CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
The following chapter elaborates the theoretical review of the research and reviews literature on the study. This presents concepts, opinions and ideas on microfinance services to the performance of small and medium enterprises as they were written by other scholars.
2.1 Financial services SMEs access from Microfinance institutions
MFIs around the world follow a variety of different methodologies for the provision of financial Services to low-income clients (Robinson, 1998). These methodologies are overwhelmingly based on the principle of financial services being related to the cash flows of the low-income client groups and thus aim to facilitate relatively frequent and very small or micro-loan and savings transactions (Ronge, 2002). Various attempts have been done to examine the effect of financing SMEs by microfinance Institutions on performance of SMEs. Maina (2012) did a survey on microfinance services contribution to entrepreneurial development in Uganda. The study employed a case study design and focused on SMEs within Nairobi. In his study, Maina noted that the banking sector in Uganda is fairly vibrant by the standards of developing third world countries. However, the sector is 90% emphatically dominated by the formal commercial banks. Credit policy for banking institutions catered mainly for big businesses only, thus implying lack of access to credit facilities for small and medium enterprises. In Nakawa division, small and medium enterprises that access microfinance institutions have the privilege to finance their business. This study seeks to determine whether most of the small and medium enterprises in Nakawa division have access to financing from microfinance institutions.
Financial literacy among SMEs owners and managers is critical in ensuring that SMEs grow from small and medium to large enterprises. According to a report by Financial Sector Deepening 2009, SMEs finance capacity is a critical component in expanding SME finance. The report noted that some MFIs were involved in enhancing the capacity for SMEs through financial literacy training. It was however noted in FSD report that attempting to build this capacity at an institutional level was unlikely to be sustainable and certainly an expensive approach among MFIs. In Nakawa division, small and medium enterprises that access microfinance institutions have the privilege to access financial literacy which improves the performance of their businesses. This study seeks to determine whether most of the small and medium enterprises in Nakawa division have accessed financial literacy from microfinance institutions.
Management of SMEs is a likely intervention that microfinance institutions are expected to offer in a bid to provide solution to many inadequacies that SMEs face. According to (Armyx, 2005), it is generally recognized that SMEs (Small and Medium Enterprises) face unique challenges, which affect their growth and profitability and hence, diminish their ability to contribute effectively to sustainable development. Among such challenges as highlighted by Wanjohi (2007) is lack of managerial training and experience. Wanjohi noted that a typical owner or managers of small businesses develop their own approach to management, through a process of trial and error. A consequence of poor managerial ability is that SME owners are ill prepared to face changes in the business environment and to plan appropriate changes in technology. Majority of those who run SMEs are ordinary lot whose educational background is lacking. Hence they may not well equipped to carry out managerial routines for their enterprises (King and McGrath 2002). According to Mugure (2008) some educational institutions have made attempts to incorporate managerial training among SMEs. There is however little known about how MFIs are imparting business management skills among SMEs and how this has affected their performance. This study therefore will provide information on how microfinance institutions are providing management skills to small and medium enterprise in Nakawa division.
Lack of sufficient market information poses a great challenge to small enterprises. Despite the vast amount of trade-related information available and the possibility of accessing national and international databases, many small enterprises continue to rely heavily on private or even physical contacts for market related information. This is due to inability to interpret the statistical data (Mwangi, 2012) and poor connectivity especially in rural areas. Since there is vast amount of information and only lack of statistical knowledge to interpret and Internet connectivity, small enterprises entrepreneurs need to be supported. Belonging to a professional body helps gain a competitive advantage in a business. Being a member of an industry association implies that one is serious about the business they do. This could also help in networking and obtaining of business information. In addition to offering financial products Mwangi (2013) suggest that microfinance institutions can provide a link to between client and SMEs through formation of business clubs, marketing associations and practicing development of well update data bases on SMEs information, their products and services. However, little has been discussed on how enhanced SMEs network and accessibility of market information provided by MFIs have contributed towards performance of SMEs. This study therefore, sought to identify how market facilitation by microfinances institutions has contributed to the growth of small and medium enterprises in Nakawa division.
According to Perpin Strup (1960), there are also special loans to finance the purchase of agricultural machinery such as tractors, harvesters at microfinance institutions. Lwakatare (2004) has also stated that at microfinance institutions construction of biogas plants and irrigation systems as well as the purchase of agricultural land may also be financed through special types of agricultural finance. There is need to find out how small and medium enterprises in Uganda use the loans they borrow which is another reason for the proposed research. This study will provide this information by questioning managers and their workers in small and medium enterprise in Nakawa Division.
2.2 Effect of microfinance services on SMEs performance
According to Daniels (2004), these enterprises have been recognized as the engines through which the growth objectives of developing countries can be achieved. They are potential sources of employment and income in many developing countries and estimated that SMEs employ 22 % of the adult population in developing countries. SMEs are said to have a favourable effect on income distribution in those new entrepreneurs with limited financial resources and according to Lisa (2009), technical skills can gain entry into the industrial sector through small industry operations. In this way SMEs have the effect of creating a new class of people, leading to the expansion of the middle class and a wider distribution of income. SMEs can survive in rural parts of the country because of their location flexibility, their lower requirement of technology and infrastructure, their nature to serve small geographic markets, and their firm commitment to local development goes a long way to contribute immensely to job creating and rural development efforts. In Nakawa division, small and medium enterprises that access microfinance institutions have the privilege to finance their business. This study seeks to determine whether small and medium enterprise in Nakawa division that have access to financing from microfinance institutions have improved their performance in terms of profitability, geographical coverage, outreach, cost effectiveness among others.
Furthermore, SMEs are believed to be behind innovation in the economy and can cause reduction in prices of goods through competition and new improved products are more frequently introduced; consequently leading to the provision of better services for their customers (Lisa, 2009). In this regard, SMEs diversify the product base of the economy and gives room for competition and removing monopolistic tendencies, leading to reduction in prices and service quality provision. This study seeks to identify whether the above merits of small and medium enterprises have been brought by access to services from MFIs.
It is believed that SMEs serve as training grounds for developing the skills of industrialized workers and entrepreneurs (Lisa, 2009). The low cost of setting up a firm enables an enterprising worker not only to provide himself a livelihood but also offer employment to others. SMEs are said to employ relatively more unskilled and semi-skilled workers and training is mainly given on-the job in the premises itself. SME proprietors often do not have the time or the personnel to engage in formal training. For the newly-initiated entrepreneur, the setting up of a small establishment enables him to put his skills and knowledge into practice and enables him to acquire further experience and to improve his ability gradually with the growth of the business (the practice makes man perfect concept). In Nakawa division, small and medium enterprises that access microfinance institutions have the privilege to finance their business. This study seeks to determine whether small and medium enterprise in Nakawa division that have access to financing from microfinance institutions have improved their performance in terms of profitability, geographical coverage, outreach, cost effectiveness among others.
In many developing countries, many loan takers have been proven to have much benefit as they get credits. Studies undertaken by Chaliand (2003) and Chijoriga (2000) on the effect of microcredit programmes on household income show that participants of such programmes usually have higher and more stable incomes than they did before they joined the programmes. Some practitioners still have reservations about the findings of those studies. Moreover, not many micro credit programmes can afford to undertake effect assessments because they are generally expensive and time-consuming.
Chijoriga (2000) revealed that there are limits to the use of credit as an instrument for poverty eradication, including difficulties in identifying the poor and targeting credit to reach the poorest of the poor. Added to this is the fact that many people, especially the poorest of the poor, are usually not in a position to undertake an economic activity, partly because they lack business skills and even the motivation for business. Chijoriga (2000), furthermore noted that it is not clear if the extent to which micro credit has spread, or can potentially spread, can make a major dent in global poverty. The actual use of this kind of lending, so far at least, is rather modest: the overall portfolio of the World Bank, for example, is only $218 million. In recent international meetings, it has been stated that a target to reach 100 million families by the year 2005 would require an additional annual outlay of about $2.5 billion. This should be compared to the total Gross Domestic Product (GDP) of all developing countries, which is now about $6 trillion. A certain sense of proportion regarding micro credit would seem to be in order. The above study did not stipulate how eradication of poverty led to the growth of small and medium enterprises, this study tried to close this gap by assessing the effect of microfinance services on the growth of small and medium enterprises in Nakawa division.
Microfinance institutions mobilize rural savings and have simple and straight forward procedures that originate from local cultures and are easily understood by the ‘population (Germidis et.al 2001). These funds are to finance the informal sector (Small and medium size businesses) in developing countries and it is known that these small and medium size businesses are more likely to fail. Maloney (2003), the creation of small and medium size businesses generate employment but these enterprises are short lived and consequently are bound to die after a short while causing those who gain job position to lose them and even go poorer than how they were. These studies above have not explained why some small and medium enterprises fail to growth even after receiving assistance from microfinance institutions, thus this study sought to assess the effect of microfinance services on the growth of small and medium enterprises in Nakawa division.
2.3 Other factors that lead to the performance of small and medium enterprises
A consequence of poor managerial ability is that small and medium enterprises owners are not well prepared to face changes in technology, majority of those who run SSEs are ordinary lot whose educational background is lacking. Hence they may not be well equipped to carry out managerial routines for their enterprise (McGrath, 2002). According to Orwa (1995) people venture into business without proper planning and sometimes for wrong motives i.e. lure for big money. As much as they anticipate making money, it is good to have objectives in place. This will help the organization to realize its purpose and this will act as a guide line of the firm’s relations to its workers, associates, clients, government, lenders etc. He also added that to be effective the owner or manager needs to have a good understanding of different style of leadership. The above study did not investigate why some small and medium enterprises fail to growth even though they have a strong managerial ability. This study seeks to establish how management ability influences the growth of small and medium enterprises.
Technology choice has important implication for growth and productivity in industry. The use of technology is always tied to an objective. Because of various types of technology can be used to achieve an organization goal or objective, the issue of choice arises. The concept of technology choice assumes access to information on alternative technologies and the ability to evaluate these effectively. According to Moustafa (1990), asserted that effective choice is based on pre-selected criteria for a technology’s meeting specified. Further, it also depends on the ability to identify and recognize opportunities in different technologies. The expected outcome is that the firm will select the most suitable or “appropriate” technology (AT) in its circumstances. The researcher is not aware whether small and medium enterprises in Nakawa division have adopted better technologies and how these technologies have enabled them to improve on their productivity.
According to Groebner (2008) an enabling environment is an opportunity that should be utilized by all business operators in Kenya. With changing governments, which come with promises of a better tomorrow and definition of new business policies, reconstruction of the economy, improvement of the infrastructures and security, small business are expected to do well. Sometimes changes in political environment, often lead to changes in legal environment and the manner in which current laws are enforced. It is hard for business operators to know all the relevant laws but it is of essence that they do so because the legal environment sets basics rules on how business should operate. The legal environment may severely limit some choices when the law changes. The researcher seeks to assess the kinds of business environment that small and medium enterprises operate and how the of business environments have affected their performance in terms of profitability, market share, geographical coverage, outreach and others.
Armyx (2005) noted that well-conceived regulation can encourage competition and ensure fair market. He further added that the government should develop public policies to guide this sub-sector, set laws and regulations that limit them from exploiting the society. Competition is necessary in business but sometimes it may be unfair. It is of importance that all the stakeholders are given full information about what is expected of them, than coming up with policies that cannot be implemented. The researcher noticed that small and medium enterprises operate under stiff competitions from similar companies as they produce or sell similar products, this study will determine how the competition they face affects their performance.
