Financial Management Modelling of the Performance of Nigerian Quoted Small and Medium-Sized Enterprises

By Toby, Adolphus J. | Journal of Financial Management & Analysis, January-June 2007 | Go to article overview

Financial Management Modelling of the Performance of Nigerian Quoted Small and Medium-Sized Enterprises


Toby, Adolphus J., Journal of Financial Management & Analysis


Introduction

The field of corporate financial management has developed very extensively since the early 1950s. Sophisticated quantitative models have been developed and applied to the analysis of the interactions among investment, financing and dividend policy decisions within a shareholders' wealth maximisation framework. The propositions outlined under The Separation Theorem, which was first identified by Irving Fisher1 in the 1930s and formally set out by Hirshleifer2 have been severally tested with data mainly from large enterprises. The crux of The Separation Theorem is that investment, financing and dividend policy decisions are irrelevant in determining enterprise value. The effects of taxation, inflation and financial market dynamics on these financial decisions have also been investigated and reported extensively. Recently, the cherished "random walk" view that stock returns are unpredictable, the "CAPM" view that the market is the only benchmark and market exposure the only source of returns, and the "expectations hypothesis" relating interest rates of various maturities and countries have all been abandoned3.

The applications of the various financial management models to the small business sector have been limited, particularly in developing economies. The persistent lack of relevant data on small enterprises is still an issue to be addressed by policy makers and the Federal Office of Statistics (FOS). However, there are a few studies that have investigated working capital management practices, financial reporting systems, and capital structure in small and medium-sized enterprises (SMEs) in U.S.A., U.K. and North America. The works of Reid4 show how in theory and practice the key variables which characterise the small firm's financial structure evolve over several time periods after inception. Reid provides a dynamic theory of the small firm which supports the cheap equity case, except when interest rates are low. Brounen, et al5 find that while large firms frequently use present value techniques and the capital asset pricing model when assessing the financial feasibility of an investment opportunity, Chief Finance Officers ( CFOs) of small firms still rely on the payback criterion.

Prelude

Since the Bolton Report in 19716, there have been a number of other surveys and studies of the growth constraints experienced by smaller firms (for example, Soufani, 2002, ACOST 1990, Aston Business School7, Cambridge Small Business Research Centre (CSBRC)8 1992). The CSBRC (1992) survey concluded that two important constraints for all firms relate to matters of finance. Due to diverse financial as well as non-financial and behavioural factors9 small businesses rely more heavily on short-term funding and this makes them more sensitive to macroeconomic changes10. Under such circumstances, businesses have to strive for more efficient working capital management and especially the management of accounts receivable and accounts payable, which make up the largest proportions of working capital needs in small firms. Peel and Wilson" indicate that if the financial /working capital management practices in the SME sector could be improved significantly, then fewer firms would fail and economic welfare would be increased substantially. Yet even though the importance of sound financial and working capital management is recognised, theoretical and empirical work on the area has been very minimal.

The deregulation of the Nigerian financial services industry between 1986 and 1992 resulted to high interest rates, persisting liquidity crisis in the banking system and credit rationing in favour of large companies. The policy sommersaults that characterised the postderegulation period ( 1993-2005) left Nigerian SMEs under severe financial stress and extreme financing gaps. The adoption of a medium-term perspective monetary policy was characterised by a high minimum liquidity ratio (MLR) and increasing cash reserve requirement (CRR) between 9-12 per cent with the consequential credit crunch and high mortality rates among Nigerian SMEs. …

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