 discussed variables used by previous researchers to measure

profitability. For example, Burns (1985) measured profitability using three indicated

variables: return on total assets, return on net assets and return on equity. Hutchinson,

Meric and Meric (1988) used two indicated variables: return on sales and return on equity

to measure profitability, while Cohen (1989) suggested four variables: asset earning

power, return on equity, net profit on sales and return on investment. Generally,

depending upon their own purpose, researchers in the literature review used different

indicated variables to measure profitability. However, three variables: return on sales

(ROS), return on assets (ROA) and return on equity (ROE) were the most popularly used

by the researchers and authors such as Ross, Westerfield, and Jaffe (1999), Meric et al.

(1997), and Burns (1985) to measure profitability.In this study, profitability of SMEs was also indirectly measured by three

indicated variables including return on sales (ROS), return on assets (ROA), and return

on equity (ROE).

• Return on sales (ROS) is computed by dividing profits by total operating revenue

and thus it expresses profits as a percentage of total operating revenue or sales.

• Return on assets (ROA) is the ratio of income to average total assets, both before

tax and after tax. It measures managerial performance.

• Return on equity (ROE) is defined as net income divided by average

stockholders’ equity. It shows the profit available to share for the stockholders.

145




As such in this study, profitability of SMEs was measured by three ratios: ROS, ROA,

and ROE. These measurements are frequently used in developed economies and

Vietnam.

4.4.1.2 Independent variables

Zikmund (1997, p.87) defined an independent variable as a variable that is expected to

influence the dependent variable. In this study, the independent variables involved

include variables used to define the efficiency of financial management practices and

variables used to define financial characteristics of SMEs.

1. Independent variables related to financial management practices

As indicated in chapter 3, in reviewing the context of financial management practices,

McMahon (1998) defined concepts of financial management practices including

accounting information system, financial reporting and analysis, working capital

management, fixed-asset management, financial structure management, financial

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

146




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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Figure 4.2: Survey instrument for measuring accounting information system

Low regard High regard1. How does your business regard its accounting informationsystem?

1 2 3 4 5 6 7 8 9

Not frequent at all Very frequent2. How frequent does your business prepare its accountingreports?

1 2 3 4 5 6 7 8 9

Not updated at all Very updated3. How does accounting information system in your businessupdate the business transactions?

1 2 3 4 5 6 7 8 9

Low involvement Highinvolvement

4. What is the owner/manager involved in preparing accountinginformation?

1 2 3 4 5 6 7 8 9

Low involvement Highinvolvement

5. What is the owner/manager involved in interpreting and usingaccounting information?

1 2 3 4 5 6 7 8 9

Very unacceptable Very acceptable6. How acceptable is your business’s accounting informationsystem?

1 2 3 4 5 6 7 8 9

Not useful at all Very useful7. How useful is your business’s accounting information inmaking decisions?

1 2 3 4 5 6 7 8 9

LowComputerization

Highcomputerization

8. How computerized is your business’s accounting informationsystem?

1 2 3 4 5 6 7 8 9


The extent of efficiency of an accounting information system was measured by

the sum of the values of eight of these indicated variables, which have a possible range of

8 to 72. The more points a business recorded, the higher the efficiency of its accounting

information system, and the accounting information system of a business was said to be

“efficient” if its sum of points of 8 items as mentioned above is greater than the average

point of 40.

Financial reporting and analysis

McMahon (1998) stated financial reporting and analysis includes the nature, frequency

and purpose of financial reporting, audit, analysis and interpretation of financial

statements, and use of physical and financial performance benchmarks. For the purpose

of this study, financial reporting and analysis included the preparation, interpretation,

148




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:

149




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


150




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:

151




attitude of owner/manger to cash management•

•

•

•

•

•

•

•

frequency (weekly, monthly, quarterly, annually or never) of preparing cash

budget

owner/manager involvement in preparing cash budget

owner/manager involvement in interpreting and using cash budget

usefulness of cash budget in providing information for making decisions

application of cash management theories to determine cash balance

reasonability of target cash balance determination

computerization of cash budget preparation

Respondents were asked to rate the position of their businesses on the nine-point scalecorresponding to each item as presented by Figure 4.4.

Figure 4.4: Survey instrument for measuring cash management practices

Low regard High regard1. How does your business regard its cashmanagement practices?

1 2 3 4 5 6 7 8 9

Not frequent at all Very frequent2. How frequent does your business prepare its cashbudgets?

1 2 3 4 5 6 7 8 9

Low involvement High involvement3. How involved is the owner/manager in preparing

cash budgets?

1 2 3 4 5 6 7 8 9

Low involvement High involvement4. How involved is the owner/manager in interpretingand using cash budgets?

1 2 3 4 5 6 7 8 9

Not useful at all Very useful5. How useful are cash budgets of your business inproviding information for making decisions?

1 2 3 4 5 6 7 8 9

Very poorly Very well6. How does your business apply theories of cashmanagement in determining the target cash balance?

1 2 3 4 5 6 7 8 9

Very unacceptable Very acceptable7. How acceptable is the target cash balancedetermined in your business?

1 2 3 4 5 6 7 8 9


8. How computerized are cash management practicesin your business?

1 2 3 4 5 6 7 8 9


152




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

153




computerization of receivable management•

Respondents were asked to rate the position of their businesses on the nine-point scale

corresponding to each item listed by Figure 4.5 and the interviewer circled theappropriate number depending on their answers.

Figure 4.5: Survey instrument for measuring receivable management practices

The extent of efficiency of receivable management practices was measured by the

sum of values of nine of indicators as described in Figure 4.5. This sum had a possible

range from 9 to 81 and the more points a business recorded, the higher its efficiency of

receivable management practices. Receivable management practices of a business were

said to be “efficient” if the sum of points was greater than the average points of 45 (9 x 5

point average) and conversely.

Low regard High regard1. How does your business regard receivablesmanagement 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 reasonable

3. How reasonable is debtors’ credit period in yourbusiness? 1 2 3 4 5 6 7 8 9

Not regular at all Very regular4. How regular does your business review debtors’discount policy?

1 2 3 4 5 6 7 8 9

Not reasonable at all Very reasonable5. How reasonable is debtors’ discount policy in yourbusiness

1 2 3 4 5 6 7 8 9

Not regular at all Very regular6. How regular does your business review percentage ofbad debts?

1 2 3 4 5 6 7 8 9

Not reasonable at all Very reasonable7. How reasonable is the percentage of bad debts inyour business

1 2 3 4 5 6 7 8 9

Not frequent at all Very frequent8. How frequent does your business implement theoriesof receivables management?

1 2 3 4 5 6 7 8 9


9. How computerized are receivable managementpractices in your business?

1 2 3 4 5 6 7 8 9

Source: Develo ed for this stud

154




c) Inventory management practices

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


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.

155




Figure 4.6: Survey instrument for measuring inventory management practices

Fixed-asset management practices

McMahon (1998) defined fixed-asset management including non-financial and financial

considerations in fixed-asset acquisition, quantitative techniques for capital project

evaluation, investment hurdle rate determination, and handling risk and uncertainty in

this context. This research examined the efficiency of fixed-asset management in terms of

financial management. In this study, the efficiency of fixed-asset management was

defined as the efficiency of capital budgeting practices and fixed-asset utility after

acquisition. This was considered before and after making investment decisions. Before

making investment decisions, the efficiency of fixed-asset management was evaluated via

the efficiency of capital-budgeting practices. After making investment decisions, the

efficiency of fixed-asset management was evaluated via the efficiency of fixed-asset

utility. Particularly, the efficiency of fixed-asset management was measured by the

following indicators on nine-point scales:

Low regard High regard

1. How does your business regard inventory

management practices?

1 2 3 4 5 6 7 8 9

Not regularly at all Very regularly

2. How regularly does your business review inventory

turnover?

1 2 3 4 5 6 7 8 9


3. How regularly does your business review inventory

level?

1 2 3 4 5 6 7 8 9

Very slow Very fast

4. How fast is inventory turnover of your business? 1 2 3 4 5 6 7 8 9

Very unacceptable Very acceptable

5. How acceptable is inventory level of your business? 1 2 3 4 5 6 7 8 9


6. How are inventory budgets of your business useful

in providing information for making decisions?

1 2 3 4 5 6 7 8 9

Very poorly Very well

7. How does your business apply theories of inventorymanagement in determining the inventory level?

1 2 3 4 5 6 7 8 9

Low High

computerization computerization

8. How computerized are inventory management

practices in your business?

1 2 3 4 5 6 7 8 9


156




attitude of owner/manager to fixed-asset management practices•

•

•

•

•

•

•

•

attitude of owner/manager to assessing capital project before making investment

decisions

frequency of using capital budgeting techniques before making investment

decision

reasonability of capital budgeting used

sophisticated extent (payback period, discounted payback period, net present

value, internal rate of return or modified internal rate of return) of capital

budgeting techniques used

reasonability of utilizing fixed assets

usefulness of fixed assets acquiredcomputerization of fixed asset management practices.

Respondents were asked to rate the position of their businesses on the scale

corresponding to each item listed by Figure 4.7.

Figure 4.7: Survey instrument for measuring fixed asset management

Low regard High regard1. How does your business regard fixed asset management

practices?

1 2 3 4 5 6 7 8 9

Low regard High regard2. How does your business regard assessing capital projectbefore making investment decisions?

1 2 3 4 5 6 7 8 9

Not regularly at all Very regularly 3. How regularly does your business review capital projects? 1 2 3 4 5 6 7 8 9

Very unacceptable Very acceptable4. How acceptable is capital budgeting utilized in yourbusiness?

1 2 3 4 5 6 7 8 9

Not advanced at all Very advanced5. How advanced does your business apply techniques ofcapital budgeting in determining capital investment projects?

1 2 3 4 5 6 7 8 9

Very unreasonable Very reasonable

6. How reasonable are fixed assets of your business utilized? 1 2 3 4 5 6 7 8 9Not useful at all Very useful

7. How useful are fixed assets acquired in your business? 1 2 3 4 5 6 7 8 9


8. How computerized are fixed asset management practicesin your business?

1 2 3 4 5 6 7 8 9

Source: Develo ed for the stud

157




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.

158




Financial planning practices of a business were said to be “efficient” if its sum of points

was greater than the average point of 40 and conversely.

Figure 4.8: Survey instrument for measuring financial planning

Based on the measurements of each component of financial management practices

as indicated earlier, the efficiency of financial management practices of SMEs was

measured by 57 items consisting of 8 items of accounting information system, 8 items of

financial reporting and analysis, 8 items of cash management practices, 9 items of

receivable management practices, 8 items of inventory management practices, 8 items of

fixed asset management practices, and 8 items of financial planning practices. These

components were strongly correlated. To avoid multicollinearity phenomena, factor

analysis was applied to extract the strongly correlated items and group them into the main

components, which were finally used as independent variables that defined the efficiency

of financial management practices in the regression model.

Low regard High regard1. How does your business regard financial planning? 1 2 3 4 5 6 7 8 9

Not regularly at all Very regularly 2. How regularly does your business prepare its financialbudgets?

1 2 3 4 5 6 7 8 9

Low involvement High involvement3. How involved is the owner/manager in preparing financialbudgets?

1 2 3 4 5 6 7 8 9

Low involvement High involvement4. How involved is the owner/manager in interpreting andusing financial budgets?

1 2 3 4 5 6 7 8 9


5. How useful are the financial budgets of your businessuseful in providing information for making decisions? 1 2 3 4 5 6 7 8 9

Not regularly at all Very regularly 6. How regularly does your business compare between actualand budgeted results?

1 2 3 4 5 6 7 8 9

Very unreasonable Very reasonable7. How reasonable are financial planning techniques appliedin financial analysis of your business?

1 2 3 4 5 6 7 8 9


8. How computerized are the financial reporting and analysispractices in your business?

1 2 3 4 5 6 7 8 9

Source: Developed for the study

159




2. Independent variable related to financial characteristics

Current ratio (CUR)

Liquidity refers to the overall level of cash and near cash assets (such as debtors and

stock) held and to cash inflows and outflows that add to and subtract from the sum of

these assets (McMahon and Stanger, 1995, p.24). When used for determining the

financial characteristics, liquidity is often measured in the form of ratios. Two kinds of

ratios: current ratio and quick ratio were used by several previous researchers such as

Stevens (1973), Burns (1985), Jaggi and Considine (1990), Hutchinson and Mengersen

(1993), Meric et al (1997). In the current study, liquidity was viewed as an independent

variable and measured by current ratio, which was derived from financial statements by

dividing current assets by current liabilities.

Debt ratio (DER)

Walker and Petty (1978, p.145) defined financial leverage to be the process of using

senior (debt or equity capital with a fixed return) capital to increase the rate of return on

junior securities. Brigham (1995, p. 429) indicated that financial leverage is the extent to

which fixed-income securities (debt and preferred stock) are used in a firm’s capital

structure. Similarly, Ross, Westerfield and Jaffe (1999, p.33) said that financial leverage

is related to the extent to which a firm relies on debt financing rather than equity.

When financial leverage is used to identify the financial characteristics of the

firm, it is often measured by the following ratios:

Equity ratio = equity/total asset, used by Hutchinson, Meric and Meric (1988),

Meric et al (1997)

•

•

•

Long-term debt ratio = long-term debt/total capital, used by Burns (1985), Meric

et al (1997)

Long-term debt to equity ratio = long-term debt/common stock equity, used by

Jaggi and Considine (1990)

160




Debt ratio = total debt /total assets, and•

•

•

•

•

•

Debt-to-equity ratio = total debt /total equity, used by Brigham (1995) and Ross,


This study examined the impact of financial leverage ratio on profitability in which

financial leverage ratio was considered an independent variable and measured by the debt

ratio, which was derived from financial statements by dividing total debt by total equity.

Total asset turnover (TAT)

Activity ratio is considered the variable to determine the financial characteristics of the

firm. Hutchinson, Meric and Meric (1988) measured activity by the following ratios:

Inventory ratio = Inventory/sales

Receivables ratio = Accounts receivable/sales

Fixed assets ratio = Fixed assets/sales

Total asset turnover = Sales /total assets

Meric et al (1997) only used two ratios of activity: total asset turnover (sales/total assets)

and inventory turnover. Noticeably, Ross, Westerfield, and Jaffe (1999) and Meric et al.

(1997) use inventory turnover in lieu of inventory ratio. Inventory ratio is calculated by

dividing the cost of goods sold by average inventory whereas inventory ratio is calculated

by dividing inventory by sales. This study examined the impact of activity ratio on

profitability in which activity ratio was measured by total asset turnover, which was

derived form financial statement by dividing sales by total assets.

In summary, in this research study, profitability measured by ROS, ROA and

ROE was defined as the dependent variable whereas the efficiency of financial

management practices, current ratio, debt ratio and total asset turnover were defined as

the independent variables. These variables were used to test the model of the impact of

financial management practices and financial characteristics on SME profitability. This

model was developed in section 4.4.2.

161




4.4.2 Model development

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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Table 4.3: Model classification

Element Type Characteristics Examples

Level of

The generalized mathematical model form can symbolically be represented as

follows:

OI = f(Ai , B j) (Eq. 4.1)

where:

OI = outcome information or objective from the model to be used by the decision

maker or the dependent variable

Ai = controllable independent decision variables in the process being modeled

BB j = uncontrollable independent variables influencing the process being modeled,

or the environment variables

f = functional relationship between the outcome information variable (the

dependent variable) and the independent variables Ai and BB j (Davis, 1996, p. 303).

aggregationDis-aggregate(micro)

Models individual Consumer choice models,processes with outcomes forecasting model for demand of

one firm Aggregate(macro)

Models a system, or firms Economic models of an industry interacting inenvironment withoutcomes, or outcomes isgroup-related

Timedimension

Dynamic Changes in the process Multiple-period inventorydue to time models, time series forecastingChanges in variable modelsspecification

Static Outcome static in nature One-period inventory model,due to static one-period mathematical

measurements of programming modelsspecified variables

Degree ofuncertainty

Deterministic All parameters are known Linear programming product- with certainty mix model, inventory model with

known demandProbabilistic Parameters vary Risk analysis for capital

according to an assumed budgeting, inventory model withknown probability random demand levels describeddistribution by a probability distribution

Source: Adapted from Davis (1996, p. 306)

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4.4.2.2 Model development for this study

Based on the generalized mathematical model form as indicated by Davis (1996) and the

variables defined in subsection 4.4.1, the model of the impact of financial management

practices and financial characteristics on SME profitability was developed as follows:

PRO = f(CUR, DER, TAT, EFF) (Eq. 4.2)

where:

PRO = Profitability = Average ( ROS, ROA, and ROE )

ROS = Return on sales = Net profit/Sales

ROA = Return on assets = Net profit/Total assets

ROE = Return on equity = Net profit/Equity

CUR = Current ratio (= Current assets/Current liabilities)

DER = Debt ratio (= Total debt/Total assets)

TAT = Total asset turnover (= Sales/Total assets)

EFF = The efficiency of financial management practices

In this model, by making some standard assumptions, equation 4.2 can be restructuredinto linear multiple regression equation (Eq.4.3) as follows:

PRO = b0 + b1CUR + b2 DER + b3TAT + b4 EFF + ε (Eq. 4.3)

where: bi (i = 0, 1, 2....) are the coefficients, ε is the error variable , CUR, DER and TAT

are the independent variables measured by ratio scale, and EFF is a multi-dimension

construct measured by 57 items related to financial management practices on the 9-point

scales. Factor analysis was used as a tool to extract and group items that are strongly

correlated into the main components defined the efficiency of financial management

practices.

The required assumptions of this multiple regression model are that (1) the error

variable (ε ) is normally distributed, (2) the mean value of the error variable is zero, (3)

164




the variance of the error variable is a fixed but unknown value, (4) the values of the error

variable are independent of one another, and (5) relationship between profitability and

variables of financial management practices is linear. Chapter 5 will discuss how the

research recognized whether or not these assumptions were satisfied and how toovercome the problem if these assumptions were not satisfied.

The mathematical model mentioned earlier may be described by the visual model

as in Figure 4.9 below.

Figure 4.9: Analytical model for the research study

Current ratio (CUR ) The efficiency of financial

management practices(EFF):

Source: Developed for the study

4.4.3 Hypothesis statements

A hypothesis is a proposition that is empirically testable. It is an empirical statement

concerned with the relationship among variables (Zikmund, 1997, p. 25). Hypotheses to

test the relationships SME profitability and current ratio, debt ratio, total asset turnover,

•

•

•

•

•

•

•

Accounting informationsystem

Debtratio(D

SME profitability:Financial reporting andanalysis (PRO)

•

•

•

Return on salesCash management practicesEReturn on assetsReceivable management

practices R )Return on equity

Inventory managementpractices


practicesFinancial planning practices

Total asset turnover (TAT )

165




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.

166




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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practices. Therefore, the hypothesis to test the relationship between profitability and the

efficiency of financial management practices is as follows:

Hypothesis 4: Profitability of SMEs is positively related to the efficiency offinancial management practices.

As indicated in subsection 4.4.1 the efficiency of a specific area of financial

management practices such as accounting information systems, financial reporting and

analysis, cash management, receivable management, inventory management, fixed asset

management, and financial planning was measured by the sum of points of 8 or 9 items.

A specific area of financial management practices was said to be “efficient” if its sum of

points is greater than the average points and conversely. In generalization, a business was

said to be “efficient” in financial management practices if all specific areas of financial

management practices are efficient. Based on this criterion, SMEs in the sample were

divided into two groups. The first group consists of SMEs that are “efficient” and the

second group consists of SMEs that are “inefficient” in financial management practices.

This study was also designed to test the hypothesis of differences in average profits of

two groups of SMEs.

Hypothesis 5: The average profit of efficient financial management SMEs differs

from that of inefficient financial management SMEs.

In summary, there are five hypotheses that were tested in this study. The first four

hypotheses were to test the relationship between financial characteristics, financial

management practices and SME profitability. The last hypothesis was to test the

difference in average profits of two groups of SMEs.

4.5 DATA COLLECTION METHODS

This section discusses how relevant data was collected for testing the model developed in

section 4.4. According to Hussey and Hussey (1997), data refers to known facts or things

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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


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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limited liability companies and joint stock companies. Stratified sampling can help to

assure the proportions of these groups of SMEs in a sample being the same in the

population.

4.5.2.4 Sampling uni ts

The sampling unit is a simple element or group of elements subject to selection in the

sample (Zikmund, 1997, p. 23). This research used the stratified sampling technique with

the fraction of 90 to select the sample. The plan procedure for selecting sampling units is

presented in Table 4.4.

Table 4.4: Number and percentage of SME sample and population

Business type Population Sample

Number Percentage Fraction Number Percentage

Manufacturing

4.6 DATA TRANSFORMATION

This section examines aspects of data transformation including purpose and methods of

data transformation. Zikmund (1997, p.540) defined data transformation as the process of

changing data’s original form to a format that is more suitable to perform a data analysis

that will achieve research objectives. Zikmund’s (1997) definition indicated the purpose

of data transformation was to create a more suitable format for data analysis.

Section 4.4.1 introduced variable definitions and measurements in which the nine-

point numerical scales were applied. These scales were constructed to collect raw data

from the respondents, however, these data need to be transformed into a suitable format

before analysis. For example, because scales, as constructed above, only provide the

5,170 35.8% 1/90 57 35.8%Stock companies 208 1.4% 1/90 2 1.4%Limited companies 4,049 28.1% 1/90 45 28.1%Private enterprises 913 6.3% 1/90 10 6.3%Trading 9,254 64.2% 1/90 103 64.2%Stock companies 185 1.3% 1/90 2 1.3%Limited companies 5,729 39.7% 1/90 64 39.7%Private enterprises 3,340 23.2% 1/90 37 23.2% Total 14,424 100.0% 160 100.0%


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values of indicated variables, these values were transformed into the values of the latent

variables through a summative score (Zikmund, 1997, p.541).

Summative score = Sum (indicated variable 1, 2, 3, …n)

As indicated in section 4.4.2 (page 162) the resumed model was based on assumptions of

normal distributions and linear relations of variables. Chapter 5 will test whether these

assumptions are satisfied. Otherwise, data transformation will be applied to create more

suitable data for analysis.

In addition, this study used the ratios: return on sales, return on assets, return on

equity as dependent variables, and liquidity ratio, financial leverage, ratio and activity

ratio as the independent variables. These ratios are derived from financial statements

collected from SMEs directly or indirectly. The process of deriving these ratios required a

transformation of raw data into more suitable data for analysis. Computer package

(Excel) will help this data transformation easily and quickly.

4.7 DATA ANALYSIS

This section briefly discusses data analysis methods whereas details of techniques used

and results of data analysis will be reported in chapter 5. Objectives of this section are (1)

to outline the data analysis techniques that will be particularly applied in chapter 5 and

(2) to appropriately match selected data analysis methods to types of data collected.

4.7.1 General consideration

The purpose of analytic methods is to convert data into information needed to make

decisions (Davis, 1996, p. 356). According to Zikmund (1997), the choice of the methods

of statistical analysis depends on (1) the type of question to be answered, (2) the number

of variables, and (3) the scale of measurement.

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Type of question the researcher is attempting to answer is a consideration in

choice of statistical technique. Based on this factor, the researcher may be

concerned about the central tendency of a variable or the distribution of that

variable.

•

•

•

Numbers of variables are also considered to determine whether the statistical

techniques applied should be univariate data analysis, bivariate data analysis or

multivariate data analysis.

Scale of measurement on which the data are based or the type of measurement

reflected in the data determines the permissible statistical technique and whether

the appropriate empirical operation may be performed.

This study was concerned with two main research questions. The first is how to describe

the financial management practices and financial characteristics of SMEs in Vietnam.

The second is to determine whether efficient financial management practices positively

affect on SME profitability and how to explain the relationships between efficient

financial management practices and SME profitability. Descriptive statistics and

hypothesis testing were two main methods of data analysis that are suitable to these

research questions.

In terms of number of variables and scale of measurements, this study was

concerned with simultaneous investigation of the impact of several independent

variables, measured by nine-point numerical scales and ratios, on the dependent variable,

measured by the ratios. Multivariate data analysis is the appropriate match for this study

(Zikmund, 1997). Specifically, multiple linear regression was developed and tested to

explain the relationships between the financial management practices and SME

profitability.

4.7.2 Descriptive statistics

As indicated in section 4.3 (page 137), this study was designed as a combination of

descriptive and explanatory research. Descriptive statistics were applied to investigate

and describe characteristics of financial management practices of SMEs in the sample.

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Descriptive analysis refers to the transformation of the raw data into a form that will

make them easy to understand and interpret. Describing responses or observations is

typically the first form of analysis (Zikmund, 1997, p.533).

In this study, the following statistical techniques were used (in chapter 5) as thetools of descriptive analysis:

calculation of averages, frequency distribution, and percentage distribution used

as a form of summarizing data

•

•

•

tabulation used as the orderly arrangement of data in a table or summary format

cross-tabulation used to allow the inspection of differences and to make

comparisons between two groups of SMEs, with and without efficient financial

management.

4.7.3 Bivariate data analysis

Zikmund (1997, p.567) defined bivariate data analysis as data analysis and hypothesis

testing when the investigation concerns simultaneous investigation of two variables using

tests of differences or measures of association between two variables at a time. This

section examines how bivariate data analysis can be used in this study.

4.7.3.1 Measures of association

Measures of association are statistical values designed to represent co-variation between

variables (Zikmund, 1997). As indicated in section 4.5 (page 162), the measurement

levels used in this study included interval and ratio measures. This allows the use of

Pearson’s correlation coefficient for measuring association among variables. The results

of correlation coefficients were presented by under standard form of reporting correlation

results – the correlation matrix. The correlation matrix would be used to present the

measures of association among the variables as outlined in section 4.5 (page 168).

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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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Table 4.5: Summary of multivariate techniques for the analysis of dependenceNumber of Number of

Technique Purpose dependent independent Type of measurement variables variables

Dependent Independent

Multiple

4.7.4.2 Factor analysis

Zikmund (1997, p. 669) defined factor analysis as a type of analysis used to discern the

underlying dimensions or regularity in phenomena. Its purpose is to summarize the

information contained in a large number of variables into a smaller number of factors. In

this study, factor analysis would be utilized before testing the multiple regression models.

Its objectives are as follows:

•

•

to determine linear combinations of variables that aid in investigating the

interrelationships (Zikmund, 1997, p. 669)

to reduce the problem of multicollinearity in multiple regression model (Zikmund,

1997. P. 672).

regression To simultaneously

investigate the effect ofseveral independent

variables on a dependent variable

1 2 or more Interval or Interval orratios ratio

Discriminantanalysis

To predict the probabilityof objects or individual

belonging in two or moremutually exclusivecategories based onseveral independent

variables

1 2 or more Nominal Interval orratio

Canonical

correlation

To determine the degree

of linear associationbetween two sets of

variables, each consistingof several variables

2 or more 2 or more Interval or Interval or

ratio ratio

Multi analysisof variance

To determine ifstatistically significant

differences of means ofseveral variables occur

simultaneously betweentwo levels of a variable

2 or more 1 Interval or Nominalratio

Source: Adapted from Zikmund (1997, p.669)

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Chapter 5 will detail the aspects of factor analysis techniques, which are applied to

extract and group the high correlation items into the principal components of financial


4.7.4.3 Multip le regression analysis

As indicated in chapter 1 (page 4), the research problem in this study is to determine

whether a relationship exists between financial management practices, financial

characteristic ratios and profitability. Multiple regression analysis is an appropriate

statistical technique for examining this research problem. Murphy III (1989) indicated

multiple regression analysis allows the appraiser to determine whether a relationship

exists between several independent variables and a dependent variable.

This study used multiple regression analysis to investigate simultaneous effects of

(1) current ratio (CUR), debt ratio (DER), total asset turnover (TAT) and efficiency of

financial management practice (EFF) on SME profitability (PRO).

As indicated in section 4.4.2, the multiple regression equation in this study was as

follows:

PRO = b0 + b1CUR + b2 DER + b3TAT + b4 EFF + ε

where: bi (i = 0, 1, 2....) are the coefficients and ε is the error variable. Chapter 5 will

discuss testing this model with empirical data to explain and determine the degree of

association between financial management and profitability of SMEs.

In summary, descriptive statistical techniques such as frequencies, descriptive

statistics and cross tabulation, bivariate analysis including test of association and test of

differences, and multivariate analysis including factor and multiple regression analysis

were the main techniques of analysis applied in this study. Chapter 5 will present, in

more detail, how these techniques are applied to analyze the data collected.

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4.8 CONCLUSIONS

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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Chapter Five:

Data Analysis And Findings

5.1 INTRODUCTION

Chapter 4 presented aspects of research methodology including research design, data

collection and data analysis methods, and hypothesis testing as support for the model. A

model of the impact of financial characteristics and financial management practices on

SME profitability was created at the end of chapter 4 (page 165). Chapter 5 presents

descriptive findings of financial management practices, financial characteristics and SME

profitability and findings of the research study related to testing the model of SME

profitability.

Objectives of this chapter are (1) to systematically present the descriptive findings

of the research study, (2) to interpret significance of these findings as results of data

analysis, (3) to present the results of testing the model for SME profitability, and (4) to

explain how the model developed from a literature review, was supported by data

analysis.

Chapter 5 is structured into 5 main sections. Section 5.1 and 5.2 respectively

introduce the chapter and links between research objectives and data analysis. Section 5.3

presents descriptive findings of financial management practices, financial characteristics,

and findings of SME profitability. Section 5.4 presents the findings of relationships

between financial management practices, financial characteristics and SME profitability

based on bivariate analysis and findings of simultaneous impact of financial management

practices and financial characteristics on SME profitability based on multivariate

analysis. Section 5.5 ends the chapter with conclusions drawn from descriptive findings

of financial management practices, financial characteristics and their impact on SME

profitability. Figure 5.1 (page 185) provides a visual picture of the chapter outline and the

links among sections as indicated earlier.



Chapter Five: Data Analysis and Findings

185


5.3 Descriptive findings of the research study

5.3.2 Descriptive findings of financialmanagement practices

5.4 Associative analysis and findings of the research study

5.3.1 Sample descriptions and SMEcharacteristics

5.3.3 Descriptive findings of financialcharacteristics

5.3.4 Descriptive findings ofprofitability

5.4.1 Factor analysis and findings

5.4.3 Multi regression analysis and

findings

5.4.2 Bivariate analysis and findings

5.4.4 Test for difference in averageprofits between efficient and

inefficient financial managementgroups of SMEs

5.5 Conclusions

5.2 Links between data analysis and research objectives

5.1 Introduction





186

5.2 LINKS BETWEEN DATA ANALYSIS AND RESEARCH OBJECTIVES

AND QUESTIONS

As indicated in chapter 1, the objectives of this research study are (1) to collect the

descriptive evidence on financial management practices, financial characteristics and

profitability of SMEs in Vietnam, and (2) to develop the model of the simultaneous

impact of financial management practices and financial characteristics on SME

profitability. Additionally, this research study is designed to answer two main questions

as follows:


characteristics and SME profitability?

• How do financial management practices and financial characteristics

simultaneously affect SME profitability?

The results of data analysis and findings presented in this chapter are linked to the

research questions and objectives as mentioned above. Firstly, descriptive findings of the

research study including findings of sample and SME characteristics, financial

management practices, financial characteristics and findings of SME profitability will be

presented respectively in section 5.3, particularly from subsections 5.3.1 to 5.3.4.

Findings presented in these subsections are linked to the objective of descriptive evidence

collection of financial management practices, financial characteristics and profitability of

SMEs in Vietnam.

Associative findings of the research study will be presented in section 5.4, in

which bivariate analysis, factor analysis and multiple regression analysis are applied to

investigate the relationships between financial characteristics, financial management

practices and SME profitability. These findings are linked to the objective of developing

and testing the model of the simultaneous impact of financial management practices and

financial characteristics on profitability. Finally, the hypothesis of difference between

mean profitability of SMEs that were efficient in financial management practices and that

of SMEs that were not efficient in financial management practices, will be tested to

provide further evidence of supporting the model. Following in this chapter is a report of

findings linked to the objectives of the research study.




187

5.3 DESCRIPTIVE FINDINGS OF THE RESEARCH STUDY

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




188

Table 5.1 (page 187) reports the distribution of the sample of responding firms in

terms of type of industry and form of ownership. Sixty-six percent of businesses in the

study sample are trading enterprises, 34 percent are manufacturing, while other industries

are beyond the research study. Compared with the planned structure as indicated in the

sampling procedure (chapter 4, page 174), the actual relationship between trading (66%)

and manufacturing (34%) was not considerably changed. Figure 5.2 and 5.3 provide a

visual distribution of sample in term of business structure.

Figure 5.2: Distribution of sample by industry Figure 5.3: Distribution of sample by ownership

34.0%

66.0%

Manufacturing

Trading

3.3%

70.0%

26.7%

Joint stock company

Limited company

Private enterprise

Figure 5.3 represents the business structure of SMEs by form of ownership by

which 70 percent of businesses in the sample are limited liability companies and 30

percent are private enterprises (26.7%) and joint stock companies (3.3%). These

proportions were not significantly changed in comparing with the fractions planned in the

sampling procedure. Therefore, they provide assurance that the sample accurately

reflected the target population on the basis of the criteria used for the stratified sampling

technique.

Table 5.2 (page 189) provides the number and percentage of firms by form of

ownership within each industry. For both manufacturing and trading industries, the

percentage of limited companies is highest (65.7% and 78.4% respectively) whereas the

percentage of joint stock companies is lowest (3.0 and 3.9% respectively) compared

within each industry. These percentages are consistent with the proportion of each form

of ownership in the target population as presented in the sample-selecting procedure in

chapter 4.




189

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




190

In summary, Table 5.3 (page 189) indicates that most SMEs in Vietnam are very

young in term of number of business operating years and small in terms of total assets,

number of employees, and annual sales compared with SMEs in other countries. The next

section will consider whether these business characteristics of SMEs affect financial

characteristics and financial management practices.

5.3.2 Descriptive findings of financial management practices

5.3.2.1 Accounting information system practices

This section respectively presents descriptive findings of accounting information system

practices of SMEs in the sample. All SMEs are found to have accounting information

systems organized formally (Table 5.4). This is a legal requirement for SMEs that are

organized in the form of private enterprises, limited liability companies or joint stock

companies because these SMEs are required to prepare and submit financial statements to

departments of taxation frequently and regularly.

Table 5.4: Characteristics of accounting system organizationNo. of firms Percentage

Characteristics of accounting system organization Formal 150 100.0%Informal 0 0.0%


Regarding the responsibility for accounting information systems, Table 5.5 (page

191) reveals that 88 percent of SMEs in the sample used an employed or in-house

accountant to record business transactions whereas less than 2 percent used an external

accountant or the owner himself or herself. “Chief-accountant” was often used for the

more complicated responsibilities, for example, 15.3 percent of SMEs required the chief-

accountant to prepare accounting reports whereas only 6.7 percent used the chief-

accountant in recording business transactions. For enterprise reporting, up to 41.3 percent

of SMEs used the chief-accountant in interpreting and using the accounting information

for decision-making.




191

Additionally, less than 2 percent of respondents answered that they used external

(or outside) accountants to record business transactions, prepare accounting reports or

interpret accounting information. SMEs in Vietnam appear to be unfamiliar with using

external accountants in their accounting information systems. This finding is similar to

DeThomas and Fredenberger’s (1985) findings in a survey of over 360 SMEs in Georgia

(USA), which revealed that only 4 percent of responding firms used external accountants.

Table 5.5: Responsibility – accounting information systemNo. of firms Percentage

Recording business transactions Owner 3 2.0%Manager 3 2.0%

Chief-accountant 10 6.7%Employed accountant 132 88.0%

External accountant 2 1.3%

Total 150 100.0%Preparing accounting reports Owner 2 1.3%

Manager 1 0.7%Chief-accountant 23 15.3%

Employed accountant 121 80.7%External accountant 3 2.0%

Total 150 100.0%Interpreting and using accountinginformation

Owner 5 3.3%

Manager 3 2.0%Chief-accountant 62 41.3%

Employed accountant 78 52.0%

External accountant 2 1.3% Total 150 100.0%

Source: Data analysis for the study

In examining the application of computers in accounting information system,

Table 5.6 (page 192) shows that 50 percent of respondents “often”, 37 percent “always”,

and only 0.7 percent “never” use computers in their accounting systems. However, while

about 91% apply computers to the production of accounting reports, only a small

percentage of SMEs in the sample apply computers to related fields such as payroll, cash

flows, asset management and business transaction recording.




192

Table 5.6: Using computer in accounting information system

No. of firms PercentageFrequency of computerapplication

Never 1 0.7%

Rarely 7 4.7%Sometimes 10 6.7%Often 76 50.7%

Always 56 37.3% Total 150 100.0%

Computer application fields Recording business transactions 8 5.3%Preparing accounting reports 136 90.7%

Managing assets 1 0.7%Controlling payroll 2 1.3%

Controlling cash flows 1 0.7%Others 1 0.7%

No answer 1 0.7% Total 150 100.0%


After analyzing the results of respondents questions concerning accounting

information system practices, the typical characteristics of accounting information

systems of SMEs in the sample are summarized as follows:

• 100 percent of SMEs have systems of accounting information organized formally.

• Employed accountants and chief-accountant still play an important role in

carrying out most accounting responsibilities whereas external accountants have

not frequently been used.

• Most SMEs have applied computers to their accounting information systems and

the most frequent application of computers is to prepare accounting reports.

5.3.2.2 Financial repor ting and analysis pract ices

Financial reporting and analysis practices of SMEs in the sample are respectively

analyzed and presented in this subsection. The first finding is that over 93 percent of

SMEs focus on two traditionally main types of financial statements, balance sheets and

income statements, which are prepared regularly (Table 5.7, page 193). This

demonstrates that SMEs strongly favour organizing financial information systems, which




193

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

Preparing financial statements Monthly 115 76.7%Quarterly 28 18.7%

Semiannually 4 2.7% Annually 3 2.0%

Total 150 100.0%

Analyzing financial statements Monthly 97 64.7%Quarterly 35 23.3%Semiannually 6 4.0%

Annually 7 4.7%Never 5 3.3% Total 150 100.0%





194

Table 5.9: Responsibility – preparing and analyzing financial statementsNo. of firms Percentage

Preparing financial statements Owner 2 1.3%Manager 1 0.7%

Chief-accountant 31 20.7%


Analyzing financial statements Owner 3 2.0%Manager 4 2.7%

Chief-accountant 54 36.0%Employed accountant 82 54.7%

External accountant 2 1.3%Never do it 5 3.3%


When conducting financial analysis, more than half of the SMEs in the sample

apply two types of financial analysis techniques (trend and ratio analysis), while only 5

percent answered that they have never applied any analysis technique. When asked what

kinds of financial ratio they have ever used, about half of respondents replied they have

used the short-term debt ratio, current ratio, total asset turnover, and fixed asset turnover

whereas only 10 percent used the long-term debt ratio (Table 5.10). This may be

consistent with the current difficulty of Vietnam SMEs in obtaining long-term loans and

the uncertainty of Vietnam’s business environment, which cause investors and bankers to

hesitate in offering long-term debts.

Table 5.10: Kinds of financial analysis and ratios usedNo. of firms Percentage

Kinds of financial analysis used Ratio analysis 57 38.0% Trend analysis 8 5.3%

Both ratio and trend analysis 81 54.0%Never 8 5.3%

Kinds of financial ratios used Current ratio 71 47.3%Quick ratio 50 33.3%Debt ratio 61 40.7%

Debt-to-equity ratio 53 35.3%

Short-term debt ratio 82 54.7%Long-term debt ratio 15 10.0%Receivable turnover 92 61.3%Inventory turnover 97 64.7%

Fixed asset turnover 73 48.7% Total asset turnover 76 50.7%

Return on sales 50 33.3%Return on assets 30 20.0%Return on equity 34 22.7%





195

In summary, after conducting the survey and data analysis, this study has

provided insight into financial reporting and analysis practices of SMEs with empirical

evidence from Vietnam. Descriptive findings of financial reporting and analysis are

summarized as follows:

• Near 100 percent of SMEs have frequently and regularly prepared and analyzed

financial statements including balance sheets and income (profit and loss)

statements.

• Most SMEs (about 70 percent) have prepared and analyzed their financial

statements based on monthly periods. Nevertheless, about 2 percent of SMEs

have never analyzed financial statements.

• In financial analysis, about a half of SMEs in the sample have frequently applied

both trend and ratio analyses.

• Ratios of activity such as receivable turnover, inventory turnover, and total asset

turnover are most frequently used, followed by ratios of liquidity and the least

used are ratios of long-term debt, and profitability of sales, assets and equity.

5.3.2.3 Cash management practices

As indicated in chapter 3, examination of cash management practices by previous

researchers have mainly focussed on examining areas such as cash budgets, cash balance

and cash surplus or shortage. This subsection presents descriptive findings of cash

management practices of the sample of 99 trading and 51 manufacturing SMEs in

Vietnam.

Table 5.11 (page 196) indicates 38 percent of respondents always prepare cash

budgets, whereas about 5 percent never prepare the budgets. On the other hand, Table

5.11 (page 196) reveals that 76 percent of SMEs prepare cash budgets monthly, 11

percent weekly, about 5 percent by quarterly periods and the balance prepares cash

budgets by semiannually and annually periods. As such, the monthly period is most

frequently used by SMEs in preparing cash budgets.




196

Table 5.11: Preparing cash budgetsNo. of firms Percentage

On cash balance determination, Table 5.12 reveals that only 12.6 percent of

responding firms “often or always”, while about 40 percent “rarely or never” determine

the target cash balance. This finding is consistent with the common trend that SMEs

rarely pay attention to setting up a cash-balance policy. Most SMEs simply consider

cash-balance as the result of differences in cash inflows and outflows without any

policies.

Additionally, Table 5.12 indicates that 83 percent of SMEs that often or always

set up their cash balance policy were based on the owner/manger’s experience in

determining the target cash balance. Percentage of SMEs applying theories of cash

Frequency of preparing cash budgets Never 8 5.4%Rarely 7 4.7%

Sometimes 17 11.4%

Often 61 40.9% Always 56 37.6%

Total 149 100.0%Period for preparing cash budget Never 9 6.0%

Weekly 16 10.7%Monthly 114 76.0%

Quarterly 7 4.7%Semiannually 2 1.3%

Annually 2 1.3% Total 150 100.0%


Table 5.12: Cash balance determinationNo. of firms Percentage

Determining the target cash balance Never 12 8.0%Rarely 46 30.7%Sometimes 73 48.7%

Often 14 9.3% Always 5 3.3%

Total 150 100.0%Cash balance determination Based on theories of cash

management 1 0.7%

Based on historical data 21 14.0%Based on owner/manager 's

experience 124 82.7%

Others 2 1.3%No answer 2 1.3%





197

management in determining the target cash balance is not significant. This reveals that

theories of cash management have not been popularly implemented in practices in

Vietnam.

For cash shortage phenomena, 20 percent of enterprises never or rarely have been

short of cash, only 2.7 percent of responding SMEs often or always have insufficient cash

for expenditure (Table 5.13). Conversely, about 40 percent of SMEs in the sample

reported that they have a surplus of cash “sometimes or often or always” (Table 5.13).

This finding is consistent with Kack and Lindgren (1999), and Vuong Quan Hoang

(1998) findings, which indicated SMEs in Vietnam seems likely to reserve cash and

maintain relatively high current ratios (chapter 2, page 55).

Table 5.13: Cash surplus or shortage

Number of firms Percentage

Regarding cash surplus investment, it is surprising that up to 75 percent of

responding SMEs did not invest cash surplus for profit purposes. About 19 percent

deposit cash surplus in bank accounts for interest and almost no firms used the cash

surplus to buy money-market instruments such as treasury bills, commercial papers or

others (Table 5.13). This can be explained, because the money market in Vietnam has not

developed, therefore, firms could not use cash surplus to purchase short-term investment

instruments for profit purposes.

Occurring cash shortage Never 12 8.0%Rarely 18 12.0%

Sometimes 116 77.3%Often 3 2.0%

Always 1 0.7% Total 150 100.0%

Occurring cash surplus Never 7 4.7%Rarely 82 54.7%


Always 4 2.7%

Total 150 100.0%Cash surplus investment Bank deposit 28 18.7%

Treasury bill purchase 1 0.7%No investment 113 75.3%

Others 1 0.7%Not cash surplus 7 4.7%





198

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%


Always 34 22.7% Total 150 100.0%





199

In reviewing receivable levels and bad debts, a relatively high percentage of

SMEs (about 80%) in the sample review their receivable levels and bad debts based on

monthly periods. However, 4.7 percent answered that they never review their bad debts

(Table 5.15). As such, like cash management practices, monthly periods are still

popularly used by SMEs in reviewing receivable levels and bad debts.

Table 5.15: Frequency of reviewing receivable levels and bad debtsNo. of firms Percentage

When analyzing the percentage of bad debts to sales, 89 percent of responding

firms indicated that their bad debts have not exceeded 10 percent of sales (Table 5.16).

This figure is not high under given conditions of financing source shortages and shows

that SMEs are relatively good in managing receivables. However, a few SMEs answered

that they did not know their percentage of bad debts to sales, and others did not answer

this question.

Review levels of receivables Weekly 16 10.7%Monthly 124 82.7%

Quarterly 8 5.3% Annually 1 0.7%

No answer 1 0.7% Total 150 100.0%

Review bad debts Never 7 4.7% Weekly 9 6.0%Monthly 120 80.0%

Quarterly 7 4.7%Semiannually 3 2.0%

Annually 3 2.0%No answer 1 0.7%


Table 5.16: Percentage of bad debts compared to salesNo. of firms Percentage

Bad debt percentages Less than 5 % of sales 66 44.0%5 -10% of sales 67 44.7%

10 -20% of sales 12 8.0%More than 20% of sales 1 0.7%

Don't know 2 1.3%No answer 2 1.3%





200

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%


Always 77 51.3% Total 150 100.0%

Prepare inventory budgets Never 7 4.7%Rarely 9 6.0%


Always 69 46.0% Total 150 100.0%





201

When asked how they determined the level of inventory in preparing inventory

budgets, 94 percent of responding firms answered they determine inventory level based

on owner/manager’s experience, only 2 percent used theories of inventory management

(Table 5.18). On the other hand, SMEs very rarely use the “Economic Order Quantity

Model” in inventory management. About 90 percent of SMEs revealed that they had

never known of the model, 6 percent know of it but never use it, while only 1.3 percent

often used the model.

Table 5.18: Basis of determining inventory levels and using EOQ ModelNo. of firms Percentage

Practices of inventory management as reviewed above demonstrate that SMEs

have a very low level of management expertise regarding inventory. They often review

inventory levels and prepare inventory budgets but the ability to applying theories of

inventory management to inventory budgeting is very limited.

5.3.2.6 Fixed asset management practi ces

On fixed asset management practices, respondents were asked questions related to

frequency of evaluating investment projects and reviewing efficiency in use of fixed

assets after investing, and methods used to evaluate an investment project. Below are the

descriptive findings of fixed asset management practices of SMEs in the sample.

Seventy-nine percent of respondents claimed that they “always or often”

evaluated projects before making capital investment decisions. However, there were also

Inventory leveldetermination

Based on theories of inventory management

3 2.0%

Based on historical data 3 2.0%Based on owner/management's

experience

141 94.0%Others 3 2.0% Total 150 100.0%

Economic Order QuantityModel application

Do not know this model 134 89.3%

Know but never use 9 6.0%Sometimes use 5 3.3%

Often use 2 1.3% Total 150 100.0%





202

6 percent respondents who claimed that they had made decisions on capital investment

without project evaluation (Table 5.19). For these firms, it seems that they are not

concerned about evaluating projects but are willing to buy fixed assets whenever needed.

On the quality of utilizing fixed assets after investing, 78.8 percent of responding firms

stated that they always or often review the efficiency of utilizing fixed assets after

investing. Only about 5 percent have never reviewed fixed assets utilization after making

decisions of investment (Table 5.19).

Table 5.19: Frequency of evaluating investment projects and reviewing efficiency of usingfixed assets after investing

No. of firms Percentage

Regarding methods used to evaluate investment projects or capital budgeting

techniques used by the firms in the sample, Table 5.20 (page 203) shows the proportion

of firms using the various techniques. Table 5.20 reveals that 86.7 percent of firms in the

sample claimed to use the payback method, falling to 33.3 percent for discounted

payback period. Only 27.3 percent stated that they 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 results are similar to those of the studies

conducted by Luama (1967), and Peel and Wilson (1996) in that payback period method

are the most popular technique used by small firms while more sophisticated techniques

such as NPV, IRR or MIRR seem to be less frequently used.

Evaluate projects before makingcapital investment decisions

Never 9 6.0%

Rarely 10 6.7%Sometimes 12 8.0%

Often 29 19.3% Always 90 60.0%

Total 150 100.0%Review efficiency of using fixed assetsafter investing

Never 8 5.3%

Rarely 10 6.7%Sometimes 14 9.3%

Often 34 22.7% Always 84 56.0%

Total 150 100.0%





203

Table 5.20: Methods used to evaluate investment projects


Descriptive findings of fixed asset management practices of a sample of 99

trading and 51 manufacturing SMEs in Vietnam are summarized as follows:

• Near 80 percent of SMEs always or often evaluate capital projects before making

decisions on investment and review the efficiency of utilizing fixed assets after

acquisitions.

• 87 percent of SMEs stated that they use payback period technique 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 reveal that SMEs have a relatively strong regard for fixed asset

management.

5.3.2.7 Financial planning practi ces

To investigate financial planning practices, respondents were asked questions related to

frequency of preparing and reviewing financial budgets, kinds of financial budgets

prepared, responsibility for preparing financial budgets, and frequency of comparing

budgeted and actual results. Listed below are the results of response to the questions that

interviewers raised with SMEs in the sample.

Table 5.21 (page 204) reports the frequency of preparing financial budgets. In line

with prior expectations, only 5.3 percent of SMEs in the sample “never” prepare any kind

of financial budgets. A majority of SMEs in the sample (76.6%) “always or often”

Methods used to evaluateinvestment projects

Payback period 130 86.7%

Discounted payback period 50 33.3%

Net present value 34 22.7%Internal rate of return 5 3.3%

Modified internal rate ofreturn

2 1.3%

No answer 4 2.7%Source: Data analysis for the study




204

prepared financial budgets during business operations. The remainder “rarely or

sometimes” prepared budgets.

Table 5.21: Frequency of preparing and reviewing financial budgets


Table 5.22 reports the percentages of SMEs in the sample that prepared types of

budgets. One hundred thirty-one of 150 SMEs asked (87.3%) had prepared sales budgets,

representing the highest percentage, while only 34 and 41 percent had ever prepared

budget balance sheets and budget profit and loss statements respectively. This is

consistent with the reported situation that SMEs in Vietnam rarely prepare budget

balance sheets and income statements though they frequently prepared actual balance

sheets and income statements (Table 5.7, page 192).

It may be explained that SMEs in Vietnam are unfamiliar with preparing budget

balance sheets and income statements. In contrast, they are relatively familiar with

preparing other kinds of budgets such as sales budgets, selling and administration

expense budgets, labour budgets, overhead cost budgets, and cash budgets.

Preparing financial budgets Never 8 5.3%Rarely 7 4.7%


Always 53 35.3% Total 150 100.0%


Table 5.22: Kinds of financial budgets preparedNo. of firms Percentage

Kinds of budget prepared Sales budget 131 87.3%Manufacturing budget 51 34.0%

Purchase budget 71 47.3%Labour budget 90 60.0%

Overhead cost budget 86 57.3%Selling and administration expense

budget

105 70.0%Cash budget 83 55.3%

Budgeted profit and loss account 62 41.3%Budgeted balance sheet 52 34.7%





205

Regarding the responsibility for preparing financial budgets, Table 5.23 reveals

that 62 percent of responding SMEs have employed or internal accountants prepare

financial budgets, falling to 34.7 percent using chief-accountants and 20.6 percent using

owners or managers. Once again, employed accountants are recognized as playing very

important roles in financial management practices while external accountants are rarely

used by SMEs (1.3%).

Table 5.23: Responsibility – preparing financial budgetsNo. of firms Percentage

In addition to preparing financial budgets, up to 83 percent of SMEs in the sample

frequently compared between budget and actual results, only 2.7 percent rarely conduct

this comparison (Table 5.24). Furthermore, budget periods for comparing budget and

actual results tend to be relatively short. Over seventy-eight percent of SMEs carry out

comparisons of budget/actual results in monthly periods. This helps SMEs quickly to

respond to in achieving budgeted objectives.

In summary, related to financial planning practices of SMEs in the sample, the

following are findings:

Responsibility for preparing budgets Owner 23 15.3%Financial manager 8 5.3%Chief-accountant 52 34.7%



Table 5.24: Frequency of comparing between budgeted and actual resultsNo. of firms Percentage

Frequency of actual/budgeted comparison Rarely 4 2.7%Sometimes 17 11.3%

Often 51 34.0% Always 74 49.3%

Total 150 100.0%Periods of actual/budgeted comparison Weekly 9 6.0%

Monthly 118 78.7%Quarterly 16 10.7%

Semiannually 4 2.7%

Annually 3 2.0% Total 150 100.0%Source: Data analysis for the study




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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

Jewelry 3.00Shoes 2.60

Manufacturing (Average) 2.05 Manufacturing 2.47Furniture 2.40Electronic components 1.70Machine tools and equipment 2.10 Apparel 2.00

Source: Osteryoung, Constand and Nast (1992) research and data analysis for this study




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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%





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5.3.3.2 Financial leverage (Debt and debt-to-equi ty ratio)

Table 5.25a (page 207) indicates that, the average debt ratio of SMEs in the sample was

30%, that is, 30 percent of total assets of SMEs are financed from debt and 70 percent

from equity. This finding is lower than that reported by Vuong Quan Hoang (1998), who

indicated that the average debt-to-total asset ratio of SMEs in Vietnam was 40 percent

(chapter 2, Table 2.21, page 54). However, a few SMEs have debt ratios as high as 108

percent while others have low debt ratios of 10 percent. Generally speaking, debt ratios of

SMEs in the sample were not high. Table 5.29 reveals that 72 percent of SMEs had debt

ratios below 30% while less than 10 percent had debt ratios over 50%. This is not

surprising because, in the 1990’s, SMEs in Vietnam have extreme difficulty in finding

outside financing sources from commercial banks, credit unions or financial companies.

Table 5.29: Descriptive findings of SME debt ratiosNo. of firms Percentage

Debt ratio

Additionally, Table 5.25a (page 207) indicated that, on average, the debt-to-equity

ratio of SMEs in the sample was about 54%. This means that SMEs use about one dollar

of debt corresponding to one dollar of equity to finance their total assets. This feature is

consistent with the current status of SMEs in that they often use assets funded by equity

as collateral to borrow short-term or long-term capital sources. However, this debt-to-

equity ratio is considered relatively low compared with large companies, which often use

about 3 dollars of equity as collateral to borrow up to 7 dollars of debt (Vuong, 1998). In

consequence, the possibility of debt financing depends upon the volume of equity source

and SMEs with limited equity sources may have extreme difficulty in seeking debt-

financing sources for expansion or growth.

Below 30% 108 72.0%From 31% to 50% 28 18.7%From 51% to 80% 11 7.3%

More than 80% 3 2.0% Total 150 100.0%





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5.3.3.3 Business activit y (Total asset turnover)

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%





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5.3.4.1 Overview of profitabi lity

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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Table 5.31: Overview of SME profitability


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%


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%





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On the other hand, Table 5.32 (page 213) also provides the findings of

relationships between profitability and business structure in which private enterprises are

more profitable than limited and joint stock companies. In term of structure, private

enterprises, limited companies, and joint stock companies accounted for 26.7%; 70.0%;

and 3.3 percent respectively, but the percentage of profitable SMEs are correspondingly

32.3%; 65.7%; and 2.0 percent for private enterprises, limited companies, and joint stock

companies. As such, although limited companies occupy 70.0 percent of SMEs in the

survey, only 65.7 percent are profitable while private enterprises occupy 26.7 percent but

32.3 percent are profitable and 15.7 percent are not profitable.

5.3.4.3 Profitabi lity and business size

This subsection analyzes profitability of SMEs in relation to business size to investigate

which business size groups (very small, small, or medium) are profitable. Table 5.33

reveals smaller businesses in terms of total assets, annual sales, and labour are more

profitable than larger SMEs. For SMEs that have total assets less than VND5 billion, the

percentage of profitable SMEs was higher than that of unprofitable SMEs. These findings

support the view that “small” is profitable.

Table 5.33: Relationship between profitability and business characteristicsNot profitable Profitable TotalNo. % No. % No. %

Total assets Less than 5 billion dong 45 88.2% 90 90.9% 135 90.0% 5 To 10 billion dong 3 5.9% 5 5.1% 8 5.3% More than 10 billion dong 3 5.9% 4 4.0% 7 4.7%

Total 51 100.0% 99 100.0% 150 100.0% Annual sales Less than 5 billion dong 36 70.6% 74 74.7% 110 73.3% 5 to 30 billion dong 13 25.5% 20 20.2% 33 22.0% 31 to 50 billion dong 1 2.0% 1 1.0% 2 1.3% More than 50 billion dong 1 2.0% 4 4.0% 5 3.3% Total 51 100.0% 99 100.0% 150 100.0%

No. of employees 1 to 10 employees 18 35.3% 48 49.5% 66 44.6% 11 to 30 employees 22 43.1% 30 30.9% 52 35.1% 31 to 50 employees 2 3.9% 6 6.2% 8 5.4% 51 to 100 employees 5 9.8% 5 5.2% 10 6.8%

101 to 250 employees 4 7.8% 6 6.2% 10 6.8%More than 250 employees 2 2.1% 2 1.4%

Total 51 100.0% 97 100.0% 148 100.0%





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In summary, analysis conducted in subsections 5.3.4.2 and 5.3.4.3 provided

descriptive findings of relationships between profitability and business structure, and

size. These findings are summarized as follows:

• The percentage of profitable SMEs in manufacturing industry is higher than that

of the trading industry.

• In term of form of ownership, the percentage of profitable SMEs is found higher

for private enterprises than that of limited and joint stock companies.

• In term of business size, the percentage of profitable SMEs is found higher for

smaller businesses than that for larger SMEs.

However, these are relatively simple descriptive statistical analysis of relationships

between profitability and business structure, and business size. More sophisticated

statistical analysis related to SME profitability will be examined and reported in section

5.4 in which bivariate analysis and multivariate analysis were applied.

5.4 ASSOCIATIVE ANALYSIS AND FINDINGS OF THE RESEARCH STUDY

This section demonstrates and reports to what extent data collected from the survey of

150 SMEs in Ho Chi Minh City, Vietnam supports the model presented in subsection

4.4.2 and hypotheses outlined in subsection 4.4.3 of chapter 4 (page 165). Firstly,

subsection 5.4.1 used factor analysis to reduce the large number of variables measuring

financial management practices into principal factors or components. Subsection 5.4.2

presents results of using bivariate analysis technique to analyze associations between

financial management practices, financial characteristics and profitability and subsection

5.4.3 reports results using multi-regression analysis to test the model of simultaneous

impact of financial characteristics and financial management practices on SME

profitability. Finally, subsection 5.4.4 reports the result of tests for difference in average

profits between efficient and inefficient financial management groups of SMEs.




216

5.4.1 Factor analysis and princ ipal components of financial management

practices

As indicated in chapter 4, the efficiency of financial management practices is a complex

and multi-dimension construct. In term of context, financial management practices may

be summarized into the following areas: (1) accounting information systems, (2) financial

reporting and analysis, (3) cash management practices, (4) receivable management

practice, (5) inventory management practices, (6) fixed asset management practices, and

(7) financial planning practices (McMahon, 1998). Chapter 4 also indicated the efficiency

of each area of financial management practices was generally measured by 8 items on

nine-point scales. The efficiency of receivable management practices was measured by 9

items on a nine-point scale. In consequence, the efficiency of financial management

practices of SMEs in the survey was measured by index or composite measure of 57

items (8 items of each area plus 9 item of receivable management area) on nine-point

scales.

Using index or composite measurements as mentioned above to measure the

efficiency of financial management practices aims at increasing the validity of

measurements. However, a large number of variables related to financial management

practices made data analysis more difficult and complicated. Factor analysis is often used

to overcome this obstacle by grouping together variables that are highly correlated into

“principal components” and, as a result, bring a simplification to analysis (Lehmann,

Gupta, and Steckel, 1998).

The fifty-seven items (as indicated in section 4.4 of chapter 4) of financial

management practices of 150 SMEs in the sample were used as input for the SPSS

(Statistical Package for Social Science) computer program to obtain the principal

components. Each principal component is a linear combination of items of the financial

management practices. Coefficients of the items of financial management practices used

to construct principal components are called “factor loadings”. The proportion of

variation explained by each principal component is found by dividing the sum of squared

loadings (known as Eigen value) by the number of items of financial management

practices. By using Kaiser’s (1960) significant rule, which suggested principal

components with Eigen values greater than unity should be considered statistical




217

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

Co. Total % of Variance

Cumulative%

Total % of Variance Cumulative%

Total % of Variance Cumulative%

1 45.238 79.365 79.365 45.238 79.365 79.365 17.083 29.969 29.9692 1.655 2.903 82.268 1.655 2.903 82.268 16.128 28.296 58.2653 1.069 1.876 84.144 1.069 1.876 84.144 14.751 25.879 84.144

4 .893 1.567 85.7115 .763 1.338 87.0496 .618 1.085 88.1347 .491 .861 88.9958 .439 .770 89.7659 .418 .734 90.49910 .354 .622 91.12111 .320 .562 91.68312 .314 .551 92.23413 .286 .502 92.73614 .267 .469 93.20515 .256 .449 93.65416 .243 .425 94.07917 .210 .368 94.44718 .198 .347 94.794

19 .181 .318 95.11220 .175 .306 95.41821 .173 .304 95.72222 .165 .290 96.01223 .150 .264 96.27624 .145 .255 96.53125 .137 .240 96.77026 .129 .226 96.99627 .119 .209 97.20528 .112 .196 97.40129 9.895E-02 .174 97.57430 9.540E-02 .167 97.74231 9.099E-02 .160 97.90132 8.716E-02 .153 98.05433 8.388E-02 .147 98.201

34 7.860E-02 .138 98.33935 7.608E-02 .133 98.47336 7.294E-02 .128 98.60137 6.485E-02 .114 98.71438 6.223E-02 .109 98.82439 6.013E-02 .105 98.92940 5.706E-02 .100 99.02941 5.244E-02 9.199E-02 99.12142 5.004E-02 8.778E-02 99.20943 4.379E-02 7.683E-02 99.28644 4.274E-02 7.497E-02 99.36145 4.213E-02 7.391E-02 99.43546 3.965E-02 6.957E-02 99.50447 3.633E-02 6.373E-02 99.56848 3.499E-02 6.139E-02 99.629

49 3.346E-02 5.870E-02 99.68850 3.104E-02 5.446E-02 99.74351 2.986E-02 5.239E-02 99.79552 2.532E-02 4.442E-02 99.83953 2.389E-02 4.191E-02 99.88154 1.960E-02 3.438E-02 99.91655 1.698E-02 2.979E-02 99.94556 1.566E-02 2.748E-02 99.97357 1.541E-02 2.703E-02 100.000Extraction Method: Principal Component Analysis.




218

significant, three principal components with Eigen values greater than unity were retained

(Table 5.34, page 217). These three principal components account for 84.14 percent of

the variation in the original data set consisting of fifty-seven items of financial

management practices. Cumulative variance explained by the three principal components

and their Eigen values are shown in Table 5.34 (page 217).

Table 5.34 identified three principal components of financial management

practices. However, since all items of financial management practices make a

contribution to each principal component, one of the difficulties in principal component

analysis is the interpretation of principal components. To facilitate an easier interpretation

of principal components, factor rotation methods were developed. This research study

uses varimax orthogonal rotation method developed by Kaiser (1958) because this

method is widely used (Chaganti et al., 1989, Weinrauch et al., 1991, Meric and Meric,

1992, Serwinek, 1992, and Busenitz, 1996). This rotation method is based on the criterion

of maximizing the factor loadings of dominant variables in each principal component.

Kaiser’s (1958) varimax rotation facilitates an easier interpretation of principal

components. The factor loadings of the three principal components are presented in Table

5.35 (page 219). The three principal components representing various financial attributes

of the firms can be named in accordance with the factor loadings of the fifty-seven items

of financial management practices as shown in Table 5.36.

Table 5.36: Three principal components of financial management practicesCom. Name of the principal component Eigen Cumulative variance

value explained (%)1

The product of the squared root of the Eigen value of the principal component and

the factor loadings of each financial management practice items shows the correlation

between the principal component and the financial management practice item. Therefore,

the financial management practice item with the highest factor loadings in the three

statistically significant principal components are presented in Table 5.35 (page 219).

Working capital management and short-termplanning practices 45.238 29.969 (~29.97)

2 Fixed asset management and long-term planningpractices 1.655 58.265 (~58.27)

3 Financial and accounting information practices 1.069 84.144 (~84.14)Source: Data analysis for the study




220

The names given to the three statistically significant principal components are

shown in Table 5.36 (page 218). In accordance with the factor loadings of financial

management items making the greatest contribution to the first principal component, it

was named “Working Capital Management and Short-term Planning Practices”. This

principal component accounts for 29.97 percent of the total variation in the original data

set. Similarly, the factor loadings of financial management items making the greatest

contribution to the second principal component, it was named “Fixed Asset Management

and Long-term Planning Practices”. The second principal component accounts for

28.30% (58.27% minus 29.97%) of the total variation in the original data set. Finally, the

factor loadings of financial management items making the greatest contribution to the

third principal component, it was named “Financial and Accounting Information

System”. The third principal component explains 25.87% (84.14% minus 58.27%) of the

total variation in the original data set. Cumulatively, three principal components

explained 84.14 percent of the total variation in the original data set.

In summary, factor analysis is a useful statistical tool to reduce a large set of

correlated variables to fewer unrelated dimensions and identifies a typology (Laitinen,

1991). In this study, factor analysis was used to group and reduce fifty-seven financial

management practice items, which were used to measure the efficiency of financial

management practices, in the original data set into three principal components of

financial management practices. Three principal components include (1) working capital

management and short-term planning practices (WCSP), (2) fixed asset management and

long-term planning practices (FALP), and (3) financial and accounting information

system (FAIS). These principal components will be used as the independent variables

replacing the fifty-seven items related to financial management practices and the variable

measuring the efficiency of financial management practices (EFF), which was developed

in chapter 4 to measure the efficiency of financial management practices. In subsections

5.4.2 and 5.4.3, as examining the relationship between profitability and financial

management, the three variables: WCSP, FALP, and FAIS are used as the independent

variables together with other independent variables such as current ratio (CUR), debt

ratio (DER) and total asset turnover (TAT).




221

5.4.2 Bivariate analysis and findings

Bivariate analysis is used for tests of association to investigate the relationships between

variables and reports the results on a correlation matrix before utilizing multiple

regression analysis. This is widely used by previous researchers (Murphy III, 1989; Litz

and Stewart, 2000). As indicated in chapter 4 and subsection 5.4.1, variables used in this

research study include the following:

• Dependent variables consisting of return on sales (ROS), return on assets (ROA),

return on equity (ROE), and profitability (PRO) defined as the average of ROS,

ROA and ROE

• Independent variables consisting of current ratio (CUR), debt ratio (DER), total

asset turnover (TAT), working capital management and short-term planning

practices (WCSP), fixed asset management and long-term planning practices

(FALP), and financial and accounting information system (FAIS).

Correlation matrixes are used for association analysis to determine whether correlation

and multicollinearity exist between variables.

5.4.2.1 Association between profitability and return on sales, return on assets and

return on equity

As indicated in chapter 4, this research study uses four variables: ROS, ROA, ROE, and

PRO as variables to measure profitability of SMEs. The correlation matrix of PRO, ROS,

ROA, and ROE are created to analyse correlation between these variables. The objective

of this analysis is to determine whether a single measure or many measures of

profitability should be used and, as a result, one model or many models should be tested.

In measuring correlation between these variables, the Pearson’s correlation coefficient is

widely used for variables measured by ratio or interval scales (Emory, 1985; Davis, 1996;

and Zikmund, 1997, p.627). Table 5.37 (page 222) below presents the correlation matrix

of variables measuring profitability of SMEs in the sample.




222

Table 5. 37: Correlation matrix of PRO, ROS, ROA, and ROE

The correlation matrix (Table 5.37) shows that profitability (PRO) and return on

sales (ROS), return on asset (ROA), and return on equity (ROE) are positively correlated

with the correlation coefficients r = 0.400, 0.924 and 0.942 (at 0.01 significant level)

respectively. Very high correlation coefficients between profitability and return on asset

and between profitability and return on equity are considered sufficient to warrant that

only one variable (PRO) needs to be analysed. However, the positive relationship with

correlation coefficient r = 0.400 between profitability and return on sales is not

considered sufficiently high to warrant only one measure of profitability and, thus, the

measures are analysed independently.

As such, after examining the correlation between dependent variables, two

variables: ROA and ROE were dropped because they are highly correlated with PRO.

Consequently, only ROS and PRO are used as dependent variables to measure

profitability of SMEs and two models of SME profitability are tested in this research.

5.4.2.2 Association between financial management practices, financial characteristics

and profitability

This subsection uses correlation matrix to investigate the correlation between financial

management practices, financial characteristics and profitability of SMEs. Objectives of

this analysis are to discover the relationship between the dependent variable (ROS or

PRO) and independent variables and to determine whether the multicollinearity exists.

According to Murphy III (1989), multicollinearity indicates a problem in multiple

regression analysis. As the independent variables have a high probability of correlation,

the regression coefficient (the bs) becomes less reliable, and confidence in the accuracy

Profitability Return on sales Return on assets(%)

Return on equity(%) (%)

Profitability (PRO) 1.000 .400** .924** .942**Return on sales (ROS) .400** 1.000 .107 .122Return on assets (ROA) .924** .107 1.000 .902**Return on equity (ROE) .942** .122 .902** 1.000** Correlation is significant at the 0.01 level (2-tailed).




223

of the equation is questioned. 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 (Murphy III, 1989).

Correlation matrix as shown in Table 5.38 is used to determine whether

relationships between financial characteristics, financial management practices and

profitability and multicollinearity among independent variables exist.

Table 5.38: Correlation matrix of PRO and independent variables

Profit-

The first row of Table 5.38 shows the correlation coefficients between PRO and

the independent variables. As expectedly, the relationships between profitability and

working capital management and short-term planning practices, fixed asset management

and long-term planning practices, and financial and accounting information system are

significantly positive with respective correlation coefficients r = 0.399; 0.498; and 0.343.

Table 5.38 also shows the significantly positive correlation between profitability and total

asset turnover with r = 0.381. Conversely, Table 5.38 reveals the relationships between

profitability and current ratio is significantly negative with correlation coefficients r = -

0.553.

In addition, Table 5.38 shows significant inter-correlation among variables in

which current ratio is be found to negatively correlate to debt ratio (r = - 0.349), working

capital management and short-term planning practices (r = - 0.281), fixed asset

management and long-term planning practices (r = - 0.299), and financial and accounting

ability

Currentratio

Debtratio

Totalasset

turnover

WCSP FALP FAIS

Profitability 1.000 -.553** .155 .381** .399** .498** .343**Current ratio -.553** 1.000 -.349** -.101 -.281** -.299** -.310**

Debt ratio .155 -.349** 1.000 .096 -.102 .024 .209* Total asset turnover .381** -.101 .096 1.000 .121 .235** .130 Working capital management andshort-term planning practices(WCSP)

.399**

-.281**

-.102

.121 1.000 .000 .000

Fixed asset management and long-term planning practices (FALP) .498**

-.299**

.024

.235**

.000 1.000 .000

Financial and accountinginformation system (FAIS) .343**

-.310**

.209*

.130 .000 .000 1.000

** Correlation is significant at the 0.01 level (2-tailed).* Correlation is si nificant at the 0.05 level 2-tailed .




224

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

Returnon sales

(%)

Currentratio

Debtratio

Totalasset

turnover

WCSP FALP FAIS

Return on sales (%) 1.000 -.286** -.025 -.256** .248** .128 .168*

Current ratio -.286** 1.000 -.349** -.101 -.281** -.299** -.310**Debt ratio -.025 -.349** 1.000 .096 -.102 .024 .209* Total asset turnover -.256** -.101 .096 1.000 .121 .235** .130 Working capital management andshort-term planning practices(WCSP)

.248** -.281**

-.102

.121 1.000 .000 .000

Fixed asset management and long-term planning practices (FALP) .128 -.299**

.024 .235** .000 1.000 .000

Financial and accountinginformation system (FAIS) .168* -.310**

.209*

.130 .000 .000 1.000

** Correlation is si nificant at the 0.01 level 2-tailed .




225

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




226

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 (%)




227

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%





228

Debt ratio – Table 5.40 (page 226) shows the relationship between profitability

and debt ratio is not significant and, as a result, hypothesis two, which stated that debt

ratio is positively related to profitability, was not supported. While unexpected, this could

be explained by two reasons. Firstly, profitability was not found to be significantly

related to the debt ratio and this might have occurred because the current ratio and the

debt ratio are related concepts. The correlation with r = 0.349 could indicate

multicollinearity in the model. However, it is not high enough (r <0.7) to question the

validity of the regression model. Secondly, profitability and debt ratio are not always

linear related as indicated by Edward and Cooley (1979).

In general, whenever the return on assets exceeds the cost of debt, leverage is

favourable, and the higher leverage factor, the higher the rate of return oncommon equity.

When the rate of return on assets exceeds the cost of debt, debt ratio is positively related

to profitability. However, when the debt ratio is continually increasing, the cost of debt

will be increased and profitability will decrease. At this point, the debt ratio is negatively

related to the profitability. Figure 5.3 (page 228) shows the relationship between the debt

ratio and profitability by which the relationship may be considered in two phases.

At the first phase, the debt ratio is below 0.6 and the profitability and debt ratio

are positively related. However, at the second phase, as the debt ratio increases over 0.6

the profitability and debt ratio are negatively related. This may be explained as follows.

When the debt ratio exceeds 0.6 the debt-to-equity will exceed 1. At that point, one dollar

of firm assets is corresponding to more than one dollar of debts. Consequently, firms will

increase risk, the cost of debt will be increased and profitability decreases. Therefore, at

this phase, profitability is negatively related to debt ratio. As such, debt ratio is not linear-

related to profitability but cubic-related as shown in figure 5.4. However, financial

leverage is a complicated issue and the detailed explanation of this issue is beyond this

research study. It should be considered and discussed in further research.




229

Figure 5.4: Rel at i onshi p bet ween pr of i t abi l i t y and debt r at i o

MODEL: MOD_1.

I ndependent : DER

Dependent Mt h Rsq d. f . F Si gf b0 b1 b2 b3

PRO LI N . 024 148 3. 65 . 058 6. 1631 4. 5102PRO CUB . 096 146 5. 15 . 002 6. 9367 - 13. 970 72. 5457 - 63. 198

Profitability

Debt ratio

1.21.0.8.6.4.2-.0

30

20

10

0

-10

-20

Observed

Linear

Cubic

Total asset turnover – Table 5.40 (page 226) shows the result of t-test with t-

statistic = 3.590 and β = 0.198. Profitability was found to be positively related to total

asset turnover at a 0.0001 significance level. This finding supports hypothesis three,

which stated that profitability is positively related to total asset turnover. It is implied that

the higher total asset turnover SMEs, the more profitable they become. However, total

asset turnover with β = 0.198 is not relatively important compared to the current ratio (β

= 0.256) in contributing to variance of SME profitability.

Efficiency of financial management practices – Table 5.40 (page 226) reveals

that profitability is positively related to working capital management and short-term

planning practices with β = 0.305 and at 0.0001 significant level. Similarly, profitability

was found to be positively related to fixed asset management and long-term planning

practices and financial and accounting information system with β = 0.374 and 0.234




230

respectively and at a significance level of 0.0001. As such, strong support was found for

hypothesis four, which was developed in chapter 4 and stated that profitability is

positively related to the efficiency of financial management practices. This finding is also

consistent with the descriptive finding of the relationship between profitability and the

efficiency of financial management practices of SMEs in the sample as shown in Table

5.42 below.

Table 5.42: Relationship between SME profitability and the efficiency of financial managementpractices

Profitability Total

Table 5.42 above shows that the proportion of profitable SMEs is much higher for

SMEs that are efficient in financial management practices, while the proportion of

unprofitable SMEs is much higher for SMEs that are not efficient in financial

management practice.

Finally, Table 5.40 (page 226) shows that correlation coefficients of variables of

financial management practice are higher than that of financial characteristics. This

suggests that variables of financial management practices are more important than

financial characteristics in contributing to variance of SME profitability.

In summary, the results of multiple regression analysis in Table 5.40 revealed

that SME profitability was influenced by financial characteristics and financial

management practices at the significance level of 0.0001, and 60.8 percent of variation in

SME profitability (R 2

= 0.608) can be accounted for variance in financial characteristics

and financial management practices. Specifically, findings of the impact of financial

characteristics and financial management practices on SME profitability are summarized

as follows:

Not profitable No.Profitable %No. % No. %

Efficiency Inefficient financialmanagement

36 70.6% 5 5.1% 41 27.3%

Efficient financial management 15 29.4% 94 94.9% 109 72.7% Total 51 100.0% 99 100.0% 150 100.0%





231

• 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

CoefficientsStd. Error Standardized t Sig.

CoefficientsModel B Beta

1 (Constant) 9.063 .629 14.401 .000Current ratio -.936 .216 -.265 -4.343 .000

Total asset turnover .198 .054 .200 3.659 .000 Working capital management and

short-term planning practices1.589 .294 .300 5.412 .000


1.967 .302 .371 6.518 .000


1.247 .297 .235 4.197 .000


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




232

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


.733 .367 .159 1.997 .048


.798 .359 .173 2.220 .028


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(%)




233

of determination R 2 = 0.251 at a significant level of p = 0.0001. The coefficient of

determination indicated that 25.1% of the variation in return on sales is explained by the

five independent variables used to measure financial characteristics and financial

management practices, while 74.9% remains unexplained. In addition, Table 5.44 reveals

the value of F = 8.003 is significant at the 0.0001 level. The value of F is not high as that

of F in the first model but it 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 return on sales and the model is useful (Keller, Warrack, and Bartel, 1994;

Davis, 1996). The next step is to evaluate significance of correlation coefficients of

independent variables.

Current ratio – Similar to profitability, return on sales was negatively related to

the current ratio at 0.05 but not at a significance level of 0.001 (Table 5.44, page 232).

This finding is also consistent with Van Horne (1986)’s theory of relationship between

profitability and liquidity. As such, return on sales of SMEs that have relatively higher

current ratios will be lower and vice versa.

Debt ratio – Table 5.44 (page 232) shows the relationship between return on

sales and debt ratio is not significant. This is unexpected and could be explained that the

return on sales was not found to be significantly related to the debt ratio and this might

have occurred because current ratio and debt ratio are related concepts. The correlation

between current ratio and debt ratio with r = 0.349 could indicate multicollinearity in the

model. However, it is not high enough (r <0.7) to question the validity of the regression

model.

Total asset turnover – Unlike profitability, return on sales was found negatively

and strongly related to total asset turnover with β = - 0.355 and at a significance level of

0.0001 (Table 5.44, page 232). This is reasonable and expected because total asset

turnover is defined as sales divided by total assets, while return on sales is defined as net

profit divided by sales. If total asset turnover increases as the result of an increase in sales

then return on sales will decrease because return on sales is calculated by dividing net

profit by sales.

Efficiency of financial management practices – Three principal components of

financial management practices including working capital management and short-term




234

planning practices, fixed asset management and long-term planning practices, and

financial and accounting information system are found to positively relate to return on

sales with respective correlation coefficients 2.954; 1.997 and 2.220 at a significance

level of 0.05. This finding also supports the hypothesis of a positive relationship between

profitability and the efficiency of financial management practices.

The results of multiple regression analysis in the case of return on sales used as

the dependent variable conducted earlier shows findings as that of multiple regression

analysis in the case of using SME profitability as the dependent variable, with the

exception of two differences as follows:

• Total asset turnover was found to be negatively related to return on sales while it

was found to be positively related to SME profitability.

• Variables measured the efficiency of financial management practices were

positively related to return on sales at 0.05 significant levels while they were

related to SME profitability at a significance level of 0.0001.

5.4.4 Test for the difference of average profi ts between efficient and

inefficient financial management groups of SMEs

As indicated in chapters 1 and 4, financial management practices included accounting

information system, financial reporting and analysis, cash management practices,

receivable management practices, inventory management practice, fixed asset

management practices, and financial planning. The extent of efficiency of each financial

management component is measured by the sum of points of eight items on the nine-

point scale (1 = not efficient at all, 9 = very efficient). If the sum of points of a financial

management component of a business is not less than the average point of 40, the

business is said to be “efficient” in applying that aspect of financial management.

Conversely, if the sum of a component is less than the average point of 40, the business is

said to be “not efficient” or “inefficient” in applying that component of financial

management. Lastly, a business is said to be efficient in financial management practices,




235

if all components of financial management practices are efficient. That means all sums of

points of components are greater than the average point of 40.

Based on the criteria mentioned above, the sample of 150 SMEs were divided into

two groups. The first included SMEs that were not efficient in financial management

practices is labeled as “inefficient group of SMEs”, and the second consisting of SMEs

that were efficient in financial management practices is labeled as “efficient group of

SMEs”. This subsection presents the result of testing the hypothesis of difference in mean

profits of two groups of SMEs.

Table 5.45 summarizes descriptive statistics of profitability of the two groups of

SMEs. The inefficient group of SMEs (41 SMEs) had mean profit return of 3.19% while

the efficient group of SMEs (109 SMEs) had mean profit return of 9.10%. This reveals

that the mean profit of the efficient group was nearly three times that of the inefficient

group.

Table 5.45: Descriptive statistics of profitability of two groups of SMEsN Mean Std. Deviation Std. Error Mean

Inefficient financial management

Statistical test was conducted to determine whether the mean profit of the efficient

group of SMEs was greater than that of the inefficient group. A hypothesis was

developed in chapter 4 and following is the result of testing the hypothesis of difference

in the mean profits of the two groups of SMEs (Table 5.56).

The result of testing shown in Table 5.46 reveals that the null hypothesis of

equality of mean profits of two groups is rejected at a significance level of 0.0001.

Consequently, the hypothesis five indicated in chapter 4, which was stated that the mean

41 3.1941 4.9262 .7693Efficient financial management 109 9.1023 4.4840 .4295Source: Data analysis for the study

Table 5.46: Independent group test of mean profit differencet-test for equality of means

t df Sig. (2-tailed)

Meandifference

Std. errordifference

Profitability Equal variances assumed -6.999 148 .000 -5.9083 .8442

Equal variances not assumed -6.706 66.428 .000 -5.9083 .8811Source: Data analysis for the study




236

profit of SMEs that are efficient in financial management practices is different from that

of SMEs that are not efficient in financial management practices, was strongly supported.

It is concluded that the mean profit of SMEs that are efficient in financial management

practices was greater than that of SMEs that are not efficient.

5.5 CONCLUSIONS

In relation to research objectives and questions, the result of data analysis as presented in

chapter 5 provides descriptive findings of financial management practices and financial

characteristics of SMEs in Vietnam. SMEs in the sample were found to maintain a

relatively high liquidity ratio, low debt ratio and moderate total asset turnover.

More sophisticated statistical techniques were applied to analyze the relationships

between financial characteristics, financial management practices and SME profitability.

The results of multiple regression analysis indicated that SME profitability is

simultaneously influenced by financial characteristics (measured by CUR and TAT) and

financial management practices (measured by WCSP, FALP, and FAIS). SME

profitability was found to be positively related to 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 at the significant

level of 0.0001. In contrast, SME profitability was found to be negatively related to the

current ratio. However, this study could not demonstrate the relationship between SME

profitability and the debt ratio. Consequently, support was found for the hypotheses one,

three and four but not for the hypothesis two.

To emphasize the importance of financial management practices and the impact

of the efficiency of financial management practices on SME profitability, the hypothesis

of difference in mean profit of two groups of SMEs was also tested. The result of testing

indicated that the mean profit of SMEs that are “efficient” in financial management

practices is greater than that of SMEs are “not efficient” in financial management

practices. This result is empirical evidence to demonstrate SMEs that they should pay

more attention to financial management practices if they want to improve their

profitability and survive in the uncertain business environment in Vietnam.



Chapter Six:

Conclusions And Implications

6.1 INTRODUCTION

Chapter 5 presented data analysis and findings of the research study including descriptive

and associated findings in relation to the research questions and objectives. The thesis

ends with chapter 6 where conclusions drawn from data analysis and implications of the

research study will be respectively summarized and presented. The objectives of chapter

6 are (1) to summarize conclusions of financial management practices, financial

characteristics, and profitability of SMEs in the sample and the results of testing the

model of SME profitability, (2) to indicate how the research study can be implemented

by financial practitioners and the Government to improve profitability of the firm, and (3)

to suggest further research in the future.

This chapter is structured into five sections. Section 6.1 introduces the objectives

and structure of the chapter. Section 6.2 summarizes conclusions related to the research

questions and testing the model including conclusions on financial management

practices, financial characteristics and SME profitability, and conclusions and revision of

the model of SME profitability. Section 6.3 indicates how the research study can be

applied to financial management practices of SMEs and knowledge of financial

management for SMEs in general.

Section 6.4 examines the limitations of the research study, and section 6.5 ends

the chapter by raising implications and suggestions for further research. Figure 6.1

provides a visual picture of the chapter outline and links among sections as indicated

earlier.



Chapter Six: Conclusions and Implications


6.2 Conclusions related to research questions and testing the model

6.2.2 Conclusions related to financialcharacteristics

6.4 Limitations of the research study

6.2.1 Conclusions related to financialmanagement practices

6.2.3 Conclusions of SMEprofitability

6.3.1 Implications for financial

management practices of SMEs

6.3.2 Contributions to knowledge ofthis research into financial

management for SMEs

6.2.4 Summary of research questionanswers

6.3 Implications of the research study

6.5 Implications for further research

6.1 Introduction


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6.2 CONCLUSIONS RELATED TO RESEARCH QUESTIONS AND

TESTING THE MODEL

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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SMEs. However, other financial statements such as statements of cash flows and

statements of funds are rarely prepared when compared with frequency of preparing

balance sheets and income statements. This is consistent with the situations that

statements of cash flows have only been mentioned in accounting information system in

Vietnam in recent years. SMEs seem to be unfamiliar with preparing statements of cash

flows.

Most SMEs (about 70 percent) have prepared and analyzed their financial

statements based on monthly periods. Nevertheless, about 2 percent of SMEs have never

analyzed financial statements (Table 5.8, page 193). Quarterly periods were expected as

the most frequently used for reporting. However the findings of financial reporting and

analysis practices showed that monthly periods are frequently used by most SMEs. This

may be explained in at least two ways. Firstly, SMEs in Vietnam must cope with the

uncertainty of the business environment therefore updating and providing updated

financial information for making decisions are necessary frequently. Secondly, most

SMEs have employed accountants organized into a division of accounting headed by a

chief-accountant thus preparing financial statements based on the monthly periods is

quite feasible.

In terms of kinds of financial analysis used, over half of the SMEs in the sample

had frequently applied both trend analysis and ratio analysis (Table 5.10, page 194).

Ratio financial analysis was relatively popular as a tool for evaluating and controlling

financial position of the firms. Almost all financial ratios were applied. However, ratios

of activity such as receivable turnover, inventory turnover, total asset turnover were most

frequently used, but ratios of liquidity and ratios of profitability were used infrequently.

6.2.1.3 Working capital management practi ces

Following patterns of many previous researchers, investigations and reports of working

capital management practices in this research include three areas: cash management,

receivable management and inventory management practices. Each were respectively

analyzed and reported in subsections 5.3.2.3, 5.3.2.4 and 5.3.2.5 of chapter 5 (page 195).

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For cash management, the following conclusions are reported. Firstly, about 80

percent of SMEs always or often prepare cash budgets, and preparing and reviewing cash

budgets are frequently based on monthly periods (Table 5.11, page 196). The opinions of

many researchers were supported by results of the survey (Appendix 2), which

demonstrated that most of the owners or managers of SMEs have rarely been trained in

skills of financial management. However, this research showed that SMEs are familiar

with using cash budgets as a tool to plan and control cash flows of the firm. On the other

hand, about 80 percent of SMEs determined cash balance based on the owner/manager’s

experience (Table 5.12, page 196). This suggests that experience is viewed as more

important than theory in practising cash management.

Only 2.7 percent of responding SMEs always or often face cash shortages for

expenditure, while about 40 percent always or often have a surplus of cash (Table 5.13,

page 197). Nevertheless, only 19 percent of SMEs deposit cash surpluses in bank

accounts while up to 75 percent did not know how to use temporary cash surpluses for

profits (Table 5.13, page 197). This finding reveals that cash surpluses rather than cash

shortages are the major problem for SMEs. Another problem reported was how to invest

the temporary cash surplus for profitable purposes. That SMEs have to keep high cash

balances is acceptable under conditions of business environment uncertainty. However,

this affects SME profitability and a trade-off between liquidity and profitability needs to

be considered.

As stated above, up to 75 percent of SMEs did not know how to invest cash

surpluses for profitable purposes (Table 5.13, page 197). An explanation may be the fact

that the money market has not developed in Vietnam, SMEs do not have access to money

market instruments such as treasury bills, commercial papers, bank acceptances and

similar instruments for short-term investment purposes. SMEs have not had opportunities

to invest rather than not knowing how to invest temporary cash surpluses for profits. This

conclusion suggests the need to develop money markets, which should be developed

simultaneously with capital or stock markets instead of being separately developed as has

happened in recent years. In addition to developing money markets, a recommendation

for policy makers is that links between components of financial market including money

market, capital market and foreign exchange market need to be developed and fostered.

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Regarding receivable management, results of data analysis and findings were

presented in subsection 5.3.2.4 (page 198). Following are conclusions and discussion

related to receivable management practices. Eighty percent of SMEs always or often sell

their products or services on credit and 63 percent always or often set up their credit

polices for the customers, whereas 7 percent of SMEs tend to sell on credit to anyone

who wishes to buy (Table 5.14, page 198). This finding suggests that selling products or

services on credit is a common trend for SMEs in Vietnam, especially under conditions

of a strong competitive market. In consequence, receivable management practices have

become extremely important and reviewing levels of receivables and bad debts need to be

conducted frequently by SMEs.

Therefore it was not surprising that most SMEs reported reviews of their levels of

receivables and bad debts monthly. As a result, the percentage of bad debts was still

controllable and maintained at an appropriate level (Table 5.16, page 199). The majority

of SMEs reported the percentage of bad debt was less than 10 percent of sales.

In inventory management practices, results of data analysis and findings were

reported in subsection 5.3.2.5 of chapter 5 (Table 5.17 and 5.18 page 200). Based on the

results of data analysis, conclusions suggest that inventory management practices of

SMEs have not been understood by management. Although they review inventory levels

and prepare inventory budgets frequently, the ability to apply theories of inventory

management in inventory budgeting is very limited. Over 90 percent of SMEs determine

inventory levels based on owner/manager’s experience and about 90 percent did not

know of the “Economic Order Quantity Model” (Table 5.18, page 201). Like cash

management, the owner’s or manager’s experience was again found to be more important

than application of theories of inventory management.

In summary, the survey found that SMEs strongly supported all areas of working

capital management practices. Cash and inventory budgets are frequently prepared.

Levels of receivables and inventory are reviewed frequently. However, SME owners

have a low level of management knowledge, and owner/manager’s experience has been

seen to be more important than application of theories of financial management.

Therefore training skills of financial management for the owners and managers is

essential.

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6.2.1.4 Fixed asset management practi ces

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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6.2.1.5 Financial planning practi ces

Financial planning practices were analyzed based on tables 5.21, 5.22, 5.23, and 5.24 and

findings were reported in subsection 5.3.2.7 of chapter 5 (page 203). The following is

summary of conclusions on financial planning practices of SMEs in the sample.

Firstly, a majority of SMEs in the sample (76.6%) always or often prepares

financial budgets in the process of business operations. This finding suggests that SMEs

have relatively high regard for financial planning practices and they are relatively

familiar with using financial budgets as tools of planning and controlling financial

situation.

Secondly, types of budgets such as sales, selling and administration expenses,

labor and cash budgets are prepared by a majority of SMEs whereas fewer SMEs prepare

the budgeted balance sheets and income statements. This finding suggests that SMEs in

Vietnam rarely prepare the budgeted balance sheets and budgeted income statements,

although they frequently prepare the actual balance sheets and income statements (Table

5.7, page 192). This is consistent with the current status that concepts of budgeted

balance sheet and budgeted income statement are relatively new in Vietnam, they have

only been introduced in recent years.

Thirdly, the majority of SMEs have employed accountants and chief-accountants

to prepare budgets whereas the percentage of SMEs engaging accountants to prepare

financial budgets was not significant. That SMEs were found to be dependent upon the

organizing and using employed or internal accountants while the external accountant are

rarely used suggests that the “old management styles”, which existed with the central-

planned economy period, and remain have a relatively strong impact on management

styles of SMEs in the 1990s. Finally, up to 83 percent of SMEs in the sample frequently

compare budgeted and actual results and monthly periods are most popularly used in

carrying out the comparisons.

Subsections 6.2.1.1 to 6.2.1.5 above presented conclusions and discussion related

to financial management practices of SMEs from the survey. These conclusions are

summarized and reported in Table 6.1 (page 246).

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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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6.2.2 Conclusions related to financial characteristics

This section summarizes conclusions on SME financial characteristics, which were

analyzed and presented in section 5.3.3 of chapter 5 (page 206). These conclusions relate

to descriptive findings of liquidity, financial leverage, and business activity of SMEs in

the sample.

6.2.2.1 Liquidity

In this research, level of liquidity of SMEs was measured by current ratios. As analyzed

and presented in subsection 5.3.3.1, SMEs were found to be in a strong liquidity position.

A relatively high proportion of SMEs (90%) was found to have current ratios greater than

one (Table 5.28, page 209). In addition, most SMEs were found to maintain relatively

high current ratios. On average, the current ratio of trading SMEs was 2.50 while

manufacturing SMEs was 2.47 (Table 5.25b and 5.25c, page 207). However, no

significant difference in the current ratios between the two sectors was found (Table 5.26,

page 208).

This finding reveals that, on average, current assets of SMEs are two and half

times higher than current liabilities. In other words, each dollar of current liabilities is

offset by 2.5 dollars of current assets. In general, this is consistent with Vietnam’s

uncertain business environment and difficulties of SMEs in obtaining the external

financing sources. However, maintaining a relatively high current ratio has adversely

impacted on profitability of SMEs since cash surplus were generally not invested for

profits.

6.2.2.2 Financ ial leverage

Financial leverage was measured by business debt ratios. Analysis and findings of

financial leverage were presented in subsection 5.3.3.2 of chapter 5 (page 210). SMEs in

the sample were found generally not to use financial leverage. Seventy-two percent of

SMEs had debt ratios less than 30% while only about 10 percent had debt ratios more

than 50% (Table 5.29, page 210). Debt has not been used to boost profitability.

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As reported in Table 5.25a (page 207) the average debt ratio of SMEs in the

sample was about 30%. In addition, the average debt ratios of trading and manufacturing

SMEs were reported to be of 30% and 27% respectively. The t-test did not demonstrate

any significant difference in debt ratios between the two groups of SMEs. With the debt

ratio of 30%, SMEs presumably do not use significant debt finance. This is not surprising

because SMEs in Vietnam have found difficulty in finding external financing sources.

This may be explained. Firstly, financial markets, especially capital markets, in Vietnam

have not been developed, SMEs are forced to rely on financing sources from commercial

banks rather than actively mobilizing sources of funds from capital market. Secondly,

commercial banks discriminate between SMEs and large companies in granting loans,

especially long-term loans. State-owned commercial banks give priority to state owned

companies rather than SMEs. Private and foreign commercial banks assume that SMEs

are higher risk than large companies. Loans are difficult for SMEs to obtain.

6.2.2.3 Business activi ty

Business activity in this study was measured by total asset turnover and descriptive

findings of this ratio were analyzed and presented in subsection 5.3.3.3 of chapter 5 (page

211).

SMEs in the sample were found to have moderate total asset turnovers with an

average ratio of 3.84 times (Table 5.25a, page 207). Over 80 percent of SMEs were found

to have total asset turnovers exceeding one. These findings conclude that the efficiency in

utilizing total assets by SMEs was relatively high. On average, SMEs produced 3.84

dollars of sales from each dollar of total assets and about 80 percent of SMEs produced

more than one dollar of sales from one dollar of total assets.

Table 6.2 (page 249) summarizes the main findings and conclusions of financial

characteristics in which current ratio, debt ratio (or debt-to-equity ratio) and total asset

turnovers were respectively used as the measures of liquidity, financial leverage and

activity.

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Table 6.2: Summary of conclusions related to financial characteristics of SMES

Financial Main findings

Characteristics Mean Range % Conclusions

Current ratio 2.49 Below 1 10.0 SMEs were found to haveFrom 1 to 2 36.7 relatively high current ratios

More than 2 53.3

Debt ratio 29% Below 30% 72.0 SMEs were found to haveFrom 30 to 50% 18.7 Low financial leverageMore than 50% 9.3

Total asset turnover 3.84 Below 1 18.7 SMEs were found to beFrom 1 to 3 51.3 moderate in total assetMore than 3 30.0 turnover

Return on sales 4.20%Return on assets 7.51%Return on equity 10.75%

Source: Summarized from Table 5.25a; 5.28; 5.29 and 5.30

6.2.3 Conclusions of SME profi tability

This section summarizes conclusions of SME profitability, which was analyzed and

reported in section 5.4 of chapter 5 (page 215). Firstly, the general conclusions of SME

profitability are summarized, then, the conclusions related to the relationship between

SME profitability and financial management practices, and financial characteristics are

respectively summarized and discussed.

6.2.3.1 General conclus ions of SME prof itabil ity

Descriptive findings of SME profitability were analyzed and reported in subsection 5.3.4

of chapter 5 (page 211). These findings generally revealed that 99 of 150 SMEs surveyed

(66%) were profitable and the remainder (34%) were 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, page 213). The size of annual profits of SMEs was not high. Level of

annual profit of SMEs in Vietnam is low compared to SMEs in other countries because of

small firm size in terms of total assets and labor.

In relation to the types of industry and forms of ownership, the following findings

were found:

• The percentage of profitable SMEs in manufacturing industry was higher than

that of the trading industry.

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• In terms of form of ownership, the percentage of profitable SMEs was found

higher for private enterprises than for limited and joint stock companies.

• In terms of business size, the percentage of profitable SMEs was found higher for

smaller businesses than for larger SMEs.

In addition to descriptive findings and conclusions, this study is concerned with

associative findings related to SME profitability. Subsection 6.2.3.2 and 6.2.3.3

respectively present conclusions of the relationships between SME profitability and

financial management practices and relationships between SME profitability and

financial characteristics.

6.2.3.2 Financial management practi ces and SME profitabi lity

By using factor analysis, fifty-seven items used to measure efficiency of financial

management practices of SMEs were reduced to three principal components including (1)

working capital management and short-term planning practices (WCSP), (2) fixed asset

management and long-term planning practices (FALP), and (3) financial and accounting

information system (FAIS) as presented in Table 5.36 (page 218).

As analyzed and reported in Table 5.38 (page 223), these principal components

were found to be significantly related to SME profitability with Pearson’s correlation

coefficients of 0.399; 0.498 and 0.343 respectively at a 0.01 significance level. This

finding was expected and leads to the following conclusions:

• SME profitability is positively related to the efficiency of three principal

components of financial management practices

• The more efficient financial management practices, the higher profitability

• By raising the efficiency of financial management practices, SMEs can improve

their profitability.

These conclusions bring about important implications in applying financial management

and improving SME profitability, which are summarized in section 6.3 (page 258).

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6.2.3.3 Financial characteristics and SME profitabil ity

As indicated in chapter 4 and reported in chapter 5, the financial characteristics of SMEs

in this research are measured by three ratios: current ratio, debt ratio and total asset

turnover. Associative findings of the relationship between SME profitability and these

ratios were analyzed and reported in Table 5.36 (page 223). SME profitability was found

to be negatively related to current ratio with the correlation coefficient of minus 0.553 at

a 0.01 significance level. This finding leads to the following conclusions:

• SMEs with higher current ratios are less profitable than SMEs with the lower

current ratios

• Maintaining higher liquidity requires SME trading-off between the two

objectives: liquidity or profitability and a wise policy of financial management

should be to maintain an appropriate liquidity ratio in order to earn a reasonable

profit.

Secondly, SME profitability was found to be positively related to total asset turnover with

a correlation coefficient of 0.381 at a significance level of 0.01 (Table 5.38, page 223).

This finding concludes that SMEs with high total asset turnover are expected to produce

more profit than that with the lower total asset turnover. On the other hand, increasing

total asset turnover by raising the efficiency of utilizing the total assets can help SMEs to

improve profitability.

Finally, SME profitability was not found to be significantly related to debt ratio.

Bivariate analysis did not demonstrate any significant correlation between debt ratio and

SME profitability. This finding was unexpected because SME profitability was assumed

to be positively related to debt ratio. This may be explained since the relationship

between debt ratio and SME profitability is not a simple linear relationship, therefore,

bivariate analysis could not investigate this relation. A more detail study of financial

leverage would be required to investigate this; however, it is beyond the objective of this

research.

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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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from Table 5.43 (page 231) based on the results of rerunning the multiple regression

programs. Removing debt ratio improved the accuracy of the model while the coefficient

of correlation (R) and the coefficient of determination (R 2) remain unchanged. This is

shown by the following changes: (1) standard error of the estimate decreased from 3.39

to 3.37, (2) F value increased from 36.994 to 44.646 (table 5.40 and 5.43), and (3) all t-

test statistics increased significantly.

Figure 6.2: The revised model of SEM profitability

Source: Table 5.43, chapter 5 (page 231)

Table 5.43 (page 231) provided the coefficient of determination R 2 = 0.608 at a 0.0001

significance level. This coefficient reveals that 60.8% of the variation in SME

profitability can be explained by changes in the following attributes: (1) current ratio with

β = - 0.265, (2) total asset turnover with β = 0.200, (3) working capital management and

short-term planning practices with β = 0.300, (4) fixed asset management and long-term

planning practices with β = 0.371, and (5) financial and accounting information system

with β = 0.235 while 39.2% remains unexplained. The revised model of SME

Working capital management and short-term planning practices (WCSP) SME profitability:

(PRO)

−

+

Current ratio (CUR )

+Fixed asset management and long-term planning practices (FALP)

•

•

•

Return on sales

Return on assets

Return on equity

+

+Financial and accounting informationsystem practices (FAIS)

Total asset turnover (TAT )

254




profitability as presented in Figure 6.2 illustrates findings presented in Table 5.43 (page

231) and provides a visual insight into the impacts of financial management practices and

financial characteristics on SME profitability.

6.2.4 SUMMARY OF RESEARCH QUESTION ANSWERS

This subsection summarizes the answers corresponding to each research question as

presented in chapter 1. The first research question related to the importance of SMEs in

Vietnam and their profitability. This question was answered in chapters 2 and 5. In

reviewing the economic structure and SMEs in Vietnam, chapter 2 found that SMEs in

Vietnam play an important role in creating employment, and increasing GDP and

exporting volume. Chapter 5, based on empirical data, found that sixty-six percent of

SMEs are profitable, however, the level of profits was not as large as that of profits of

SMEs in the industrialized countries.

Research question two was concerned with how researchers in the literature

review have identified the context of financial management practices and financial

characteristics, and how they proposed to measure SME profitability. This research

question was answered in chapter 3 where literature on financial management was

reviewed. Answers to this question are summarized below:

• Financial management practices include accounting information systems,

financial reporting and analysis, working capital management practices, fixed

asset management practices and financial planning (McMahon, 1998).

• Financial characteristics include liquidity, financial leverage, activity and

profitability (Burns, 1985, Hutchinson, Meric and Meric, 1988, Jaggi and

Considine, 1990, Laitine, 1992, and Meric et al., 1997).

• Profitability is generally measured by the following ratios: return on sales, return

on assets, and return on equity (Burns, 1985; Hutchinson, Meric and Meric,1988;

Laitinen, 1992, Meric et al., 1997)

Research question three related to links between financial management practices and

financial characteristics to SME profitability. This question was answered in chapter 3

255




where previous researchers indicated that financial management practices and financial

characteristics significantly affect SME profitability (Edwards and Cooley, 1979; Van

Horne, 1986; Burns and Walker, 1991).

Research question four concerned in this study called for an examination of

relationships between financial management practices, financial characteristics and SME

profitability in Vietnam. This question was answered in chapters 4 and 5. Chapter 4

designed the measurement scales for efficiency of financial management practices and

defined variables to measure financial characteristics and profitability. Chapter 5

analysed data and indicated a positive relationship between financial management

practices, financial characteristics and SME profitability, except debt ratios (Table 5.38,

page 223).

Research question five focussed on the extent to which financial management

practices and financial characteristics affect SME profitability. This question was

answered in chapter 5 where financial management practices and financial characteristics

were found to simultaneously affect SME profitability. Specifically, the current ratio

negatively affects SME profitability, while 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 positively affect

SME profitability.

The final research question related to what action could improve financial

management and profitability of SMEs in Vietnam. This question was answered in

chapters 5 and 6. After testing the model of SME profitability, chapter 5 indicated SME

profitability was influenced by financial management practices and financial

characteristics. This was the basis for recommending action that could improve

profitability of SMEs. Details of these actions are examined in section 6.3 (page 258)

where the implications of the research study are considered.

Table 6.3 (page 257) summarizes answers corresponding to each research

question defined in chapter 1. These research questions were developed for the research

problem; therefore, answering these questions contributes to solve the research problem.

Table 6.3 is completed based on reviewing all chapters in linking to each research

question, summaries of answers, which were contributed to research problem solution.

256




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

SME profitability in Vietnam?

4 & 5 • Variables measuring financial management practices

and financial characteristics, except debt ratio, werefound to be related to SME profitability (Table 5.38,page 223).

5. How do financialmanagement practicesand financialcharacteristics affectSME profitability?

5 • Financial management practices and financial

characteristics simultaneously affect SMEprofitability.

• 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.

257




6.3 IMPLICATIONS OF THE RESEARCH STUDY

This section presents implications of the research study outcomes including the

implications for financial management practitioners, government, and training

organizations and comments on the contribution to knowledge of this research into

financial management practices of SMEs.

6.3.1 Implications for financial management practices of SMEs

This research model indicated that variation in SME profitability could be explained by

the changes in:

1. current ratio,

2. total asset turnover,

3. efficiency of working capital management and short-term planning practices,

4. efficiency of fixed asset management and long-term planning practices, and

5. efficiency of financial and accounting information system.

Furthermore, the hypothesis that differences expected in mean profits between the

efficient and inefficient financial management SMEs was supported by empirical data

analysis. The model of SME profitability tested by the empirical data in earlier chapters

provides important implications for SME financial management practitioners,

government, and training organizations. For financial management practitioners, several

implications are based on the model of SME profitability and conclusions on differences

in average profits between efficient and inefficient financial management SMEs.

Implication 1: Viewpoint of financial management role

Owners and managers of SMEs in Vietnam believe that marketing plays the most

important role in producing profits, while financial management only plays a role in

protecting financial position of a business. This research study indicates that efficiency of

258




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

259




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.

260




In financial management practices, the financial manager or owner should have regard to

the effects of these components on profitability and decisions should be reviewed to

determine whether they affect the efficiency of financial management and thus affect

SME profitability.

Implication 4: Implications for the government policy-makers

The main objective of this study is to identify implications for financial management

practices of SMEs. However, in this research study, SMEs were found to have difficulties

involving the government policies, which make financial management practices

ineffective and ineffective. As reviewed in chapter 2, SMEs continue to play important

roles in developing the multi-sector economy and the government has polices to promote

and support development of SMEs. Government policies will be more effective if the

policy-makers understand current practices of financial management of SMEs. Based on

the descriptive findings of financial management practices of SMEs in the survey, this

study recommends the following issues to be considered by government policy-makers.

• Remove discrimination between SMEs and large companies and between state

and non-state SMEs in granting loans.• Develop the financial market including both capital and money markets.

• Provide training programs in financial management skills for the owners and

managers of SMEs.

Implication 5: Implications for training and teaching organizations

Findings on financial management practices and financial characteristics of SMEs help

teaching and training organization personnel to understand the bahaviour of SMEs in the

field of financial management. This will be basis for developing more appropriately

training programs for owners and managers of SMEs.

261




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.

262




• This study contributes to the knowledge of financial management practices and

financial characteristics of SMEs in Vietnam which can be considered

representative of emerging economies. As indicated in chapter 3, the descriptive

findings of financial management practices and financial characteristics of SMEs

around the world are numerous, however most findings involve SMEs in the

developed or market economy countries while findings involving SMEs in the

developing or emerging countries are few, and findings involving SMEs in

Vietnam are rare. Therefore descriptive findings of financial management

practices and financial characteristics of SMEs in this study expand the literature

of financial management in general and especially financial management of SMEs

in Vietnam.

6.4 LIMITATIONS OF THE RESEARCH STUDY

Regardless of its high ambitions, doctoral research is constrained by resource limitations,

both financial and non-financial resources. Limitations of time, funding and scope of the

study required the research study to focus on a limited number of objectives. Moreover

the research problem and questions often directly or indirectly involve multiple areas of

financial management while limits of time and funds would not make all areas can beinvestigated.

Because of limited access to scare resources, this study could not research SMEs

in all regions of Vietnam but only selected SMEs located in Ho Chi Minh City as the

target population and considered the target SMEs representative for all SMEs in Vietnam.

Although Ho Chi Minh City is the biggest city with the largest number of SMEs located,

differences in knowledge and style of management between SMEs located in Ho Chi

Minh City and SMEs located in other regions may lead to differences in financial

management practices and financial characteristics. As a result, an overestimation may

exist due to the higher level of management knowledge of SMEs in Ho Chi Minh City.

Similarly, due to limited resources this study uses the stratified sampling

technique with one SME in lieu of 90 for personal interview. Given more time and funds,

the fraction would be reduced to 30 and the sample has been broadened.

263




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

264




relationships between financial management practices, financial characteristics and SME

profitability could be used as the foundations for the further research. Additional

implications of this study for the further research could include the following:

• Findings on financial characteristics of SMEs could be applied to the further

comparative research of differences in financial characteristics between SMEs

and large enterprises in Vietnam.

• Findings on financial management practices could be used as the basis for specific

and detailed research into every separate aspect of financial management practices

in Vietnam such as financial reporting and analysis, working capital management,

fixed asset management, capital budgeting, and for financial planning.

•

This study’s findings of relationships between current ratio, total asset turnover

and SME profitability could lead to expanded research to the large companies,

state and foreign companies in Vietnam.

• This study could not demonstrate the significant relationships between debt ratios

and SME profitability, and this could be explained that debt ratio are not always

linear-related to profitability but cubic-related. This finding could be used as the

basis for more specific and detailed research on financial leverage and

relationships between financial leverage and profitability.

• This study’s research methodological approached and findings on current ratios,

debt ratios, debt-to-equity ratios, total asset turnovers, returns on sales, returns on

assets, and returns on equity could lead to further research on investigating and

building industry averages of financial ratios in Vietnam. Such research is

necessary and important for financial management practices in this country.

• The model of SME profitability developed in this study could be applied as the

basis for the further research on building competitive strategies for SMEs.

265



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Appendix 1: Survey instrument

SURVEY OF

FINANCIAL MANAGEMENT PRACTICES

OF SMEs IN HO CHI MINH CITY

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)?

Owner...................................................................11

Manager................................................................2

Chief-accountant ..................................................3

Other, please specify ...........................................4, please specify……………………………….

Your cooperation by answering questions raised by the interviewer is viewed as the mostimportant contribution to support for the development of SMEs.

Thank you for spending time to answer the questionnaire.



A. COMPANY PROFILE

(Please circle the appropriate number that best answers to each question)

1. Owner/manager details

1.1 What is your position in your business (Please circle one that applies)?

Owner...................................................................1Manager................................................................2

Chief-accountant ..................................................3

Other, please specify ...........................................4, please specify……………………………….

1.2 What is your HIGHEST educational qualification or nearest equivalent (Please circle one that applies)?

High school .........................................................1

Bachelor degree....................................................2

Master degree .......................................................3Higher degree .......................................................4

Others ..................................................................5, please specify ……………………………….

1.3 Do you ever attend management training programs related to financial management (Please circle one

that applies)? Never ...................................................................1

Rarely (from 1 to 2 attentions) .............................2

Sometimes (3 to 4 attentions) ...............................3Often (more than 4 attentions)..............................4

Always .................................................................5

1.4 What best describes your background (Please circles one that applies)?Management general ............................................1

Technical field......................................................2

Business general...................................................3Financial management..........................................4

Others ..................................................................5, please specify ………………………………

2. Business details

2.1 What best describes the type of industry of your business (Please circles one that applies)?

Manufacturing .....................................................1

Trading ................................................................2Service .................................................................3


2.2 What best describes the form of ownership of your business (Please circles one that applies)?

Private enterprise..................................................1

Limited company..................................................2

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

2



2.4 How many employees does your business currently have (Please fill the number that applies)?

Full-time:.............................................................. employees

Part-time:.............................................................. employees

2.5 Which of the following ranges is the best indication of your business total assets (Please circle one thatapplies)?

Less than 5 billion dong .......................................1

5 to 10 billion dong ..............................................2More than 10 billion dong ....................................3

2.6 Which of the following ranges is the best indication of your business annual sales (Please circle one

that applies)?Less than 5 billion dong .......................................1

5 – 30 billion dong ...............................................2

31 – 50 billion dong .............................................3

More than 50 billion dong ...................................4

2.7 What best describes your business’ profitability (Please circles one that applies)?

Profitable..............................................................0 Not profitable .......................................................1

2.8 Which of the following ranges is the best indication of your business annual net profits?

Less than 50 million dong ....................................1

50 to 300 million dong .........................................2301 to 500 million dong .......................................3

More than 500 million dong.................................4

B. FINANCIAL MANAGEMENT

1. Accounting information system

1.1 Who is responsible for the following duties in your business (Please circle the number that applies for

each duty)?

Duties Owner Manager Chief-

accountant

Employed

accountant

External

accountant

Recording business transactions 1 2 3 4 5

Preparing accounting reports 1 2 3 4 5

Interpreting and using accounting information 1 2 3 4 5

1.2 What best describes characteristics of the organization of your business accounting system (Please

circle number that applies)?

Formal .................................................................1Informal ...............................................................2

1.3 Does your business ever utilize computers in accounting (Please circle number that applies)? Never ...................................................................1Rarely ..................................................................2

Sometimes ...........................................................3

Often ....................................................................4

Always .................................................................5

3



1.4 If yes, which of the following is the most popular application (Please circle number that applies)?

Recording business transactions ..........................1

Preparing accounting reports ...............................2

Managing assets ..................................................3Controlling payroll ..............................................4

Controlling cash flows .........................................5

Others, please specify ..........................................6, please specify …………………………..

1.5 Efficiency of accounting information system (Please circle number that applies on each scale)

Here are some statements, which describe how owner/manager may feel about the efficiency of accounting

information system. 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.


1. How does your business regard its accounting informationsystem?

1 2 3 4 5 6 7 8 9

Not frequent at all Very frequent

2. How frequent does your business prepare its accounting

reports?

1 2 3 4 5 6 7 8 9

Not updated at all Very updated

3. How does accounting information system in your businessupdate the business transactions?

1 2 3 4 5 6 7 8 9


4. What is owner/manager involvement in preparing accounting

information?

1 2 3 4 5 6 7 8 9


5. What is owner/manager involvement in interpreting and usingaccounting information?

1 2 3 4 5 6 7 8 9


6. How acceptable is your business’s accounting information

system?

1 2 3 4 5 6 7 8 9


7. How useful is your business’s accounting information useful

in making decisions?

1 2 3 4 5 6 7 8 9

Low

computerization

High

computerization

8. How computerized is your business’s accounting information

system?

1 2 3 4 5 6 7 8 9

2. Financial reporting and analysis

2.1 What kinds of financial statements are regularly prepared in your business (May circle more than one

number)?

Balance sheet .......................................................1Income statement (Profit and loss statement)....... 2

Statement of cash flows .......................................3Statement of funds ...............................................4

Other ....................................................................5, please specify ……………………………………

4



2.2 Who is responsible for the following duties in your business (Please circle number that applies for each

duty)?

Owner Manager Chief-

accountant

Employed

accountant

External

accountant

Never do

it

Preparing financial statements 1 2 3 4 5 6Analyzing financial statements 1 2 3 4 5 6

2.3 How often are the financial statements of your business prepared and analyzed (Please circle number

that applies for each duties)?

Monthly Quarterly Semiannually Annually Never

Preparing financial statements 1 2 3 4 5

Analyzing financial statements 1 2 3 4 5

2.4 What kinds of financial analysis are currently used in your business (May circle more than one

number)?Ratio analysis ......................................................1

Trend analysis .....................................................2Both .....................................................................3Other ....................................................................4, please specify ……………………………………..

2.5 What kinds of financial ratios are currently used for financial analysis in your business (May circle

more than one number)?Current ratio ........................................................1

Quick ratio ...........................................................2

Debt ratio .............................................................3

Debt-to-equity ratio .............................................4

Short-term debt ratio ...........................................5Long-term debt ratio ............................................6

Receivable turnover .............................................7Inventory turnover ...............................................8

Fixed asset turnover ............................................9Total asset turnover .............................................10

Return on sales ....................................................11

Return on assets ...................................................12Return on equity ..................................................13

Never use any ratio ..............................................14

2.6 Does your business ever apply computers in financial reporting and analysis (Please circle number thatapplies)?

Never ...................................................................1

Rarely ..................................................................2Sometimes ...........................................................3

Often ....................................................................4

Always ................................................................5

2.7 If yes, what area is your computer applied (Please circle number that applies)?Financial reporting ..............................................1

Financial analysis ................................................2

Both .....................................................................3Other ....................................................................4, please specify ……………………………………

5



2.8 Efficiency of financial reporting and analysis (Circle one number that applies on each scale)

Here are some statements which describe how owner/manager might feel about the efficiency of financial

reporting and analysis practices. Please indicate the most appropriate number that describes your business

position on the scale.






1. How does your business regard financial reporting and

analysis?

1 2 3 4 5 6 7 8 9


2. How frequent does your business prepare financial statements

(balance sheet, income statements, statements of cash flows)?

1 2 3 4 5 6 7 8 9


3. How involved is the owner/manager in preparing financial

statements?

1 2 3 4 5 6 7 8 9


4. How involved is the owner/manager involve in interpreting

and using financial statements?

1 2 3 4 5 6 7 8 9


5. How useful are the financial statements of your business in

providing information for making decisions?

1 2 3 4 5 6 7 8 9


6. How frequent does your business analyze financial statements(balance sheet, income statements, statements of cash flows)?

1 2 3 4 5 6 7 8 9


7. How useful are financial ratios applied in financial analysis of

your business?

1 2 3 4 5 6 7 8 9

Low

computerization

High

computerization8. How computerized are the financial reporting and analysis

practices in your business?

1 2 3 4 5 6 7 8 9

3. Cash management practices

3.1 Does your business ever conduct or occur the following ones (Circle one number that applies for each

described below)?

Never Rarely Sometimes Often Always

Preparing cash budget 1 2 3 4 5

Determining the target cash balance 1 2 3 4 5

Occurring cash shortage 1 2 3 4 5

Occurring cash surplus 1 2 3 4 5Utilizing computers in cash management 1 2 3 4 5

3.2 How often is the cash budget prepared and reviewed in your business (Circle one that applies for

each)?

Never Weekly Monthly Quarterly Semiannually Annually

Preparing cash budget 0 1 2 3 4 5

Reviewing cash budget 0 1 2 3 4 5

6



3.3 On what basis does your business determine target cash balances (Circle one that applies)?

Based on theories of cash management ...............1

Based on historical data .......................................2

Based on owner/manager’s experience ...............3

Other ....................................................................4, please specify ………………………………..

3.4 Where does your business often invest the temporary cash surplus (Circle one that applies)?

Bank deposit ........................................................1Treasury bills .......................................................2

Both above ..........................................................3

Other ....................................................................4, please specify ………………………………..

No where .............................................................5

3.5 In cash management, what area is the computer applied (Circle one that applies)?

Preparing cash budget .........................................1

Recording cash transactions ................................2Both above ..........................................................3

Other ....................................................................4, please specify ……………………………..

3.6 Efficiency of cash management (Circle one number that applies for each scale)

Here are some statements which describe how owner/manager might feel about the efficiency of cash

management practices. Please indicate the most appropriate number that describes your business position

on the scale.






1. How does your business regard cash management practices? 1 2 3 4 5 6 7 8 9


2. How regularly does your business prepare cash budgets? 1 2 3 4 5 6 7 8 9


3. How involved is the owner/manager in preparing cash budgets?

1 2 3 4 5 6 7 8 9


4. How involved is the owner/manager in interpreting and using

cash budgets?

1 2 3 4 5 6 7 8 9


5. How useful are cash budgets of your business in providing

information for making decisions?

1 2 3 4 5 6 7 8 9

Very poorly Very well

6. How does your business apply theories of cash management indetermining the target cash balance?

1 2 3 4 5 6 7 8 9


7. How acceptable is the target cash balance determined in your

business?

1 2 3 4 5 6 7 8 9

Low

computerization

High

computerization

8. How computerized are cash management practices in your business?

1 2 3 4 5 6 7 8 9

7



4. Receivable management practices

4.1 Does your business ever carry out the things listed below (Circle one that applies for each)?

Never Rarely Often Sometimes Always

Sell products or services in credit 1 2 3 4 5

Set up its credit policy to the customers 1 2 3 4 5Use computers in receivable management 1 2 3 4 5

4.2 How often does your business review its levels of receivables and bad debts (Circle one that applies foreach row)?

Never Weekly Monthly Quarterly Semiannually Annually

Review its levels of receivables 0 1 2 3 4 5

Review its bad debts 0 1 2 3 4 5

4.3 Which of the following ranges is the best indication your business’s percentage of bad debts (Circle

one that applies)?

Less than 5% of sales ..........................................1

5 – 10% of sales ..................................................210 –20 % of sales ................................................3

More than 20% ....................................................4

Don’t know ..........................................................5

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


on the scale.






1. How does your business regard to receivables management

practices?

1 2 3 4 5 6 7 8 9


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


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

8



debts?


7. How reasonable is the percentage of bad debts in your business

1 2 3 4 5 6 7 8 9


8. How frequent does your business implement theories of

receivables management?

1 2 3 4 5 6 7 8 9

Low

computerization

High

computerization

9. How computerized are receivable management practices in

your business?

1 2 3 4 5 6 7 8 9

5. Inventory management practices

5.1 Does your business ever do the following ones (Circle one that applies for each row)?


Review its inventory levels 1 2 3 4 5

Prepare inventory budget 1 2 3 4 5

Utilize computer in managing inventory 1 2 3 4 5

5.2 On what basis is the inventory level determined (Circle one that applies)?Based on theories of inventory management .......1

Based on historical data........................................2

Based on owner/manager’s experience ................3

Other ....................................................................4, pleasespecify……………………………………….

5.3 Does your business ever use “economic order quantity model” in inventory management?Do not know this model ......................................1

Know but never use .............................................2

Sometimes use .....................................................3

Often use .............................................................4Always use ..........................................................5

5.4 Efficiency of inventory management (Circle one that applies for each scale)

Here are some statements which describe how owner/manager might feel about the efficiency of inventory


on the scale.






1. How does your business regard inventory management

practices?

1 2 3 4 5 6 7 8 9


2. How regularly does your business review inventory turnover? 1 2 3 4 5 6 7 8 9


3. How regularly does your business review inventory level? 1 2 3 4 5 6 7 8 9

Very slow Very fast

4. How fast is inventory turnover of your business? 1 2 3 4 5 6 7 8 9


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5. How acceptable is inventory level of your business? 1 2 3 4 5 6 7 8 9

Very useful at all Very useful

6. How are inventory budgets of your business useful in providing information for making decisions?

1 2 3 4 5 6 7 8 9

Very poor Very good

7. How does your business apply theories of inventory

management in determining the inventory level?

1 2 3 4 5 6 7 8 9

Low

Computerization

High

computerization

8. How computerized are inventory management practices in

your business?

1 2 3 4 5 6 7 8 9

6. Fixed asset management practices

6.1 Related to fixed asset management, does your business ever do the following ones (Circle one that

applies for each row)?


Evaluate its projects before making capital investment

decisions

1 2 3 4 5

Review efficiency of using fixed assets after investing 1 2 3 4 5

Use computer in managing fixed assets 1 2 3 4 5

6.2 Which methods does your business use for assessing capital projects (May circle more than one

number)?

Payback period ....................................................1Discounted payback period .................................2

Net present value .................................................3

Internal rate of return ...........................................4Modified internal rate of return ...........................5


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

Others ..................................................................4, please specify…………………………………….

6.4 Efficiency of fixed asset management (Circle one that applies for each scale)

Here are some statements which describe how owner/manager might feel about the efficiency of fixed asset


on the scale.






1. How does your business regard fixed asset management practices?

1 2 3 4 5 6 7 8 9


2. How does your business regard assessing capital project

before making investment decisions?

1 2 3 4 5 6 7 8 9


10



3. How regularly does your business review capital projects? 1 2 3 4 5 6 7 8 9


4. How acceptable is capital budgeting utilized in your business? 1 2 3 4 5 6 7 8 9

Not advanced at all Very advanced

5. How advanced does your business apply techniques of capital

budgeting in determining capital investment projects?

1 2 3 4 5 6 7 8 9

Very unreasonable Very reasonable6. How reasonable are fixed assets of your business utilized? 1 2 3 4 5 6 7 8 9


7. How useful are fixed assets acquired in your business? 1 2 3 4 5 6 7 8 9

Low

computerization

High

computerization

8. How computerized are fixed asset management practices in

your business?

1 2 3 4 5 6 7 8 9

7. Financial planning practices

7.1 Related to financial planning, does your business ever conduct the ones listed below (Circle one that

applies for each row)?


Preparing financial budgets 1 2 3 4 5

Comparing between budgeted and actual results 1 2 3 4 5

Using computer in financial planning 1 2 3 4 5

7.2 What are objectives of financial planning? (May circle more than one)

Sales maximization .............................................1

Cost minimization ...............................................2Profit maximization .............................................3

Quality product or service ...................................4

Growth .................................................................5

Survival ...............................................................6

No goal or policy .................................................7

7.3 What type of budget does your business regularly prepared? (May circle more than one).Sales budget ........................................................1

Manufacturing budget .........................................2

Purchase budget ...................................................3

Labor budget .......................................................4Overhead cost budget ..........................................5

Selling and administration expenses budget ........6

Cash budget .........................................................7

Budgeted profit and loss account ........................8

Budgeted balance sheet .......................................9

7.4 Who is responsible for preparing budgets (Circle one that applies)?Owner ..................................................................1Financial manager ...............................................2

Chief-accountant .................................................3

Employed accountant ..........................................4

External accountant .............................................5

7.5 How often is comparison of between budgeted and actual results conducted (Circle one that applies)?

Daily ....................................................................1

Weekly ................................................................2

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Appendix 2: Vietnam Background information

General Information

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

1

Figure removed due to

copyright restrictions



2

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.



3

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



4

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.



5

Head of State and Government

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



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%

Inflation (1999) :0.1%Total exports (1999) :US$11.523 billionTotal imports (1999) :US$11.636 billionCurrent account deficit (1999) :US$113 millionUnemployment (1999 est.) :7.4% (significant variation between urban and rural areas)

Macroeconomic Environment and Reform Prospects

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.

6



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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