COLLEGE OF FINANCE, MANAGEMENT AND DEVELOPMENT

DEPARTMENT OF PUBLIC FINANCIAL MANAGEMENT AND ACCOUNTING

Factors Influencing the Financial Performance of Micro and Small

Enterprises:The Case of Arada Sub City of Addis Ababa

A Thesis Submitted to Ethiopian Civil Service University, College of

Finance, Management and Development, Department of Public
Financial Management, in Partial Fulfillment of the Requirement for
Award of Masters Degree in Accounting and Finance.

BY: MULUGETA WONDIMU

ID No ECSU 1703817

Adviser: Lemma Gudissa (PhD)

Addis Ababa Ethiopia

December, 2019
 DECLARATION
I, the undersigned, declare that this thesis is my original work and not been presented for a degree in
any other university, and that all sources of materials used for the thesis have been duly
acknowledged.

Declared by:
Mulugeta Wondimu Signature__________________ Date___________________

Place and date of submission: Ethiopian Civil Service University, December, 2019

Table of Contents
DECLARATION....................................................................................................................................i

i
Table of Contents..................................................................................................................................ii
LIST OF FIGURE................................................................................................................................iv
Abbreviation and Aacronyms...............................................................................................................iv
CHAPTER ONE....................................................................................................................................1
INTRODUCTION TO THE STUDY....................................................................................................1
1.1 Background of the study.........................................................................................................1
1.2 Statement of the Problem........................................................................................................2
1.3 Objectives of the Study...........................................................................................................6
1.3.1 General Objective................................................................................................................6
1.3.2. Specific Objectives..............................................................................................................6
1.4 Scope of the Study..................................................................................................................6
1.5 Significance of Study..............................................................................................................6
1.6 Limitations of the Study..........................................................................................................7
1.7 Operational Definitions of key Terms and Terminology........................................................7
CHAPTER TWO...................................................................................................................................9
LITERATURE REVIEW......................................................................................................................9
2.1. Conceptual Review......................................................................................................................9
2.1.1 Definitions and Concepts of Micro and Small Enterprises....................................................9
2.1.2 Definition of SMES’s in Ethiopian Context........................................................................10
2.2. Theoretical Framework.............................................................................................................11
2.2.1 Financial Performance of MSEs..........................................................................................11
2.2.2. Factors Affecting the Financial Performance of MSE’s.....................................................12
2.2.3 Strategies of Financial Performance of MSEs.....................................................................16
2.2.4. Overview of the MSE Sector in Ethiopia............................................................................18
2.2.5. MSEs Support Service Provided by City Government of Addis Ababa.............................18
2.3. Empirical Studies......................................................................................................................19
CHAPTER THREE.............................................................................................................................27
RESEARCH METHODOLOGY........................................................................................................27
3.1. Introduction...............................................................................................................................27
3.2. Research design.........................................................................................................................27
3.3. Population Definition................................................................................................................27
3.4. Type and Source of Data...........................................................................................................27

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 3.5. Sampling Design.......................................................................................................................28
3.6. Data Collection Methods...........................................................................................................29
3.7. Methods of Data Analysis.........................................................................................................29
3.8. Research Variables and Measurement......................................................................................30
Chapter four.........................................................................................................................................32
Data Presentation, Analysis and Interpretation...................................................................................32
4.1. Introduction...............................................................................................................................32
4.2. Background characteristics of the respondents.........................................................................33
4.2.1. Demographic characteristics...............................................................................................33
4.2.2. Business Characteristics of the respondents.......................................................................34
4.3. Analytic study on Factors Determining the financial performance of MSEs...........................36
4.3.1. Results from descriptive statistics.......................................................................................36
4.3.2 Management and expertise skills that determine financial performance of MSEs..............41
4.3.3. Entrepreneurial factors that affect the financial performance of MSEs..............................43
4.3.4. Politico-legal factors that affect the financial performance of MSEs.................................45
4.3.5. Financial factors that determine the financial performance of MSEs.................................47
4.3.6. Cost Management quality that affects the financial performance of MSEs.......................49
4.3.7. Capital Structure that affects the financial performance of MSEs.....................................51
4.4 Correlation Analysis..................................................................................................................52
4.4.1 Model Specification Test.....................................................................................................53
4.4.2 CLRM Assumptions and Diagnostic Tests.........................................................................55
4.5 Regression Analysis and Discussion of Results.........................................................................60
CHAPTER FIVE.................................................................................................................................64
CONCLUSION AND RECOMMENDATOINS................................................................................64
5.1. Summary...................................................................................................................................64
5.2. Conclusion.................................................................................................................................64
5.3. Recommendations.....................................................................................................................66
6. REFERENCE................................................................................................................................68
7. Appendices....................................................................................................................................75

LIST OF TABLE
Table 1 Operationalization and Measurement of Variables................................................................31

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Table 2 Demographic characteristics of respondent............................................................................33
Table 3 Business characteristics of respondents.................................................................................34
Table 4 Initial capital and Current capital of respondents...................................................................35
Table 5 Age and growth pattern of the Enterprises.............................................................................36
Table 6 Sources of finance..................................................................................................................37
Table 7 Challenges in accessing loan..................................................................................................38
Table 8 Ranking Business registration process...................................................................................39
Table 9 Business registration process..................................................................................................39
Table 10 Management and expertise skills factors that affect the performance of MSEs...................40
Table 11 Entrepreneurial factors that affect the performance of MSEs..............................................42
Table 12 Politico-legal factors that affect the financial performance of MSEs..................................44
Table 13 Financial factors that determine the financial performance of MSEs..................................46
Table 14 Cost Management quality that affects the financial performance of MSEs.........................48
Table 15 Cost-to-Revenue Ratio........................................................................................................50
Table 16 Debt-to-equity (D/E) ratio....................................................................................................51
Table 17 Correlation Matrix of Dependent and Independent Variables..............................................52
Table 18 Correlated Random Effects - Hausman Test........................................................................54
Table 19 Heteroskedasticity Test: White.............................................................................................57
Table 20 Covariance Analysis: binary................................................................................................58
Table 21 regression analysis...............................................................................................................61

LIST OF FIGURE
Figure 1 Conceptual frameworks.........................................................................................................26
Figure 2 Initial capital and Current capital of respondents..................................................................35
Figure 3 Normality Test- BJ...............................................................................................................57

Abbreviation and Aacronyms

CS Capital Structure

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CSA Central Statistical Agency
CMQ Cost management quality
CIR Cost-to-Income Ratio
EC Ethiopian calendar
ENT Entrepreneurship factor
FIN Financial factor
MoTI Ministry of Trade and Industry
POT Pecking Order Theory
PO-LEG Political legal business climate
RLT Relationship Lending Theory
TOT Trade-Off Theory

Abstract
This research aims to investigate factors affecting the performance of MSEs with a special
emphasizes on manufacturing, construction service trade sectors in Arada sub city, Addis Ababa. In
order to investigate these issues a mixed method research approach was utilized, by combining
financial report analysis, questionnaires and in-depth interviews. More specifically, the study used
three years (2009 - 2011) data for 76 MSEs in Arada sub city.The respondent operators were
selected using stratified sampling technique. Besides, the interview questions were analyzed using
descriptive narrations through concurrent triangulation strategy. The empirical study elicited six

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major challenges which seem to affect performance of MSEs in sub city which include:
entrepreneurial skill, accesses to finance, capital structure, cost management quality, legal and
regulatory business climate and age. The findings further indicate that, there exists linear and
significant relationship was found between independent variables and dependent variable.
Moreover, the selected independent variables significantly explain the variations in the dependent
variable at 1% level of significance. Based on findings, recommendations to government bodies, to
operators of MSEs and suggestions for other researchers are forwarded.

Key words: MSEs, financial performance, factors

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 CHAPTER ONE

INTRODUCTION TO THE STUDY

1.1 Background of the study

Micro and small enterprises (MSEs) play an important economic role in different countries; they are
considered to be the main drivers for innovation, poverty eradication, employment creation, and
social integration (Matsotso & Benedict, 2014). They play a vital role across the globe. In Europe,
they are considered as a main source of entrepreneurship skills, technological innovation and
employment creation (European Commission, 2005). Accordingly, more than 23 million MSEs
provide approximately 75 million jobs in this Region. In order to adopt free market economic
principle European countries opened their door to the MSEs which account to 40% of their
economies (Matsotso & Benedict, 2014).

In addition to that, MSEs contribute highly in international economic development for the Asian
countries. For example, MSEs are the spinal cord of Singapore‟s economy, which contributes
approximately 47% of the country‟s Gross Domestic Product (GDP) and generating more than 62%
of the available jobs within the country (Sariaslan, 1994).

In Africa, about 90% of the businesses are in operations which contribute approximately 50% of the
Gross Domestic Product (GDP) and employment (ILO,2018). Many countries have realized efficacy
of small business toward improving the productivity of their nations. Due to this reason they are
keeping vigilant eye on the growth of MSEs and encourage broader participation of people in
running Medium and Small Enterprises (MSEs) (ILO, 2018).

According to the Ethiopian Central Statistical Authority (2006), almost 50% of all new jobs created
are attributable to MSEs sector and 98% of business firms in Ethiopia are MSEs, out of which Small
Enterprises account for 65% of all businesses. Federal Micro and Small Enterprises Development
Agency report (2013) indicates that the MSEs sector created 1.5 million new job opportunities and
about 4 billion Birr loan was provided by microfinance institutions during the years 2006-2010.

Recognizing the significance of this sector as a key factor for rapid economic development, the
Government of Ethiopia had issued Micro and Small Enterprises Strategy in 1997 and established
Micro and Small Enterprises Development Agency in 1998 at federal level. The primary objective of

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the national MSEs development strategy is to create an enabling legal, institutional and other
supportive environment for the growth and development of MSEs (FeMSEDA, 2015).

Addis Ababa is the largest as well as the dominant political, economic, cultural, and historical city of
the country established in 1887. It is divided in to ten sub-cities and 116 weredas, which are the
smallest administrative unit in the city. Arada is one of the ten Sub Cities, which is located in the
northern area of the city, nearby the center. It borders with the districts of Gullele, Yeka, Kirkos,
Lideta and Addis Ketema. It is divided in to ten weredas. The economic activities in Arada are
diverse. According to official statistics from the federal government, some 24.6 percent people in the
city are engaged in trade and commerce; 21.6 percent in manufacturing and industry; 15.25 percent
Homemakers of different variety 13.5 percent in civil administration; 9.6 percent in transport and
communication; 8.1 percent in education, health and social services; 6.2 percent in hotel and catering
services; and 1.15 percent in agriculture. (MoTI, 2018). According to Addis Ababa City
Administration Small and Micro and Small Enterprise Development Bureau annual report
(2018/19), There are about 653 registered MSEs in Arada Sub City Administration on five different
sectors: Manufacturing, Construction, Service providers, trade and on urban Agriculture.

Tegegne and Meheret (2010) indicated that despite the fact that national MSE development strategy
is formulated by government, until very recently, the government had not extended adequate support
to the development of the sector. This can also easily seen on the limited jobs available in the market
compared to the population of unemployed number of youth that join the working age and the
substantial controversy existing over the underlying growth assumptions, the job creation potential,
and the net contribution of MSEs to national employment and urban poverty reduction (FeMSEDA,
2015). This is due to different institutional, policy, operational and financial constraint factors
existing from both sides, from government and MSE’s owners.

Thus, this paper tries to assess the different policy, financial and operational factors affecting MSE
growth in Addis Ababa by assessing the key MSE’s financial performance factors of some selected
enterprises which are working in Arada sub City Administration.

1.2 Statement of the Problem

The role of Micro and Small Enterprises (MSEs) in socio-economic development as a means for
generating sustainable employment and income is progressively recognized. In developing countries,
the MSE sector is the largest source of employment and income generation activity, particularly for

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the urban population (Wasihun & Paul, 2010). Nowadays, in almost all economies of the world,
MSEs are becoming a crucial and key factor for sustained growth and development and becoming
the lifeblood of most economies (Berhanu, 2014). In Ethiopia, like any other developing countries,
MSE has become an increasingly widespread used strategy for its labor intensiveness, suitability to
produce more jobs with less capital per job created, its utilization of locally available resources,
fostering of linkage within and among various sectors and its resilience to internal and external
economic shocks (FeMSEDA, 2015).

Although they are commonly perceived as an engine of a country's economy, research indicates that
micro and small businesses tend to have a higher failure rate as compared to large organisations
(Wasserstein, & Lazar, 2016). Because of their small size, a simple management mistake is likely to
lead to sure death of a small enterprise hence no opportunity to learn from its past mistakes.
Improper capital structure decision, poor cost management quality, entrepreneurial factors,
inconvenient political-legal business climate and luck of experience have been posited as the main
causes of failure of MSEs (Longenecker, et al. 2006). Lack of credit has also been identified as one
of the most serious constraints facing MSEs and hindering their development (Oketch, 2000).

Business success is about the achievement of goals and objectives of a company, which is not
explicitly defined (Matsotso & Benedict, 2014). There are various ways to measure business
financial success that includes profits, survival, return on investment, sales growth, and others
(Schmidpeter & Weidinger, 2014). Profit is the most important concept in business, it the reward or
return for taking risks & making investments. For most businesses, making a profit is a key business
objective (Mwangi, 2013). This study tries to identify factors affecting the financial performance of
MSEs in terms of profit.

All researches suggest that there is an optimal capital structure the one that maximizes the value of
the firm and simultaneously minimizes the cost of capital thus striking a balance between risk and
return. However, it is not yet possible to provide financial managers with a precise methodology for
determining a firm’s optimal capital structure (Gitman & Zutter 2010). Capital structure is a very
important financial decision as it is directly related to the risk and return of a firm. Any immature
capital structure decision can result in high cost of capital; thereby lowering firm’s value while
effective capital structure decision can do the opposite (Salim, & Yadev, 2012).

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When a firm recovers and grows continuously, serious competition will occur and the firm will
probably be under pressure to adjust the product price to gain profit. Price reduction is not enough
to bring success to MSEs. However, the key success factor in MSEs is cost management quality
because management of firm cost is a process of resource allocation to add more value to products
by emphasizing effective use of firm cost (Kelly & Tan, 2017). Cost management is an important
tool to increase business competitive potential as executives have to consider and collect detailed
information of occurred cost as well as cutting down unnecessary expenses to reduce firm cost
(Bryan, 2017). Therefore, cost management is crucial and executives should pay attention to it in
order to obtain accurate cost information that can be used for administration, decision-making, and
effective internal control to achieve the highest organizational goals.

MSEs have a problem of finance when establishing the business most individual sources of finance
come from personal savings and loans acquired from relatives, friends and money lenders with high
amount of interests (Ministry of Trade and Industry (2005). After the business goes operational, the
probability of becoming profitable and paying back debts along with accrued interest is less. Small
and Micro Enterprises (MSEs) are commonly believed to have very limited access to credit facilities
and other financial support services provided by financial institutions. This is because, these MSEs
cannot provide the necessary collateral demanded by the financial institutions and financial
institutions find it difficult to recover the high cost involved in dealing with small firms (Gebrehiwot
& Wolday, 2006). Significant number of researches in Ethiopia have identified finance as one of the
main factors that affect success, performance and growth of MSEs (Fetene, 2010).

Entrepreneurship is recognized as an important driver of economic growth, productivity, innovation,

and employment. Entrepreneurship is related to the functional role of entrepreneurs and includes
coordination, innovation, uncertainty bearing, capital supply, decision-making, ownership, and
resource allocation in their organization.The growth of a firm is, to a certain extent, is a matter of
decisions made by individual entrepreneur. This is very much pronounced for MSEs that are run by
owner-managers. Personality traits, motivation, individual competencies and personal background
are important factors for the success/failure of MSE (Shane, Locke, & Collins, 2003)

The regulation of businesses by laws, policies, and incentives influences economic activity in
various ways. It is widely acknowledged that there is no ‘optimal approach’ to regulation, meaning
that the intensity or the scope of regulating business-to-business and state-to-business relations is

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largely dependent upon local conditions, private-sector needs and the interests of national policy-
makers (Nganwa, 2013).The legal and regulatory system that calls for complex registration and
licensing requirements demands tedious and costly reporting practices imposing heavy costs on
MSEs and hence reduce their profitability of the business. Unpredictable government policies
coupled with grand corruption, high taxation pose great threat to growth of MSEs (Nganwa, 2013).

Other interesting factor is firm age and its effects on firm performance. The link between age and
performance of a company has been extensively examined in the finance literature as well as other
disciplines such as economics and organizational studies. Theoretical and empirical papers are
ambiguous regarding the relationship between age and firm performance. On the one hand,
researches suggest that older firms outperform younger firm since they have more experience in the
industry. They call this phenomenon as “learning by doing” (Coad et al., 2013). Another strand of
research suggests that older firms do not have the flexibility to adopt new changes as they get older
so that they perform worse than younger firms (Barron et al., 1994). In line with the above, it is
required to complement the literature by empirically investigating the relationship between firm age
and profitability in a developing country, Ethiopia.

To address above problems, this study therefore intended to provide a holistic view of factors
affecting the financial performance of MSEs through a comprehensive review of literature and
empirical study available on the area. This will expect to result in the development of a theoretical
framework for the initiation of policies and programmes for enterprise development. From the
practical point of view, it serves not only to provide a self-check to current enterprise sector, but also
to increase the involvement in business activities through a better understanding of the determinants
of the financial performance of the enterprises. Such an understanding of the pre-requisites for
Arada Sub City MSEs to perform well in their businesses is of critical importance especially in
today’s competitive environment.

Thus, this reach work, ultimately attempts to discourse the following key research questions:

i. What does the practice of financial performance in MSEs look like?

ii. What are the major internal factors that influence the financial performance of MSEs?
iii. What are the major external factors that influence the financial performance of MSEs?
iv. Does firm age affect MSEs financial performance?
v. What should be done to enhance financial performance of MSEs operation?

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1.3 Objectives of the Study

1.3.1 General Objective

The general objective of the study was to identify factors affecting the financial performance of
MSEs in Arada Sub City, Addis Ababa.

1.3.2. Specific Objectives

In order to handle the problem and meet the general objective stated above, the study was deal with
the following specific objectives:

1. To examine the financial performance MSEs in the Arada Sub City of Addis Ababa.

2. To identify the external factors that affects the financial performance of MSEs in the Sub City.

3. To identify the internal factors that affects the financial performance of MSEs in the Sub City.

4. To evaluate the relationship between firm age and financial performance of MSEs in the Sub
City.

5. To forward possible recommendations that would help enhance financial performance of MSEs
in the Sub City.

1.4 Scope of the Study

This study was delimited to studying the key factors affecting of financial performance of MSEs in
Arada Sub City of Addis Ababa. It’s targeted at those sectors which ware expected to play a
significant role in the MSEs sector development in the sub city. It focuses only on assessing the
major personal and organizational characteristics of entrepreneurs in MSEs to check whether these
factors affect their performance. It confine to 4 key MSE sectors; Trade, Manufacturing,
Construction and Service, which are considered as growth corridors.

1.5 Significance of Study

The findings of this study would be useful to the academicians and researchers in broadening of the
prospectus with respect to this study hence providing a deeper understanding of the critical factors
that affect the performance of MSEs. The findings of this study would help MSEs in Arada sub city
and others, within an insight into the benefits of using different factors studied in this research to
predict the factors that affect the performance of MSEs. The government can also use the findings of

6
this study to assist in policy formulation and development for a framework for critical finance,
marketing, work premises and other factors that affect the performance of MSE. Moreover, the
findings of this study will help the policy makers and financial institutions how to encourage
establishing or expanding MSEs. It also enables them to know what kind(s) of policies should be
framed.

1.6 Limitations of the Study

The study was surrounded to individuals operating MSE activities or establishments in all Arada sub
city. Moreover, due to human, financial and material limitation, the study is restricted to a limited
number of individual operators who were operating the business in the Arada sub city during the
survey period.

1.7 Operational Definitions of key Terms and Terminology

Capital Structure (CS): the capital structure is the balance between equity and debt that a business
uses to finance its assets, day-to-day operations, and future growth. It is a combination of debt and
equity which is calculated by dividing a MSE’s total liabilities by its owner(s)r equity.

cost-to-income Ratio(CIR): is expresses the efficiency ratio which measured by dividing the
operating costs by operating income

Debt: is a duty or obligation to pay money, deliver goods, or render service under an express or
implied agreement.

Enterprise: It refers to a unit of economic organization or activity whether public or private engaged
into the manufacturing of goods

Factors: A factor is a contributory aspect such as cost management quality, capital structure
decision, politico-legal, financial, management and entrepreneurial influences that affect
performance of micro and small enterprises.

Financial Performance is a general measure of a firm's overall financial health over a given period.

Initial Paid-up Capital: is that part of the issued capital of an establishment that has been paid by the
owners to start the operation.

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Micro Enterprise: means enterprise having a total capital, excluding building, not exceeding Birr
50,000 in the service sector or not exceeding Birr 100,000 in the industrial sector and engages 5
workers, including the owner, his family member and other employees

Performance: in this paper performance defined in terms of profitability of the MSEs

Respondent: respondents are those individuals who are owner managers or operators of an
enterprise.

Small Enterprise: means an enterprise having a total capital, excluding building, from Birr 50,001 to
Birr 500,000 in the case of service sector or Birr 100,001 to Birr 1,500.000 in the case of urban
agriculture, artisanal mining and construction sector engages from 6 to 30 workers including the
owner, his family members and other employees

Organization of the Study

This research work organized as: following the introduction chapter, the second chapter presents an
overview of theoretical and empirical related literature to the study and conceptual framework of
research variables. The third chapter dedicated on the research design and methodology applied for
this research work, followed by the fourth chapter data presentation, analysis, and interpretation. The
last and fifth chapter provides conclusion and policy recommendation.

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 CHAPTER TWO

LITERATURE REVIEW

2.1. Conceptual Review

In many developing countries, including Ethiopia, MSE development programs are viewed as a key
policy strategy to embrace the growth of MSE sector (Belay, 2012). One of the indicators of success
is profit and profit generating capacity of the business through generating income. The word
profitability is composed of two words Profit and Ability. Ability refers to the earning capacity or
power of an enterprise to earn the profit through increasing income. So, profitability may be defined
as the ability of a given investment to earn a return from its use. Profitability of a concern indicates
the financial stability and the greater the possibility of profit earning (Kavitha, 2012). Thus, this
research looks at the growth of MSE in terms of profitability of the business.

2.1.1 Definitions and Concepts of Micro and Small Enterprises

The definition of micro and small enterprises is still controversial. There is no generally accepted
definition of micro and small enterprises. The study conducted by International Labor Organization
in 2005 a number of definition on Small and Micro Enterprises (SMEs were identified in different 75
countries (ILO 2005). Nonetheless technical definitions differ from one country to another usually
based on level of employment or number of asset or a combination both. The levels of development
for a country determine measures of size for Small and Micro Enterprises (SMEs) but the common
agreement point are total investment, sales turnover and total number of employees (Kayanula and
Quartey, 2000).

Bolton Committee (1971) discussed, first an “economic” and “statistical” definition of a small firm
was formulated. Under the “economic” definition, a firm is said to be small if it meets the following
three criteria: relatively small share of their market place, managed by owners or part owners in a
personalized way. On the other hand, the “statistical” definition, the Committee proposed two
criteria; size of the small firm sector and its contribution to GDP, employment, exports, etc.; the
extent to which the small firm sector’s economic contribution has changed over time (Bolton, 1971).

The sectorial classification has also used as criteria to define MSEs by Bolton Committee.
Accordingly firms in manufacturing, construction and mining were defined in terms of number of
employees (in which case, 200 or less qualified the firm to be a small firm), those in the retail,

9
services, wholesale, etc. were defined in terms of monetary turnover (in which case the range is
50,000-200,000 British Pounds to be classified as small firm) whereas, firms in the road transport
industry are classified as small if they have 5 or fewer vehicles (Bolton, 1971).

However, there have been criticisms of the Bolton definitions. This center mainly on the apparent
inconsistencies between defining characteristics based on number of employees and those based on
managerial approach.

In Japan, small-scale industry is defined according to the type of industry, paid-up capital and
number of paid employees. Thus, small and medium- scale enterprises are defined as: those in
manufacturing with 100 million yen paid-up capital and 300 employees, those in wholesale trade
with 30 million yen paid-up capital and 100 employees, and those in the retail and service trades
with 10 million yen paid-up capital and 50 employees (Kayanula and Quartey, 2000).

Currently European Union definition categorizes companies with fewer than 10 employees as
"micro", those with fewer than 50 employees as "small". By contrast, in the United States, small
business is defined by the number of employees, it often refers to those with fewer than 100
employees, while medium-sized business often refers to those with fewer than 500 employees.
(Kayanula and Quartey, 2000).

Generally, from the global experiences of the definitions of MSE entails that there is no commonly
used definition of MSE across the countries of the world. However, all the definitions have taken the
common criteria such as the number of employees, paid up capital, sectorial category, market share
and the management entity.

2.1.2 Definition of SMES’s in Ethiopian Context

Similar to the global experience, the definition of MSEs in Ethiopia consist paid up capital and
number of employees as criteria except that it categorize the firms as formal and informal.

According to Ministry of Trade and Industry (MoTI) definition, MSEs based on capital investments
a yardstick, has been developed for formulating micro and small enterprise development strategy in
1997. The definition given by MoTI states the difference between micro and small enterprises based
on paid up capital. Micro enterprises are those businesses enterprises, in the formal and informal
sector, with a paid up capital not exceeding Birr 20,000 and excluding high-tech consultancy firms
and other high tech establishments whereas, small enterprises are those business enterprises with a

10
paid up capital of above Birr 20,000 and not exceeding Birr 500,000 and excluding high tech
consultancy firms and other high tech establishments (Commission on Legal Empowerment of the
Poor, 2006).

On the other hand, Central Statistical Agency (CSA) categorizes enterprises into different scales of
operation on the size of employment and the nature of equipment. According to CSA;
Establishments employing less than ten persons and using motor operated equipment are considered
as small scale manufacturing enterprises whereas enterprises in the micro enterprise category are
subdivided into informal sector operations and cottage industries. As the third category, Cottage and
handicraft industries are those establishments performing their activities by hand and using non
power driven machines (Central Statistical Agency, 2012).

according to federal urban job creation and food security agency establishment council of ministers
regulation No.374/2016; “micro enterprises” means an enterprise having a total capital, excluding
building, not exceeding Birr 50,000 in the service sector or not exceeding Birr 100,000 in the
industrial sector and engages 5 workers, including the owner, his family member and other
employees; “small enterprises” means an enterprise having a total capital, excluding building, from
Birr 50,001 to Birr 500,000 in the case of service sector or Birr 100,001 to Birr 1,500.000 in the case
of urban agriculture, artisanal mining and construction sector engages from 6 to 30 workers
including the owner, his family members and other employees.

In light of the above definitions and taking into consideration the Ethiopian situation, in this paper
micro and small enterprisese defined in the regulation No.374/2016 context.

2.2. Theoretical Framework

2.2.1 Financial Performance of MSEs

Financial performance is the ability of the MSEs to operate efficiently, generate effective income,
survive, and expand by observing environmental opportunities and threats (Turyahebya, 2013).
Financial performance gauges the proper use of enterprises’ resources to maximize profit and
wealth. The monetary financial tasks are performed periodically from the accounts, profit and loss
statements or the balance sheets of the Enterprises to measure the extent of their business success
(Srinivas 2013; Harashet al., 2014).

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The Financial reports are used to analyze the performance of the MSEs against the internal and
external finances to ensure their proper utilization and prediction of the enterprises’ capacity for
future eventualities (Levasseur, 2002). It is interesting to note that other than the characteristics of
debt that affect the financial performance of MSEs, the power sharing between debt holders and
business proprietors may also have an impact on how debt financing option affects financial
performance (Levasseur, 2002)

According to Codjia (2010), a statement of financial performance is an accounting summary that

details an organization’s revenues, expenses and net income. As part of business management,
financial performance measurement can be one of the biggest challenges faced by businesses in the
enterprises sector, especially with regard to their survival, if management is not trained on how to
manage finance and measure performance. It is necessary to be able to assess whether or not a
company has performed well over a certain period of time. From its profit and loss account, analysts
can observe the profit it has generated. It is also necessary to know if a company is in a good short-
term financial position, and if it is in a good financial position for long-term growth.

2.2.2. Factors Affecting the Financial Performance of MSE’s

If a MSE want be successful, it is necessary for them to fully understand what factors exert impact
on the development of the MSE. Once they know about both positive and negative effects within and
outside the company, they can produce suitable strategies to handle any predicted situation.
Therefore, examining internal and external factors is considered the most important task for an
MSEs before launch any strategic plan (Wanjiku, 2009: pp. 81-82).

2.2.2.1 Internal Factors

The internal factors that included in the study are management and entrepreneurial factors. The
management factor can be classified as capital structure decision and cost management quality.

Theory of Capital Structure

Scholars have defined capital structure in terms of equity-debt relationship. According to Pandey
(1995) capital structure represents the proportionate relationship between debt and equity used by
the firm in financing the projects. Gitman (2010) describes capital structure as a mix of debt and
equity that a firm uses to finance its operations. Horne van and Wachowicz (2007) noted that capital

12
structure is a mix of a firm’s permanent, long term financing represented by debt, preferred stock
and common equity.

The Pecking Order Theory of business finance advanced by Myers and Majluf (1984) argue that
firms will prefer to use internally generated funds and if eternal funds are required, debt will be
preferred to issuing shares. Firms will use debt only when they have exhausted the internal funds.
Mijid (2009) suggests that the Pecking Order Hypothesis in general, advocates the existence of an
optimal capital structure (or an optimal capital structure range) of the firm, this optimal capital
structure range being dependent on the firm’s trade-off of the various factors influencing its decision
of the source of finance. This is against the propositions of the non-optimal capital structure
perception.

After Modigliani and Miller’s (1958) “irrelevance theory of capital structure”, the capital structure
theory has been a study of interest to finance economists. Extensive researches have been performed
to investigate the relationship between capital structure and firms’ performance in different countries
while Ethiopia has very little contribution in the literature.
Concept of Cost Management Quality (CMQ)
Cost data is significantly important for planning, commanding, and controlling. Executives must pay
attention to cost data of product or service whether it is self-production or trading. It is necessary to
know about recording and calculating systems which are accurate, reliable, and useful for business
decision-making of the users, such as price setting, cost-volume-profit analysis, break-even analysis,
etc. It is also related to controlling cost and expenses efficiently to gain the largest business profit.
Cost is a resource with value measured by monetary unit paid for materials, products, and services.
Materials, products, and services obtained are proceeded to create maximum benefits and returns for
business in the present and future (Henri et al., 2016)

Occurred cost is both expired costs and unexpired costs. Based on objectives of consideration and
administrative use, costs can be categorized in many forms and types to correspond with operation
and resource allocation as cost management to achieve the greatest operational success (Finney et
al., 2008; Hooley et al., 2005).

Cost management, defined in most studies, concerns with investment in projects to gain returns, for
example, the study of Botín and Vergara (2015) claimed that management of operating costs is
necessary in building sustainability of economy. Consequently, activity-based costing (ABC) and

13
PDCA's Deming cycle have been applied to develop a cost management system for continual
improvement of operation and efficient reduction of cost.

2.2.2.2 External Factors

The external factors that include in this study are finance source and politico-legal business climate.
Nevertheless, the factors must be closely monitored to ensure that stringent measures are taken
within the best time to either take advantage of the opportunities or combat the threats found in the
external environment.
Theory of Entrepreneurial
The ‘big five’ model advocated for by Johnson (1998) is widely used as a robust indicator of
personality traits. These big five factors that are generally agreed as personality traits or
characteristics include: extraversion, emotional stability, agreeableness, conscientiousness and
openness to experience. Based on the big five model, researchers have further classified
entrepreneurial personality traits in to five categories: need for achievement, locus of control,
motivation, risk-taking propensity, and self-efficacy. These traits are important psychological factors
that would influence the performance of MSEs (Johnson 1990). Some research indicate that
psychological factors can create a new venture or drive success of business (Baum, Locke & Smith,
2001).
Theory of Finance
Pecking Order Theory (POT) that dictates hierarchical orders of financing decisions of firms
(Matias & Serrasqueiro, 2016). Agliardi et al (2016), Mwarari & Ngugi (2013) noted order of
preference in POT first, second and third sources of financing as internal, debt and equity financing
respectively.

According to Proença et al (2014), small companies do opt for internal financing; however, this will
depend on firm’s internal funding capacity to meet its needs at each stage, Agrebi (2009). Matias &
Serrasqueiro (2016) established that SMEs financing decisions follow POT predictions, in case of
debt financing decision if firms don’t generate enough funds internally then, Proença et al (2014),
short-term debt is preferred than long-term debt.

Management characteristics also prefer POT preference whereby informed managers (Chen et al,
2013) opt for internal financing where else optimistic managers focus on maximizing profitability
levels of a firm to enable internal financing and ensure optimal cash inflows associated with debt

14
financing. Despite finance costs associated with debt financing, Proença et al (2014) noted that risk
averse managers would still opt for external financing. In most cases, there is no space for equity
financing (Chen et al, 2013) since there is a direct link between debt financing and fund deficit.

Trade-Off Theory (TOT) is an approach used to strike a balance between merits and demerits
associated with use of debt financing. Initially, Modigliani & Miller (1963) noted that optimal
capital structure could be acquired through a balance between financial distress costs and the tax
benefit. Father research has classified TOT into two categories; static TOT or dynamic TOT. In the
Static TOT hypothesis, a firm’s optimum debt ratio is determined by a trade-off between costs and
benefits of borrowing, Modigliani & Miller (1963) with firm's assets and investment plans held
constant.

Lopez-Gracia and Sogorb-Mira (2008) emphasized an offset merits (between tax benefit and reduced
cash flow) and demerits (increased cost of financial distress and increased agency costs between
owners and creditors). Mwarari & Ngugi (2013) indicated firms’ preference of Debt than Equity
until a point of financial distress significance is attained. Therefore, Tangible assets have low
financial distress than intangible assets, Mwarari & Ngugi (2013) and Jong et al (2011).

Relationship Lending Theory (RLT) which dictates lending technologies in different countries
with different institutional setting on; legal, judicial, social and tax systems, Namara et al (2017).
Berger et al (2006) noted that SMEs benefit from small institutions that rely on soft information to
enable relationship lending. Retap et al (2016) highlighted factors contributing towards a successful
quality lending index among them; trust, commitment, amount of information sharing, closeness,
satisfaction level and quality of the relationship. Berger et al (2006) emphasized on good
relationship between lending officer of a financial institution and SMEs’ management.

Therefore, there is a lot of work by management team of SMEs before arriving of final decision
regarding external financing. Various risks are involved in each form of financing but also there is
benefits associated by each. Risk averse investor opt for internal financing, which provides minimal
chances of raising enough funds for expansion of business. Relationships in various bureaucracies
handling issuance of credit is very important towards better resource allocation to productive sector
on an economy.

15
2.2.2.3. Role of Age of SMEs in their Financial Performance

There are in general two different approaches to form hypotheses about the effects of firm age on
performance. One may be labelled the Ecology approach in reference to Hannan and Freeman
(1984). The alternative can be labelled Evolutionary in reference to Jovanovic (1982), although its
principles also adhere closely to Nelson and Winter (1984).

In the ecology approach, the focus is on the maturation of the firm, how its routines mature and how
the firm changes, or fails to change, alongside changes in its environment. A range of different
liabilities are used to conceptualize the dangers that arise throughout an organisation’s life: the
liabilities of newness, adolescence, age, senescence and obsolescence (Coad, 2017).

Unlike the ecology approach, the evolutionary approach puts more emphasis on learning and
selection. It is complementary to the ecology approach rather than a substitute for it, as it emphasizes
population dynamics over internal changes. In concise form, it has been summarized recently as “up
or out” dynamics): firms must either learn or exit. (Haltiwanger et al., 2013).

2.2.3 Strategies of Financial Performance of MSEs

Strategy of Financial Performance of MSEs is designed to give MSEs the key tools and perspectives
from strategy and finance to achieve these objectives. The programme will help to understand how a
MSE’s strategic agenda can evolve, and how MSEs can use that understanding to better identify
opportunities for profitable differentiation. MSEs will then learn how to use those opportunities to
formulate an execution plan, drive organizational alignment and ultimately improve financial
performance.

Thinking strategically is no longer a skill confined to bigger company; it is now crucial for
professional success across a wide range of roles and responsibilities. The greater executives
understand business strategy and financial performance, the better they are able to develop strategic
agility in the face of disruption and make faster and smarter decisions. They will also be better
equipped to help their organizations stay ahead of emerging opportunities, and drive the innovation
initiatives needed to succeed in today’s more challenging markets

Two schools of thought have emerged as pro-MSE’s and anti-MSE’s perspectives in the studies of
MSE’s regarding their role in developing and developed countries. Most donor countries and
development agencies share the view of the pro-MSE’s that is springing up of such entrepreneurial

16
and innovative ventures help promote economic growth and help reduce the high poverty level in
such developing economies (Beck & Demirguc-Kunt, 2005).

The pro-MSE has argued that MSE’s enhance competition and entrepreneurship and thus have
economy wide benefits in efficiency, innovation and productivity growth. Thus, direct government
support of MSE’s can help countries reap social benefits. Second, MSE’s are generally more
productive than large firms but are impeded in their development by failures of financial markets
and other institutions for capital and other non-financial assistances. Thus, pending financial and
institutional improvements, direct government support of MSE’s can boost economic growth and
development. The growth of MSE’s boosts employment more than the growth of large firms because
MSE’s are more labor intensive So subsidizing MSE’s may help reduce poverty (Beck & Demirguc-
Kunt, 2005).

However, the anti-MSE has questioned the efficacy of MSE’s in promoting growth and reducing
poverty. First, they argue that large enterprises may exploit economies of scale and more easily
undertake the fixed costs associated with research and development, boosting productivity. They
argue further that some researchers found that small businesses are neither more labor intensive nor
better at creating jobs than large firms (Thormi &Yankson, 1985).

Moreover, they doubt the crucial role of small businesses and instead emphasize the importance of
the business environment facing all firms, big and small. Small businesses create monopoly. They
are of the view that if there are low entries and exit barriers, well defined property rights, effective
contract enforcement, and access to finance, it will work to promote conducive business
environment for all firms and not only small firms (Beck & Demirguc-Kunt, 2005).

However, scholars attempted to reconcile the above controversies by the flexibility of the business
technology and people involves. Levy and Powell (2005) noted that, MSE’s are thought to be
flexible and innovative organizations that are able to respond quickly to customer and market
demands (flexibility). Contrary to what happens in large firms, the production technologies of many
manufacturing MSE’s may inhibit flexibility (Gupta & Cawthorn, 1996), while Carrie et al. (1994)
believe that it is people rather than technology that provides flexibility.

Despite the controversies in efficiency and poverty reduction, literature shows small business plays a
vital role in the socio economic and political contribution in both developed and developing nations.

17
Small business contributes to equitable distribution of wealth and decentralization of economic
power. A small business requires less capital and they are labor intensive in their nature.

2.2.4. Overview of the MSE Sector in Ethiopia

The Ethiopian government has formulated a National MSE Development and Promotion strategy in
1997, which enlightens a systematic approach to alleviate the problems and promote the growth of
MSEs. The overall objective of the strategy is to create an enabling environment for MSEs, with
specific objectives to facilitate economic growth; bring equitable development; create long-term
jobs; strengthen cooperation between MSEs; provide the basis for medium and large-scale
enterprises; promote export; balance preferential treatment between MSEs & bigger enterprises. The
strategy targets support measures and beneficiaries such as small manufacturers in food, textiles,
leather, clothing metal works, and crafts; self-employment (focus on school leavers, disabled and
unemployed youth and women (MoTI, 1997)

2.2.5. MSEs Support Service Provided by City Government of Addis Ababa

The promotion of MSEs is one of the strategic directions pursued by the City Government of Addis
Ababa Micro and Small Enterprise Development Agency during the GTP I implementation period
(2010/11-2014/15), the agency focused on promoting the development and competitiveness of MSEs
by providing different supports.

Accordingly, the following core support has been planned first the strategy backs to create and
implement an enabling legal framework. Second, it envisages establishing user-friendly business
environment, for example, by simplifying and standardizing registration, licensing, and other
enterprise development services. Finally, the agency offers direct policy support by devising targeted
and specific support programs such as access to finance, access to appropriate training and
technology, marketing linkage, provision of physical infrastructures and access to working and
selling spaces and other handholding supports as deemed appropriate.

Consequently, to harness the potential of MSEs city government of Addis Ababa MSE agency
developed its own strategy and within branch offices in all of the ten sub city admiration and aim to
provide the following support services; facilitate Credit Service provided by Micro finance
institutions, in order to enhance the efficiency and productivity of MSEs training are provided MSE
operators on business management, accounting and other technical skill trainings, facilitate and

18
provide Market linkage: to address market linkage problems of MSEs the agency facilitated
networking with consumers and supplied production and sales centers, allows them to show/display
their products in bazaars and exhibitions and provided sales premises, Formation of new Enterprises
by enacting different activities in forming and formalizing enterprises through the legal registration
processes and offer One Stop Shopping service to supply services in an integrated, transparent and
effective way

2.3. Empirical Studies

In Ethiopia the last two decades, several policies were formulated and regulations promulgated
relating to diverse social, economic and political issues. The most important policy and institutional
reforms which include the support for those in extreme need and the provision of enabling
environment for private sector development. To enhance the development of private sector, the
government has formulated a National MSE Development and Promotion Strategy in 1997, which
aims to use an approach to alleviate the problems of unemployment and promote the growth of
MSEs.

Despite the contribution to employment and economic growth this day, most MSEs face critical
constraints both at the operation and start up level. According to research report of Commission on
Legal Empowerment of the Poor (2006) SMEs in the economy have been constrained by a number
of factors. Prominent among these are limited management and entrepreneurial skill of the
owners/managers, lack of experience, lack of adequate access to credit, Unfavorable business
climate and excessive corruption.

Aryeetey et.al (1996) indicated that most of the small business enterprises’ operators have little
formal education in managing their business. The background of the owners/managers, therefore,
places a limitation on their managerial capabilities. This problem has affected the scope of their
operation in terms of efficient capital structure decision and cost management quality. Thus, they are
not able to take full Advantage of emerging opportunities (Steel, 1996). In certain situations,
managerial incompetence has led to operational inefficiencies resulting in poor performance
(Pappoe, 1992)

Megginson (2003), Kuratko and Hodgetts (1995) and Hall (1995) postulate that the skill and
capability as one of the challenges of MSEs that can be reflected in terms of business knowledge, a
lack of management skills, and inexperience. Managers of small firms are assumed to be generalists

19
rather than specialist and are thus responsible for allocating limited resources and cannot afford to
make poor decisions. Moreover an over-reliance on the single owner manager and existence of
reluctance to move away from this managerial tendency on the part of the owner-manager translates
into poor human resources practices where no new qualified staff is hired or authority and
responsibility delegated to other employees (Megginson et al., 2003).

Henri et al. (2016) also examined cost management strategies and overall financial operations of
organizations with data collection from 319 manufacturing-related firms of Canada. The study found
that cost management has significantly positive relation with overall financial operations and is also
considered as a long-term strategy to improve supply chain systems and manufacturing of different
cost structure.

Hussin et al. (2013) investigated necessary cost management skills for owners of SMEs as they
found that SME owners in Malaysia lacked of cost management skills, while the Malaysian
government encouraged cost management trainings. Cost management is important for enterprises as
follows: (1) firms are able to negotiate price with buyers to create sustainable profit; (2) it helps
reduce operational risks; (3) accurate prediction of activity cost control deviation of manufacturing
and operation; and (4) correct cost estimation enables firms to control stocked products
administration effectively.

Zeleke (2009) conducted a study on the efficiency of management as a determinant of long-term

survival in micro, small and medium enterprises in Ethiopia, and his research ascertains that
excellent management skill is of highest importance in order to lead an innovative firm to success.
However, while many entrepreneurs need to acquire an excellent education and experience in their
specific scientific area, they often lack business management capabilities. This constitutes a threat to
their survival and is a major constraint and obstacle to their growth and development, which often
prevents them from transforming the excellent scientific and technological competencies into the
real economy.

Managerial effectiveness influences every aspect of a business and is often believed to be the most
important factor contributing to small business failure (Zeleke, 2009) Many MSEs owners/managers,
however, do not always have skills and experience in areas such as business planning, financial
reporting, marketing, customer relations and financial management. The company is at risk when
owners and managers, as management, do not possess the appropriate knowledge; and either do not

20
recognize this lack of expertise or are not willing or aware to ask for advice (Syed & Mohammed,
2009).

To support the creation and growth of MSEs, management capacity building is a key aspect. Indeed,
without the necessary management skills, many viable companies with good product offers never
reach their potential or might even risk being led out of business, by competition or by lack of
treasury for example. The smaller the size of the MSE, the more the attitudes and managerial skills
of the head of the MSE are critical to ensure the success of the MSE and its potential growth. (Syed
& Mohammed, 2009).

The findings of Mulu (2009) also indicate that banks and micro finance institutions (MFIs) do not
seem to support MSEs expansion. Due to this 85% of the respondents have never received credit
from these formal sources. The availability of other informal sources of finance, however, affects
growth positively and significantly. This shows that in the absence of formal source of credit,
informal networks appear more appealing for MSE’s. Hence, firms with better network to borrow
from informal sources such as, relatives, friends, and suppliers better loosen credit constraints, and
grow faster. Lack of finance has been considered in many studies as a key success factor for MSEs
(Rolfe et al., 2010); (Mbonyane & Ladzani, 2011).

According to Lumpkin and Dess (1996) the business performance of MSEs are affected by its
business climate. As they noted that an unfavorable business climate has negative effect on small
firm performance and business profitability. Davidson (1989) identified that an unfavorable tax
system, complicated rules and regulations can heavily hamper small firms’ business performance.
Krasniqi (2007) showed that corruption is a major source of the rise in unfair competition. He further
emphasized that the cost of complying with regulations and increased tax rates increases small firms’
expenses while limiting their profitability.

Bianchini et al. (2017) propose an analysis of the differential effects of corporate governance on
firms' innovation across the firm age distribution. They find that the expected negative impact is
stronger for younger than for older firms. Their results suggest that young firms tend to privilege
short-termism and value preservation rather than long-term risky innovation strategies.

Following Coad’s literature review are six empirical papers. These are organized according to the
two themes of entrepreneurship and innovation. Entrepreneurship is a key area for age research.

21
Some scholars even define entrepreneurship in terms of age limits, (e.g. Van Praag and Versloot,
2007 define entrepreneurial firms as those aged less than seven years).

Anyadike-Danes and Hart (2017) provide a large-sample representative picture of how a cohort of
firms changes with age. Grazzi and Moschella (2017) focus on a specific breed of entrepreneurial
firm – young exporters. Cowling et al. (2017) address the liabilities of young entrepreneurial firms
by investigating how UK young firms fared during the recent financial crisis. Van Stel et al. (2017)
focus on how firm owners’ individual characteristics (in particular their start-up motive) and firm
age influence earnings.

The second main organizing theme is innovation. Regarding innovation, theoretical work has put
forward that young firms are more likely to perform radical innovation (Acemoglu and Cao, 2015).
However, how can young firms be expected to be more innovative when they have to start from
scratch, and lack capabilities, experience and routines?

Empirical work has therefore found mixed results for whether younger firms are more innovative
than older firms. How does the nature of innovation change with age? Cucculelli (2017) investigates
how several indicators of innovation change with firm age. Pellegrino (2017) looks at how barriers
to innovation change with firm age.

Within the group focused on economic performance, Anyadike-Danes and Hart (2017) provide a
detailed picture of survival rates, growth trajectories and net job creation by 239 thousand UK
private sector firms born in 1998, over their first 15 years of life. They show that age matters
critically for both survival and growth. Two thirds of firms die within the first five years after birth,
and although survival chances improve after age 5, only 10 percent of the cohort survive to age 15.

Equally, most firms which grow, grow in the first five years, and the fastest rates of growth are
recorded up to age 5 too. After age 5 the average growth paths of surviving firms are pretty much
flat. The authors also analyse the size-dependence of survival and growth conditional on age. The
finding on survival is that (given age) larger firms have a better chance of survival but, extending
this conventional result, they also show that when small firms grow, their survival chances improve.

The results on growth can be summarise quite simply: most firms in the cohort are born small – 85
percent with less than 5 jobs – and of those that survive age 15 most are still small – 60 percent with
less than 5 jobs. As far as most of the cohort survivors are concerned, firm performance is better

22
characterised as ‘neither-up-nor-out dynamics’, rather than the conventional formulation of ‘up-or-
out dynamics’. They find that job growth is concentrated at both ends of the size distribution. The
contributions to employment change are almost equally divided between a very small number of
very small firms (5 percent of the survivors born with less than five jobs) which grow extremely
rapidly, and a similar number of larger firms which grow relatively slowly.

Cowling et al. (2017) also focus on UK firms, by gathering data from the Small Business Survey.
They take sales and employment growth as performance indicators and apply an approach that fits
within the ecology frame described above. After observing that older firms were hit harder by the
2008 financial crisis, Cowling and colleagues investigate to what extent age and entrepreneurs’
experience interact in shaping the way SMEs coped with the effects of the crisis. Their results
suggest that entrepreneur experience had little fortifying effect in that specific macroeconomic
context, as owners’ commitment and involvement decreases as the firm ages, leading to a liability of
age where the firm relies too much on rigid routines and can less easily adapt to the crisis.

Van Stel et al. (2017) explicitly apply an evolutionary approach of learning and selection in their
focus on learning among surviving firms. The study focusses on whether start-up motives are
associated to differential entrepreneurs’ earnings, and to what extent the relationship between
entrepreneurs’ tenure and earnings is related to start-up motives. They use a large sample of
European entrepreneurs drawn from the European Community Household Panel (ECHP) covering
the period 1994-2001. Van Stel and colleagues investigate the effect of learning by the entrepreneur.
The longer a firm has survived, the more learning has arguably taken place, and this is reflected in
the entrepreneur’s earnings. In addition, they find that earnings of necessity entrepreneurs are
significantly lower than those of opportunity entrepreneurs, irrespective of the type of necessity
motive. Moreover, these differences remain rather stable over the course of the entrepreneur’s
business tenure, i.e., these differences are of a permanent nature.

Grazzi and Moschella (2017) investigate whether the export status of firms affects the patterns of
employment growth of firms across different age classes. They gather together a unique dataset
combining the universe of Italian firms and detailed information on export transactions. Their results
provide evidence on differences in how exchange rates affect young and experienced exporters. In
particular, early exporters appear to be better equipped than established firms to face exchange rate
variations, as their exports decrease less following a currency appreciation. The paper by Grazzi and

23
Moschella (2017) illustrates the complementarity of the ecology and evolutionary approaches: The
ability to engage in competition in foreign markets is a signal of high performance, and indeed
exporting firms grow more than other firms. However, Grazzi and Moschella also find that the effect
is stronger among young firms, suggesting that the selection process is working particularly
intensively among young firms. That the exports of young firms are less sensitive to exchange rate
fluctuations suggests that they rely less on price and more on other factors for their competitiveness.
This means that young firms are innovative, in a broad sense, while older firms are comparatively
rigid, as the ecology approach predicts.

Cucculelli, (2017) also focuses on the Italian evidence, but by looking at innovation as a
performance indicator. The analysis is based on an ad-hoc survey compiled through a questionnaire-
based interview, and financial data drawn from the Bureau van Dijk AIDA Database. Cucculelli
finds that the probability to introduce product innovations is affected by CEOs’ tenure and the
degree of maturity of the last product launched in the market. The mechanism is especially relevant
for new entrants vis-à-vis mature firms. In this sense, Cucculelli focuses on learning within firms,
and finds that aging implies building up resources and capabilities despite the fact that the simple
correlation between the incidence of product innovation and age are negative. After controlling for
time since last product innovation and tenure of the CEO, however, the correlation becomes positive.
Cucculelli’s analysis thus also demonstrates the complementarity between the ecology and
evolutionary approaches, as it is arguably the inertia created by a long tenured CEO and a long time-
span since previous innovations that decrease the firm’s tendency for product innovation.

Finally, Pellegrino (2017) also focuses on innovation as a performance indicator, and specifically on
firms’ perceived barriers to innovation. The study is based on the data from the Spanish Innovation
Survey (PITEC) for the period 2004-2011 and, as with the study by Cowling and colleagues,
Pellegrino’s analysis is particularly illuminating from an ecology approach. Pellegrino finds that
young firms seem to be more affected than mature ones by the internal and external shortages of
financial resources. This demonstrates the liability of newness as it suggests that a lack of legitimacy
and reputation entail that young firms struggle to access finance. Even more interestingly,
Pellegrino’s results document the maturation within firms as the data allow a distinction between
perceived and revealed obstacles, showing that a lack of skilled employees is a revealed obstacle for
firms in general, while only older firms actually perceive this. Finally, Pellegrino’s results
demonstrate the liability of obsolescence in that older firms tend to face obstacles related to demand

24
and market conditions, which indicates that they have not been able to keep up with the evolution of
the environment.

Overall, the Special Issue papers confirm that firm age is a relevant variable deserving appropriate
consideration in theoretical and empirical studies enquiring into the determinants of firms’
performance. Moreover, provided the observed concentration of positive performance in the early
years, the need for extensive and comprehensive datasets emerges, with an appropriate coverage of
young firms. Such datasets need to include detailed information on the members of organisations,
such as matched employer-employee datasets. This allows for further elaboration of the opposing
effects that age increases experience but also rigidity. Both mechanisms are established in the papers
in this Special Issue and their combined effects on performance in general is not certain.

The gathered evidence also bears policy implications. At a general level, it is clear that one-size-fits-
all policies supporting firms’ performances are not likely to be effective. Industrial policies should
be designed by considering firms’ and product life courses, sectors of activity, ownership structure,
and type of performance indicator that is targeted.

2.4 Conceptual Framework

Since business performance is influenced by many different factors, operators need to understand
factors that influence businesses performance of its operation as intended. Li et al. (2005) uses three
indicators to measure business performance, namely; efficiency, growth and profit. The company's
performance is a multi-faceted phenomenon which is difficult to measure (Aragon-Sanchez &
Sanchez-Marin, 2005). Factors that affect the performance of MSEs include management
skills(capital structure decision and cost management quality), entrepreneurial factors, finance,
business climate (politico-legal) and age (experience) of MSEs. Nevertheless, the factors must be
closely monitored to ensure that stringent measures are taken within the best time to either take
advantage of the opportunities or combat their threats. The relationship of independent and
dependent variables can be expressed and shown in the figure below.

25
 Capital
Structure
Decision
Management’s

Capacity Cost
Management
quality

MSEs
Entrepreneurial Factors
Financial
performance
Finance Source

Political – Legal Business

Climate

Age of Firm

Source: Own Depiction

Figure 1 Conceptual frameworks

26
 CHAPTER THREE

RESEARCH METHODOLOGY

3.1. Introduction

This chapter discusses the methodology and the research design which was applied to achieve the
objectives of this study. The chapter begins with a description of the research design, followed by
justifications to the chosen methodology. The research design includes details of the chosen study
population and sample, the design for data collection instruments and methods for data collection.

3.2. Research design

It is acknowledged that several options are available in social research but the choice of approach
depends largely on the objectives of the study. The study was employed a descriptive research
design. The main reason for using this design was due to the fact that this design is supposed to help
to briefly assess the major challenges encountering the MSEs sector development along with the
future prospects. Moreover, this design helped to briefly explain, other than simply describing the
existing performance of the sector.

3.3. Population Definition

Igbokwe (2009) defines population as those units for which the findings of the survey are meant.
From a statistical point of view, the term “population” refers to the total of items about which
information is desired. The attributes that are the object of study are referred to as characteristics and
the units possessing them are called as elementary units. The aggregate of such units is generally
described as population (Kothari, 2004). The population of the study comprises mainly those MSE
enterprises that are currently functioning across the study area, and those formally registered and
paid income tax by preparing financial statement for tax declaration.

3.4. Type and Source of Data

In this study relevant data were collected from secondary and primary data sources. Secondary data
was extracted from the last 3 year data of financial statement prepared for the purpose of income tax
declaration, collected form Arada sub-city revenue and custom authority and MSE agency. The
primary data source will obtain from the top management level of MSE owners in relation to the
major determinant that affect their profitability of MSE. The data was collected by survey method

27
using questionnaire and interview from the selected sample members of the selected MSE sectors
those operating their business in the study area. The study analyzed the effect of independent
variables over the growth of MSE in terms of profitability of MSE business that was used as
dependent variable in the study area.

3.5. Sampling Design

Stratified random sampling was used to get information from different sizes of the MSEs. This
technique was preferred because it is used to assist in minimizing bias when dealing with the
population. If a population from which a sample is to be drawn does not constitute a homogeneous
group, stratified sampling technique is generally applied in order to obtain a representative sample
(ed. Kothari 2004). The strata’s are sectors including: construction, service, manufacturing and trade.
Although there are no general rules, the sample size usually depends on the population to be
sampled. In this study to select sample size, first prepared a list of the population of MSEs those
formally registered for paying tax in the Arada sub city then the sample was selected randomly. The
sample size which was select from MSEs of manufacturing, construction, service, and trade was
considerers as representative and also large enough for precision, confidence and generalizability of
the research findings.

Based on Yemane (1996) sample size determination formula, it is possible to determine the sample
size, at 95 % confidence level and 0.05 precision levels.

Where:

n = number of observation=228

N = population size=529

e = sampling error/level of precision = 0.05

The total sample sizes of observations were calculated based on the above sample size determination
formula. This total sample size was proportionally distributed to each stratum.

28
Accordingly, 228 observations were selected from the total of 529 MSEs. Therefore, from
manufacturing (36), construction (45), service (66), and trade (81) were selected. The questionnaires
and interviews were administered on the sample of 76 and 20 operators respectively.

3.6. Data Collection Methods

To collect data the study used Mixed methods approaches that combining both qualitative and
quantitative techniques. Mixed methods encompass multifaceted approaches that combine to
capitalize on strengths and reduce weaknesses that stem from using a single research design. Using
this approach to gather and evaluate data may assist to increase the validity and reliability of the
research.

In order to realize the target, the study used well-designed questionnaire and interview. They were
completed by the owner managers/or operators of the enterprises. Face-to-face interviews held with
the MSEs operators/and the relevant owner managers who heads the enterprises in the selected
sectors. The interview method of data collection is preferred due to its high response rate. Through
interviews, clarification of issues is easily achievable leading to accuracy of data from the
respondents. The study also applied a well-designed Five point Likert scale questionnaire to gather
primary information; this was completed by owner managers of the MSEs.

The Secondary source of data for this research was used to collect quantitative financial data from
Balance sheet and income statements of MSE operators in the study area. The study used a
longitudinal data set for 3 year period from 2009-2011 E.C to analysis a given sample of MSE over
time, and thus provides multiple observations on each MSE in the sample. In the disciplines
of econometrics and statistics, panel data refers to multi-dimensional data that generally involves
measurements over some period of time. As such, panel data consists of researcher's observations of
numerous phenomena that were collected over several time periods for the same group of units or
entities (Howell, 2013).

3.7. Methods of Data Analysis

Analysis of data is a process of editing, cleaning, transforming, and modeling data with the goal of
highlighting useful information, suggestion, conclusions, and supporting decision making Igbokwe
(2009). Data from the field will edit and code appropriately to make meaning out of them. Editing

29
will do to correct errors, check for non-responses, accuracy and corrects answers. Coding will do to
facilitate data entering and a comprehensive analysis.

Data gathered through qualitative data tools ware analyzed through discussion under major thematic
areas, after the necessary pre-analysis task such as recording, transcribing and coding was made.
Quantitative data gathered through questionnaire and document review was analyzed using EVIEW
version 9. Both descriptive and inferential statistics ware used for analyzing quantitative data.
Specifically regression was used to compare the significance of the response of respondents.

Linear Regression Analysis

The study was use multivariate regression analysis to establish relationship between the independent
variables and the dependent variable by use of the following regression formula:

Yit β 0 + β 1 X it + β 2 X it + β 3 X it + β 4 X it + β 5 X it + β 6 X it +єi +Uit

Where:
Y Financial performance (Dependent Variable) represented by total revenue minus total
cost for i MSE at time t
X1-X6 Independent Variables
X1 Availability of entrepreneurial skills MSE i, in year t

X2 Capital structure of the MSE i, in year t

X3 Cost management quality of the MSE i, in year t
X4 Access to Finance MSE i, in year t
X5 Political- Legal business climate of the MSE i, in year t
X6 Age of MSE i, in year t

β0 Coefficient of the model

β 1–β 9 Beta Coefficient of Determination
ei Random disturbance term for each cross section which is constant over time
ui,t An error term which varies across each cross section and throughout time
3.8. Research Variables and Measurement

The selection of financial performance measures that reflect the true situation of micro and small
businesses with some degree of certainty and reliability is indeed a crucial process (Rami & Ahmed
2007, p.6). In this study, profit is used as a dependent variable to measure the financial performance
of MSEs. Here the change in profit is used as the measure of the dependent variable performance of
the enterprises involved in the survey. The independent variables for this study are entrepreneur

30
factors, capital structure, cost management quality, finance source, political and legal business
climate and age of the MSE.

Table 1 Operationalization and Measurement of Variables

Dependent Definition Measurement

Variable
Financial Is the act of performing; of doing something Profit = Total Revenue
Performance successfully; using resources – Total Cost
Entrepreneurial Refers to factors that include: need for Five point Likert scale
factors achievement, locus of control, motivation, risk (5 = strongly agree, 1 =
taking propensity, self- efficiency. strongly disagree)
Capital structure The Debt-to-Worth Ratio (or Leverage Ratio) is a Debt-to-Worth Ratio =
measure of how dependent a company is on debt Total Liabilities / Net
financing as compared to owner’s equity. It shows Worth
how much of a business is owned and how much is
owed.
Is an expense as a percentage of revenue
Cost-to-Income cost-to-income ratio =
Ratio (CIR) proxy (efficiency ratio). To get the ratio divide the operating costs/
operating costs by operating income
to CMQ operating income

Accesses to finance The ability of enterprises to obtain financial Five point Likert scale
services, including credit, deposit, payment, (5 = strongly agree, 1 =
insurance, and other risk management services. strongly disagree)
Political- Legal The existence of the necessary infrastructure which Five point Likert scale
business climate supports the control, direction or implementation of (5 = strongly agree, 1 =
a proposed or adopted course of action, rule, strongly disagree)
principle or law

Age of firm number of years the business in operation Number of years

31
 Chapter four

Data Presentation, Analysis and Interpretation

4.1. Introduction
In this chapter, data collected from sample respondents are presented and interpreted. To facilitate
ease in conducting the empirical analysis, the results of descriptive analyses are presented first,
followed by the inferential analysis. For the sake of convenience, related questions were treated
together. 90 questionnaires were distributed across the four MSE sectors of the Arada sub city, out of
which 76 were completed and collected back successfully, representing 84.4% response rate. Out of
the 90 questionnaires administered 14, 26, 19 and 31 were distributed to manufacturing, service,
construction and trade respectively. The numbers of questionnaires retrieved from manufacturing,
service, construction and trade are 12, 22, 15 and 76 which represents a response rate of 86%, 85%,
79% and 87% respectively.
In addition to primary data which collected by questionnaire and interview, the research employed
secondary data. MSEs ware observed over 2009-2011 periods, allowing us to collect panel data of
228 observations. Annual balance sheet and income statement reports of the sample MSEs.
Generally, this section is organized in the following manner: First, the general information about
MSEs were presented and analyzed. Second, data collected through questionnaires, interviews and
secondary source were analyzed concurrently. Moreover, the results of regressions analysis were
analyzed.

32
4.2. Background characteristics of the respondents

4.2.1. Demographic characteristics

Table 2 Demographic characteristics of respondent
Sex frequency percentage Marital status frequency Percentage
Male 52 64.40 Single 34 44.70
Female 24 35.60 Married 38 50
Age Divorce 3 3.90
Under 20 years 0 0 Widowed 1 1.30
20 – 35 years 46 60.50 Work
Experience
36 – 50 years 22 29.00 0 - 5 years 48 63.15
Above 50 years 8 10.5 6 - 10 years 19 25
Educational 11 - 20 years 7 9.20
qualification
Read and write 8 10.50 Above 20 years 2 2.60
High school complete 24 31.60
Certificate 3 3.90
Diploma 19 25.00
Degree and above 22 28.90
Source: Field survey, 2019
In this study 64.40% of the participants are male, whilst 35.6% are female. This result reveals that
more men are highly engaged in their own ventures than females. This finding could be pointing out
the reality that customarily men are the providers for their households; female take care of their
families. According to Woldle, Leighton and Adesua (2008:6), research on gender of
owner/manager tends to focus on the male owner/managers, as the proportion of businesses owned
by men exceeds those owned by women with most studies reporting that failure rates for businesses
owned by females are higher than those for male. Reasons for this include limited access to finance,
stringent collateral requirements, women’s double duties.
As shown in table 2 above, 60.50% of respondents are in the 20-35 age categories, 29% of
respondents are found in between age of 36-50 and 10.5% of respondents are over 50 years. The
respondents under age of 20 years were not found. Majority of the respondents are found in between
age of 20-35 which indicates MSEs which organized by governments are found in the young age.
According to Woldle, Leighton and Adesua (2008:6), the influence of the age of the owner/manager
advocates the younger owner/manager because the younger owner/manager has the necessary
motivation, energy and commitment to work and is more inclined to take risks, whereas the older

33
owner/manager is likely to have reached his/her initial aspiration. Hence, younger owners/managers
are more likely to sustain and grow their ventures than their older counterparts.
As shown in table 2 above, 31.60% of the respondents have completed high school education, 28.90
% of the respondents have degree and above, 25% of respondents‟ are diploma holders, 10.50 % of
respondents can read and write and 3.90% of have certificate level of education.The result displays
that majority of respondents are found at a satisfactory education levels, they are university
graduates, armed with diplomas, degrees and above qualifications.
Educational background of owners/managers are widely believed to be a key source of innovative
efforts because his/her attained education level is attributed to cognitive ability, capacity for
information processing, tolerance for ambiguity and propensity or receptivity to innovation
Umidjon, et al, (2014:13).
Pertaining to marital status of the respondents, 50 % are married, 44.70% are single, 1.30% widowed
and 3.90% divorced. Married and Single owners happened to be almost similar in number.
Revealing that, marital status does not affect ownership of an MSE.
Regarding work experience 63.15% of respondents have experience on their businesses for the past
five years, 25% of respondents are in existence for six to ten years. The respondents of 9.20% and
2.60% have business experience of 11 to 20 years and above twenty years respectively. The result
basically indicates that most of the MSEs are young in existence with less than five years in the
sector.

4.2.2. Business Characteristics of the respondents

Table 3 Business characteristics of respondents
Business sector Number Percentage Numbers of employees Number Percentage
manufacturing 12 15.78 0–5 57 75
trade 27 35.52 6 -30 17 22.37
construction 15 19.73 Above 30 2 2.63
service 22 28.94
other
Source: Field survey, 2019
Among the sampled sectors of SMEs the majority of them were engaged in trade 35.52% followed
by service which constitute 28.94%, construction and manufacturing constitute 19.73%, 15.78%
respectively.

34
Dividing MSEs by sector is believed to be very helpful in studying factors determining the
performance of the MSEs. This is because firms in different sectors of the economy face different
types of problems. That means the degree of those critical factors in manufacturing sector may differ
from the factors that are critical to service, construction and trade sectors.

The majority of enterprises having 0-5 employees constitute 75%, 22.37% of the enterprises employ
6-30 staff and only 2.63% enterprise have more than 30 employees. From this it can be understood
that the study covers 97.37% of the study samples were indeed micro and small enterprise. Micro
enterprise, according to the strategy in use, consist of employees (including the owner or family) not
greater than 5 and while small scale enterprise is an enterprise which has 6-30 employees (Federal
Democratic Republic of Ethiopia MSE strategy, 2011).

Table 4 Initial capital and Current capital of respondents

Capital range Startup capital Current capital
No % No %
Less than birr 50,000 38 50 5 6.60
Between birr 50,000 to birr 100,000 29 38.16 44 57.89
Between birr 100,000 to birr 1,500,000 4 5.26 18 23.68
Above birr 1,500,000 2 2.60 2 2.60
I do know 3 3.90 7 9.21
Source: Field survey, 2019

Figure 2 Initial capital and Current capital of respondents

Source: Field survey, 2019

35
 In this study, managers of MSEs were posed questions about the initial capital and their current
capital to see whether there is change on the size of the businesses. The number of enterprises having
initial capital of birr less than 50,000 were 38 and those having initial capital in between 50,000 to
100, 000 were 29, which has completely changed currently. The current trend, as it can be seen from
the above figure 2 is that the capital of the enterprises has increase.
As it can be seen from table 4 the number of enterprises within the range of less than 10,000 has
decreased from 38 to 6 which implies the businesses showed change in their capital which in turn
indicate the growth of the enterprises. The same thing was observed in those enterprises which had
capital of over 50,000. Initially they were only 29 but currently the number those enterprises are 47,
which is by far greater than those who indicated as their initial capital.

4.3. Analytic study on Factors Determining the financial performance of MSEs

4.3.1. Results from descriptive statistics

Table 5 Age and growth pattern of the Enterprises

Table 5. 5 a Table 5. 5 b
growth No of
Age trade service construction Manufacture sum pattern respondent
growing 64
3 to 5 years 7 9 11 9 36 stagnating 4
6 to 10 years 15 12 4 3 34 declining 1
above 10 years 5 1 0 0 6 bankrupted 0
I don't know 7
Sum 27 22 15 12 76 sum 76
Source: Field survey, 2019
Dual question concerning the MSEs age and growing pattern ware asked. A questions ware
formulated to establish whether there was relation between the business age and the variable
business financial performance. The questions were aimed at finding the extent to which number of
years the business in operation can affect the growing pattern of financial performance of the MSEs.
Business age was measured through the following categories: 3-5 years; 6-10 years and 11 years and

36
more. Enterprises which have the age of below three years excluded from the sample, because it is
difficult examine the growth pattern of these enterprises
The age of the sample MSEs in Arada sub city vary from sectors to sectors and the mean age is
approximated as 5.78 years. Among the respondent 7 firms have the age of below one year and 34
firms which are 44.73% of the respondent firm have the experience of 2 to 5 years and the rest 29
and 6 firm have 5 to 10 and above 10 years of age respectively.
Therefore 29 firms which are 38.16% have more than 5 years of experience and at the same times 64
respondents believe that their enterprise is growing in terms of capital. 4 respondents confirmed that
their business does not show any growth and progress rather it is stagnating; only one of the
respondent confirmed that their business is declining and 7 respondents do not know the status well.

Table 6 Sources of finance

Enterprises taken lone Number Percentage
Yes 24 31.58
No 52 68.42
Sources of finance
Personal saving 25 32.89
family 22 27.63
MFIs 10 13.16
Iqub/idir 8 10.53
Saving and creadit coopeatives 6 7.89
Family,Friends/relatives 3 3.95
NGOs 2 2.63
Commercial bank 1 1.30
Other 0 0
Source: Field survey, 2019
As can be seen from the table 6 among the sample MSEs only 31.58 % of respondent explain as they
take lone. Interns of sources of finance, personal saving (32.89%) are the most frequently used
sources, followed by family (27.63%), micro finance institutions (13.16%) Iqubi/Idir (10.53%),
saving and credit association(7.89%) friends/relatives 3.95%), NGOs (2.63%) and banks (1.30%) are
used by MSEs as sources of their finance. The results depicts that most of the respondents have

37
sacrificed by saving their hard earned money with a view of starting their own ventures to provide
for their families and create jobs.
Besides, interview responses reveal that majority of MSEs in the study area use informal sources.
The formal financial institutions have not been able to meet the credit needs of the MSEs. According
to majority interviewee, the reason for emphasizing on informal sector is that the requirement of
collateral/guarantor is relatively rare since such sources usually take place among parties with
intimate knowledge and trust of each other. But the supply of credit from the informal institutions is
often so limited to meet the credit needs of the MSEs.

Table 7 Challenges in accessing loan

challenges in accessing loan Number Percentage
high collateral requirements 83 36
high interest rate 58 25.44
short time for loan repayment 43 18.86
No/limited institution willing to give loan 25 11
long bureaucracy to secure loans 11 4.82
difficulty in developing business 8 3.50
do not know where to ask 0 0
Other 0 o
Sum 228 100
Source: Field survey, 2019
As shown in table 7 above Respondent those taken loan and Those who did not taken any
loan/finance for their development were asked to identify the possible problem that constrain them to
access finance and have autonomy to choose top three challenges if they face all stated constraints.
Accordingly majority of the respondents indicated the top four significant challenges. They are
higher collateral requirements by money lender institutions 83(36%), high interest rate for loan
58(25.44%), short time loan repayment period 43(18.86%) and 25(11%) counted for limited or no

38
institution willing to provide loan for MSEs. In addition long bureaucracy to secure loans and
difficulty in developing business plan are the hindrance indicated by the SMEs owners/managers.
To wind up, such constraint of finance for MSE affects their performance directly or indirectly.
There are studies which support this finding. Lack of financial resources is often reported as the
major obstacle and limiting factor that is experienced by SMEs in developing countries. Therefore,
funding is a problem (Millicent & Reginald, 2014:61). Moreover financial institutions find it
difficult to provide funding to SMEs because most small businesses do not have assets to secure
collateral securities (Moaisi, 2005:18). However, according to Wiese (2014:37), the ultimate source
of finance was gained through spouse/partner salary, government pension, income from another job,
and family contributions

Table 8 Ranking Business registration process

Ranking Business Trade Trade TIN Certification of

VAT
registration process licensing Name issuing Competency (COC)
very simple 61.84% 76.12% 0 1.30% 0
simple 38.16% 21.25% 0 15.10% 0
difficult 0 2.63% 66.21% 57.52% 19.31%
very difficult 0 0 33.79% 26.13% 80.58%
Source: Field survey, 2019
Enterprises has been requested to rank how the business registration process is working, accordingly,
61.84% of the respondent ranked getting trade licensing very simple, 76.12% of the respondent
ranked getting trade name very simple and 1.30% of the responded ranked getting VAT registration
as simple. Whereas the respondent somehow leveled getting certification of competency, Tin issuing
and somehow VAT registration as difficult and very difficult. The responded also requested to
justify the difficult level of the above three requirement and the result presented herewith on table 9
Table 9 Business registration process
Reason for difficulty Business registration process TIN issuing VAT COC
high time consuming 22.36% 18.42% 59.21%
requires a lot of money 7.89% 10.52% 81.58%
misunderstand of requirements for registration 36.84% 43.42% 19.74%

39
mixed message from government office 38.16% 47.37% 14.47%
Source: Field survey, 2019
Respondents were asked different questions regarding the factors determining the financial
performance of MSEs in Arada sub city and their responses are organized in the following manner.
There are a number of challenges that determine the performance of MSEs in association with
different factors. This part explains the descriptive statistics calculated on the basis of the factors that
determine the performance of MSE. The results of measures of central tendency and dispersion were
obtained from the sample of respondents of manufacturing (M), service(S), construction(C) and
trade (T) are presented in the following table.

4.3.2 Management and expertise skills that determine financial performance of MSEs
Table 10 Management and expertise skills factors that affect the performance of MSEs
Management and expertise M S C T Total
M SD M SD M SD M SD M SD
skills

Lack of clear division of duties 3.83 1.21 3.91 1.37 4.47 1.10 3.59 1.32 3.92 1.25
and responsibility among
employees
Poor organization and 3.42 1.66 3.59 1.52 4.20 1.13 3.67 1.21 3.7 1.38
ineffective communication
Lack of well trained and 3.50 1.40 3.73 1.54 4.53 0.99 3.52 1.22 3.82 1.29
experienced employees
Lack of low cost and accessible 3.75 1.31 4.05 1.18 4.38 1.02 3.69 1.16 3.97 1.17
training facilities
Lack of strategic business 3.58 1.50 3.73 1.18 3.60 1.70 3.74 1.11 3.66 1.37
planning
Grand mean/standard deviation 3.81 1.29
Source: Field survey, 2019
As shown in table 10 above, Lack of clear division of duties and responsibility among employees is
the main problems that hinder the performance of MSEs. It shows a mean score of 3.83, 3.91, 4.47

40
and 3.59 with a standard deviation of 1.21, 1.37, 1.10 and 1.32 for MSEs engaged in manufacturing,
service, construction and trade respectively. Therefore, the average score of the respondents with
regard to, Lack of clear division of duties and responsibility among employees indicates their
agreement with considerable deviations among them. To the contrary, the respondent of all sectors
are neither ‘agree’ nor ‘disagree’ with the issue of poor organization and ineffective communication.
The mean scores and standard deviations clearly show that they are almost undecided. That is means
of 3.20, 2.92, 3.05 and 2.81 with standard deviations of 0.95, 0.96, 0.1 and 0.99 for MSEs
manufacturing, service, construction and trade respectively.
The table also shows lack of well trained and experienced employees is the problem of operators
engaged in manufacturing, service, construction and trade with mean score of 3.50 and 3.73,4.53 and
3.52 with standard deviations of 1.40,1.54,0.99 and 1.22 respectively. With regard to strategic
business planning the mean scores are 3.58, 1.50, 3.60 and 3.74 with standard deviation of 1.50,
1.18,1.70 and 1.11 for operators engaged in manufacturing, service, construction and trade
respectively. This shows that MSEs have a problem with developing and implementing the strategic
planning activities successfully. Likewise, in relation to costly and inaccessible training facilities, the
table above shows that, the mean score of 3.75, 4.05,4.38 and 3.69 with standard deviation of
1.31,1.18,1.02 and 1.16 for MSEs engaged in manufacturing, service, construction and trade
respectively.
It is argued from a theoretical perspective that management experience and continuous training
provide a particular entrepreneur with the necessary skills and competences needed for successful
entrepreneurship Enock N., (2010). With adequate education mixed with management experience
and training puts a manager in a better position to make tough decisions and forecasting under
conditions of uncertainty which in turn with those competencies making these particular managers
perform better than untrained individuals.
In this regard in an interview conducted with operators of MSEs, it was confirmed that they had
many management problems which stem from factors such as poor record keeping, insufficient
training and lack of relevant qualifications. Furthermore, most of these enterprises operate without
systems in line with good management practice in which the owner manager is the sole decision
maker and his/her absence leads to a halt (temporarily stop) in decision making. Similarly,
interviewees unanimously indicated that, inability (low technical skills) to troubleshoot failures on

41
 machinery and/or equipments is a critical problem. Since the operators of MSEs cannot afford to
employ specialists in the fields of maintenance with technical knowledge.
Coming down to the matter of lack of a proper business plan for the business, in an interview
conducted with operators, it was confirmed that operators of MSEs have no proper business plans at
start faces the most challenges during the course of their lives. According to operators, lack of trust
in doing business on the other hand seems to have prevailed in most of the cooperative and
partnership business (mistrust between business associates). As evident in the study eleven have had
a case of distrust among members of cooperatives and partners in their particular business.
To conclude, all these managerial constraints were confirmed by the respondents in this survey who
indicated that their businesses were constrained by poor management practice, mistrust among
business associates, insufficient training, lack of proper business plan and lack of relevant
qualifications among employees.

4.3.3. Entrepreneurial factors that affect the financial performance of MSEs

Table 11 Entrepreneurial factors that affect the performance of MSEs
Entrepreneur factors M S C T Total
M SD M SD M SD M SD M SD
Lack of motivation and drive 3.83 1.30 3.68 1.41 4.33 1.02 3.26 1.34 3.78 1.27
Lack of tolerance to work hard 3.75 1.60 3.73 1.44 4.42 0.94 3.41 1.44 3.82 1.36
Lack of persistence and courage to 3.58 1.28 3.82 1.34 4.47 0.80 3.63 1.17 3.87 1.15
take responsibility for ones failure
Absence of initiative to assess ones 3.92 1.34 3.93 1.19 4.60 0.64 3.85 1.22 4.07 1.10
strengths and weakness
Lack of entrepreneurship training 3.92 3.82 1.21 4.33 0.90 3.81 1.10 2.46 1.16

Lack of information to exploit 3.50 1.28 3.82 1.16 4.40 0.78 3.89 1.14 1.90 1.09
business opportunities
Grand mean/standard deviation 3.65 1.19
Source: Field survey, 2019
Among the entrepreneurial factors, lack of persistence and courage to take responsibility for ones
failure scores the highest mean as 3.58, 3.82, 4.47 and 3.63 with standard deviation of 1.28,
1.34,0.80 and 1.17 manufacturing, service, construction and trade respectively.
The second most important factor that affects the performance of MSEs is absence of initiative to
assess ones strengths and weakness. Their mean score of 3.92, 3.93, 4.60 and 3.85 with standard

42
deviation of 1.34, 1.19, 0.64 and 1.22 for owners engaged in textile and garment, food processing
and wood and metal work respectively. This shows that the operators of all sectors agreed with that
they have faced the problem of assessing their weaknesses and strengths.
Furthermore, the arithmetic mean and standard deviation indicates that lack of entrepreneurship
training is the third entrepreneurial factors that hinder the success of entrepreneurs employed in all
sectors. Given that a mean score of 3.92, 3.81,4.33 and 3.90 with standard deviation of 1.21, 0.95
and 1.10 for MSEs engaged manufacturing, service, construction and trade respectively. Regarding
lack of information to exploit business opportunities, the mean of 3.50, 3.82,4.40 and 3.89 with
standard deviation of 1.28, 1.16, 0.78 and 1.14 for an operator engaged in manufacturing, service,
construction and trade respectively. Thus, it may be concluded that lack of information to exploit
business opportunities is the fourth factor that hinder the performance of MSEs engaged in four
sectors.
As opposed to this, the table 11 shows that lack of motivation is not a serious problem of operators
engaged in three sectors. The disagreement on this factor is justified by the calculated means of 2.38,
2.46, 2.51 and 2.49 with standard deviations of .96, .89 and .85 for operators engaged in
manufacturing, service, construction and trade respectively. However, the table indicates that lack of
tolerance to work hard moderately hinders the performance of MSEs operated in manufacturing,
service, construction and trade with means of 3.75, 3.73, 4.42 and 3.41 and a standard deviations of
1.60, 1.44, 0.94 and 1.44 respectively.
Starting with lack of motivation and drive, this has to do with the main reason(s) for the
entrepreneur(s) establishing the business and the relationship of this with the performance of the firm
(Enock N., 2010:39). In an interview conducted with an operator of MSEs, few (two) interviewees
replied that lack of motivation and drive affect the performance of MSEs. Even though the results in
this study show only two operators whose business is constrained by lack of motivation and drive, it
has been proven that this is a major constraint to many small business owners. A study by Bark Ham
shows a positive relation between motivation of the entrepreneur(s) and the performance of the firm;
in other words the more positive motivation of the entrepreneur(s) the more likely the business will
grow Bark H. R., (1992).
According to interview conducted with operator it was confirmed that, lack of tolerance to work hard
and absence of initiative to assess ones strengths and weaknesses are another factor affecting the
performance of MSEs. According to them this is due to negligence on the part of employees and/or

43
 owner managers to develop and implement such a culture of tolerance and assessment of strengths
and weaknesses. Amazingly, all of the interviewees confirmed that, lack of persistence and courage
to take responsibility for ones failure (low level risk taking) is the main entrepreneurial factor that
affects the performance of MSEs.
Lack of entrepreneurial training was mentioned by operators in the entire study area. According to
interviewees, it featured as a key problem in all sectors. A number of interviewee respondent felt that
enough training in entrepreneurship would better prepare to perform in their business endeavours.
Furthermore, with regard to lack of information to exploit business opportunities interview was
conducted with operators of MSEs. It was confirmed that, the operators do not heightened the ability
and awareness for recognizing and audaciously exploiting business opportunities. According to
them, this is due to lack of persistently and continually seeking of information opportunities.
Consequently, it hampers the performance of MSEs and the fulfillment of competitive urges in
general.

4.3.4. Politico-legal factors that affect the financial performance of MSEs

Table 12 Politico-legal factors that affect the financial performance of MSEs
Politico-Legal Factors M S C T Total
M SD M SD M SD M SD M SD
The tax levied on my business is not 3.58 1.28 3.82 1.29 4.53 0.86 3.78 1.22
3.93 1.16
reasonable
Bureaucracy in company registration 4.08 1.20 3.91 1.40 3.93 1.06 3.96 1.09
3.97 1.19
and licensing
Lack of government support 3.75 1.35 3.86 1.26 3.93 0.87 4.0 1.07 3.89 1.14
Political intervention 4.00 3.36 3.93 3.81 1.08 3.78 0.27
Lack of accessible information on 3.92 1.18 3.82 1.11 4.33 0.76 3.74 1.24
government regulations that are 3.95 1.07
relevant to my business
Grand mean/standard deviation 3.90 0.97
Source: Field survey, 2019

As it is indicated in table above, the mean and standard deviation for the politico-legal factors were
calculated. The table shows the bureaucracy in company registration and licensing has a mean score
of 4.08 with a standard deviation of 1.20 for manufacturing, mean score of 3.91 with standard
deviation of 1.40 for service, mean score of 3.93 with standard deviation of 1.06 for construction and

44
mean score of 3.96 with standard deviation of 1.09 for trade. Therefore, it may be concluded that
bureaucracy in company registration is the main factor that affects the performance of all sectors.
This is followed by average score of the respondent’s response with regard to unreasonable tax and
related issues.
According to the table 12 above, enterprises engaged in Manufacturing, service, construction and
trade, the tax levied on their business is not reasonable. The agreement on the non-reasonability of
the tax amount is justified by the calculated means of 3.58, 3.82,4.53 and 3.78 with standard
deviation of .95, .93,086 and .99 respectively. The mean score 4.00 and 3.98 and standard deviation
0.93and 0.99 shows that, the operators of Manufacturing and construction in MSEs agree with the
problem related to political intervention around their working areas. But, the business owner
manager engaged in service, and trade were neither ‘agreed’ nor ‘disagreed’ with this problem.
Furthermore, the table indicates that lack of government support is another problem that affects the
performance of enterprises engaged in Manufacturing, service with a mean of 3.94 and 3.77 and
standard deviation of .80 and .87 respectively. But, respondents of service, and trade were disagreed
with the factors related to lack of government support. The mean score and standard deviation
clearly shows their disagreement. That is mean of 2.49 and standard deviation of 1.22 for owner
manager engaged in service, and trade sector. Lastly, the table indicates that the owner managers
engaged in all sectors are neither ‘agreed’ nor ‘disagreed’ with related to lack of necessary
information on government regulations. That is a mean score of 3.32, 3.28, and 3.18 with standard
deviation of .91, .89 and .95 for an operator engaged in Manufacturing, service, construction and
trade respectively.
Furthermore, the politico-legal environments were mentioned among the key constraints to
enterprises in the field survey, it is recognized that some respondents are classified as the major
constraints to enterprises. Even when opportunities have been created, MSEs have not been able to
draw the full advantage due to absence of appropriate policy support. According to interviewees,
there still exists an overly bureaucratic government system that often results in unnecessary delays in
compliance and is excessively costly. This includes a complex system, lengthy procedures and rules.
For example, registration of a business, getting working places, payment of stamp duty among
others. For enterprises found in Arada sub city, this poses a major challenge and cost as the owners
of the business would need to close for days in order to travel to concerned governmental offices to
access these services sometimes without success. Operators believe that these requirements force

45
enterprises to operate informally, which greatly limits their opportunities for growth, or to go out of
business.

4.3.5. Financial factors that determine the financial performance of MSEs

Table 13 Financial factors that determine the financial performance of MSEs
Finance factors M S C T Total
M SD M SD M SD M SD M SD
Inadequacy of credit institutions 3.92 1.14 4.36 1.37 4.67 0.68 4.26 1.02 4.30 1.05
Lack of cash management skills 3.50 1.21 3.68 1.24 4.27 1 3.48 1.22 3.73 1.17
Shortage of working capital 3.92 1.26 4.39 0.89 4.47 0.86 4 1.12 4.20 1.03
High collateral requirement 3.75 1.30 3.73 1.25 4.08 1.32 4 1.34 3.89 1.30
from lending institutions
High interest rate charged by 4.25 0.84 4.36 0.88 3.80 0.90 4.04 1.15 4.11 0.92
lending institutions
Loan application procedures are 4.08 0.91 4.55 0.59 3.60 1.10 4.19 1.09 4.11 0.92
too complicated
Grand mean/standard deviation 4.06 1.07
Source: Field survey, 2019
With regard to inadequacy of credit institutions, the mean scores are 3.92, 4.36, 4.67 and 4.26 with
standard deviations of 1.14, 1.37, 0.68 and 1.02 of those operators engaged in manufacturing,
service, construction and trade respectively. From this it can be inferred that the inadequacy of credit
institution is a main problem in performance of MSE. In relation to shortage of working capital, the
mean score are 3.92, 4.39, 4.47, and 4.00 with standard deviation of 1.26, 0.89, 0.86, and 1.12 for
operators engaged manufacturing, service, construction and trade respectively. However, with regard
to factors like high interest rate charged by lending institutions and complicated loan application
procedures of institutions have the same grand mean scores of 4.11. When they are separately seen,
the mean scores are 4.25, 4.36, 3.80 and 4.04 and with standard deviations of 0.84, 0.88, 0.90, and
1.15 for high interest rate charged by lending institutions and 4.08, 4.55, 3.60, and 4.19 with
standard deviations of 0.91, 0.59, 1.10, and 1.09 for manufacturing, service, construction and trade

46
respectively. However, lack of cash management skills is considered as a least factor in determining
performance of MSEs by respondents. It has mean score of 3.52, 3.63, 4.27 and 3.47 with standard
deviation of 1.21, 1.24, 1.00 and 1.22 for operators of manufacturing, service, construction and trade
respectively.
Operators were interviewed to give their opinion on the nature of problem related to financial
factors. It was found that, mainly the operators usually suffer of shortage of cash leading to their
inability to cover their daily needs adequately. The shortage of cash leads not to use their potential in
the market. The other cause of this low cash presence at the disposal of the operators could be the
increasing expense incurred by their respective MSEs in relation to purchase of raw materials and
services such as transportation, in addition to cost of utilities consumed both at home and work
place. The operators frequently mitigate this problem of cash shortage through borrowing and
lending each other. The other mechanism of easing such cash shortage is through diversification of
income generating activities.
The presence of affordable credit is essential for enterprise growth. With regard to credit access and
availability, there are both formal and informal sources serving the operators in the studied area. The
informal sources consisted of loan from other fellow operators, family, relatives and friends.
According to responses from the operators, the capital generated from such sources, along with a
loan secured from friends and own savings constitute a portion of the start-up capital of the MSE.
Credit and saving association and MFI are the formal source of credit used by operators, though
there are other financial service providers like state-owned and private commercial banks.
Even if many writers including Vandenberg support the already established opinion on micro-
finance that holds a view that micro-finance is a useful way of channeling finance to the poor and
overcoming the difficulties, they face challenges in securing credit from formal financial institutions
such as banks (Vandenberg, 2006:33). It was identified from interviewee that the terms and
condition of credit and saving share company is not suitable to the operators as the its fixes short
repayment period with higher interest rate and service charge of total up to 20% which is very
difficult for MSEs to afford. Obviously, such high loan cost further damages the already low market
share and revenue of the enterprises. On the other hand, the interviewees‟ pointed that the short
repayment period scheduled by the MFI put them in worrisome state as they face shortage of market
resulting in their inability to repay the loan with in the period stipulated by the MFI. Given the
market problem of the MSEs, it is fair to suggest the MFI to effectuate a grace period policy‟.

47
Majority of interviewees stated that they frequently use informal sources as main sources of fund
suggesting the requirements of collateral and loan application procedures are relatively low or none
in case of informal sources. Intimacy and trust of each other used as security in the form of collateral
guarantee. In conformity with the finding, according to Terfasa et al., (2016:30) the problem of
access to finance is more severe for MSEs as the loan requirement of microfinance institutions
(MFIs) is complicated. A large proportion of both micro and small enterprises do not apply for a
loan or credit due to cumbersome bureaucracy, limited working premises, and high collateral
requirement. Similar to this finding supported by other study, most SMEs prefer to use personal
savings and contributions from relatives because they find it very difficult to access financing from
micro financial institution and commercial banks due to strict requirements such as collateral
security and high repayment costs Mbugua (2014:18).

4.3.6. Cost Management quality that affects the financial performance of MSEs
Table 14 Cost Management quality that affects the financial performance of MSEs
Cost Management quality M S C T Total
M SD M SD M SD M SD M SD
We charge lower price than our 3.08 0.9 2.95 0.95 3.07 0.88 3.07 0.91 3.04 0.91
competitors
We heavily invest in sales 3.16 0.8 3.09 0.86 3.0 0.65 3.03 0.93 3.07 0.81
promotion
We emphasize on cost cutting 2.6 0.82 2.3 0.70 2.67 0.9 2.4 0.97 2.49 0.85
and internal efficiency program
Our major expenditure is on 4.08 0.8 2.5 0.96 4.13 0.64 2.19 0.95 3.23 0.84
technology based delivery system
to lower costs
We outsource functions to 1.4 0.9 1.93 1.28 4.41 0.51 1.58 1.16 2.33 0.96
control costs
Grand mean/standard deviation 2.83 0.87
Source: Field survey, 2019
As it can be observed from the above Table 14, regarding charging lower price than competitors and
heavily invest in sale promotion, on average respondents are at neutral agreement level. The sample
respondents responded that they disagree with the application of cost cutting and internal efficiency
program in their company score lowest mean as 2.6, 2.3, 2.67 and 2.4 with standard deviation of
0.829, 0.7, 0.9 and 0.97 for manufacturing, service, construction and trade respectively. On average

48
manufacturing and construction enterprises’ respondent are at agree the mean value of 4.08 and 4.13
with standard deviation of 0.08 and 0.64 level of agreement respectively on question about major
expenditure is on technology based delivery system to lower costs. Whereas trade and service
enterprises’ said that they disagree with the mean score of 2.19 and 2.50 with standard deviation of
0.95 and 0.96 respectively.
As one can observe from the above table, out of all respondents except construction enterprise with
mean score of around 2 of them said that they strongly disagree with the idea that said their company
applies outsource functions to control costs; but construction enterprise respondents responded that
they strongly agree with idea of outsource functions to control costs strategy at mean score of 4.41
with 0.56 deviation form average in their company.
The researcher use secondary data for this study, according to Tharmila & Arulvel (2013) secondary
data is a type of data that have been previously collected for some other project rather than the one at
hand but found useful by the researcher. The researcher collected financial statements particularly
balance sheet and income statement for a period covered three years (2009-2011 E.C). The reason
behind the researcher considers only three years data is difficulty to collect many years’ data because
of time and enterprise specific constraints. The reason behind using secondary data is because of the
information for this topic is accessible from secondary data sources and also, secondary data is easier
to use and together with primary data tends to be more comprehensive and also useful for the
researcher to concentrate on the data analysis and interpretation. Therefore the study use revenue,
cost debt and equity data from secondary source to manipulate profit, cost-to- income ratio and
capital structure of the MSEs
Capital structure is a combination of debt and equity. It can be measured by current ratio (liquidity
ratio) that indicates a MSE's ability to pay short-term obligations or those due within one year. It
tells how a MSE can maximize the current assets on its balance sheet to satisfy its current debt and
other payables.

49
Table 15 Cost-to-Revenue Ratio
Std.
Mean Median Maximum Minimum Dev. Observations
Revenue 0.69642 0.68555 1.21172 0.29687 0.204844 228
Cost 0.038201 0.03805 0.05725 0.0095 0.01057 228
Profit 0.65822 0.65093 1.17308 0.27608 0.201229 228
Cost-to-revenue ratio 0.05736 0.056 0.09 0.018 0.016325 228
Source: own computation from sample MSEs financial report
As it is presented in table 15, the expenses as a percentage of revenue (efficiency ratio )indicates,
with a few variations – it is essentially how much a MSEs spends to make a birr; entities are
supposed to attempt minimizing efficiency ratios (reducing expenses and increasing earnings). This
result indicates that on average, MSEs spends approximately 0.057 cents to earn a birr with a
maximum of 0.09 and the minimum of 0.018. This indicates the most efficient enterprise spent on
average 0.018 cents to make a birr and the least efficient enterprise spent on average 0.09 cents to
earn a single birr.
The mean value of financial performance was measured by financial profit which is total revenue
minus total cost of the companies. This result indicates that on average, from 0.696 birr revenue
0.038 amount is cost of the enterprise and the remaining 0.658 is profit with the maximum and the
minimum rage of profit 1.17 and 0.28 respectively. The volatility of profit on revenue and cost from
the mean value which measured by standard deviation and it shows 0.2 implies that, profit deviate
from its mean by 0.2 in to both sides.

4.3.7. Capital Structure that affects the financial performance of MSEs

The debt-to-equity (D/E) ratio is calculated by dividing a MSE’s total liabilities by its owner(s)r
equity. These numbers are available on the balance sheet of a MSE’s financial statements.The ratio
is used to evaluate MSE’s capital structure. It is a measure of the degree to which a MSE is financing
its operations through debt versus wholly-owned funds. More specifically, it reflects the ability of
owner equity to cover all outstanding debts in the event of a business downturn. Therefore The
researcher divide total debt to total equity to see if there is any different effect and took them as a
measure of capital structure. From 76 sample MSEs only 24 of respondent was take lone and three
years (2009 to 2011E.C) data was collected form those MSEs thus 72 observation is used to analysis
capital structure of the MSEs.

50
Table 16 Debt-to-equity (D/E) ratio
Observatio
  Mean Median Maximum Minimum Std. Dev. ns
0.041 0.030 0.223 0.026 0.058 72
equity 11 55 00 21 40
0.000 0.000 0.043 0.000 0.001 72
Debt 63 14 95 01 90
D/E 0.015 0.004 0.197 0.000 0.032 72
ratio 22 65 10 31 51
Source: own computation from sample MSEs financial report
Debt equity ratio has a mean value of 0.015, this indicates that MSEs financed their total assets
through equity,and the debt portion the asset is very small amount 1.5%. It also deviates from the
mean by 0.325 in to both sides. This is due to the only long-term source of financing available to
Ethiopian MSEs is direct borrowing from Ethiopian commercial banks, but this source is also
difficult to get finance easily because of very restrictive policies and high level of debt guaranties
required. As evidenced by Melese (2013) Ethiopian firms are largely depends on restricted loans of
financial institutions and no other source such as raising capital from equity or debt market are
available since there are no established capital markets in the country. This kind of relation also
detects by other researcher on different sectors and different countries like as Abor (2005).

4.4 Correlation Analysis

Here in this section the associations of independent variables with the dependent variable of
financial performance as well as the independent variables themselves were analyzed and discussed
by using a correlation matrix. As described by Brooks (2008), correlation measures the extent of
linear relationship between two or more variables. If two variables are correlated, it doesn’t mean
that one variable affects the other and vice versa, rather it means that they are being treated
completely in the same manner. Similarly speaking, once we are sure for a linear association
between the two variables and on average their movements are related to an extent which is given by
the correlation coefficient. A correlation coefficient of two variables ranges between -1 and +1. A
correlation coefficient of negative one implies that a perfect negative linear relationship between the
two variables while positive one indicates a perfect positive linear association. On the other extreme,
a correlation coefficient of zero indicates that the absence of any linear relationship between two

51
variables. Table 17 below presents a correlation matrix which shows the degree of linear relationship
between the dependent and independent variables of the study.

Table 17 Correlation Matrix of Dependent and Independent Variables

Covariance Analysis: Ordinary
Sample: 2009 2011
Included observations: 228
Correlation
  PROFIT CS CMQ ENT
PROFIT 1      
CS -0.176829 1    
CMQ 0.364853 -0.440569 1  
ENT 0.066035 0.010707 0.038023 1
FIN 0.295135 0.511295 -0.652409 -0.077857
PO-LEG -0.008045 0.055195 -0.453673 -0.098955
AGE 0.506441 -0.181308 0.1909 0.073706
Source: own computation through EVIEW 9

According to the correlation matrix above table 17 and respective significance levels; explanatory
variables of Capital structure, Cost Management quality, Entrepreneurial skills, Access to Finance,
Political- Legal business climate, Age found to have a significant linear association with the
dependent variable of Financial performance. From these independent variables age, Cost
Management quality and financial factors found to have a strongly significant positive correlation
with financial performance; whereas capital structure appeared a negative and statistically significant
association with the dependent variable.
Even though the correlation analysis gave some hints on what factors to relate with financial
performance of MSEs in Arada sub city,Addis ababa, a more detail discussion of results and
conclusions to be made based on the multiple regression analysis results due to that regression is
more powerful as well as flexible tool than correlation (Brooks, 2008).

4.4.1 Model Specification Test

The first step before running a regression analysis and thus to investigate significant factors that can
affect financial performance of MSEs, in Arada sub city of Addis Ababa is to specify an estimation
model. As noted by Thomson et.al. (2013) panel data can be estimated using four distinctive
estimation models including pooled cross section estimation, fixed effect estimation, random effect
estimation, and first difference estimation techniques. As per Brooks (2008), pooled regression

52
estimation assumes that the intercepts are the same for each firm and throughout each year of
observation period. This could be improper assumption, because it might create firm specific effect
called heterogeneity which is constant over time. On the other hand, in first difference estimation the
intercept and the unobserved effect are differenced away. Moreover in first difference estimation we
have to lag the model one period and subtracted it from the original model to obtain a first difference
equation. But, first difference panel estimation is appropriate if and only if a strong autocorrelation
between the residuals observed.
According to Brooks (2008), among others the two most widely used panel estimation approaches
that can be appropriate for a research in the area of finance are fixed effects model and random
effects model. Fixed effects model allow the intercept in the regression model to differ throughout
cross-sections but not over time, whereas all of the slope estimates are fixed both for individual cross
sections as well as over time. Random effects model also known as the error components model, as
of fixed effects; propose that different intercepts for each cross sections that do not vary over time,
with the relationships between independent and dependent variables assumed to be the same both for
each cross-section and over time. However, the difference between the two is that under a random
effects model, the intercepts for each cross-sectional unit are assumed to arise from a common
intercept α (which is the same for all cross sections as well as over time), plus a random variable ε i
that varies crosssectionally but not over time.
As per Brooks (2008), the random effects model is more proper when the cross sections in the
sample are randomly selected from the population; while a fixed effect model is more efficient when
cross sectional units in the sample effectively comprise the entire population. More specifically, the
GLS transformation procedure involved under the random effects model will not eliminate the
explanatory variables that are constant over time, and then their impact on the dependent variable
can be accounted. Furthermore, since there are fewer parameters to be estimated in random effects
model (due to the absence of dummy variables) and thereby degrees of freedom are saved, the
random effects model should yield more efficient estimation than the fixed effects one. Moreover,
random effects model is appropriate if number of cross sections is larger and time period
observations are smaller, and if the assumptions underlying random effects model hold, random
effect estimators are more efficient than fixed effect estimators Gujarati, (2004). On the other hand,
the random effects approach has a major problem that it is appropriate only when the composite
error term is not correlated with all of the independent variables. This assumption of random effect is

53
more stringent than its correspondent one in the fixed effects occasion, because with random effects
we thus require both cross sectional error term and new individual observation error term to be
uncorrelated with all explanatory variables. This can also be interpreted as a consideration of
whether any unobserved omitted variables (that were allowed to have different intercepts for each
cross section) are not correlated with the selected explanatory variables. If error terms and
independent variables are not correlated, a random effects model can be better to use; if not the fixed
effects one is appropriate (Brooks, 2008).
In order to test validity of the above assumption there by to choose appropriate model for the study,
a hausman test was carried out by the researcher. The hausman test as presented below tests the null
hypothesis of random effects model is appropriate against the alternative that makes fixed effects
model appropriate. So, if the probability of hausman chi-square is less than 0.05, the researcher
could use fixed effects model otherwise random effects could be used.

Table 18 Correlated Random Effects - Hausman Test

Chi-Sq.

Test Summary Statistic Chi-Sq. d.f. Prob.

Cross-section random 8.997180 5 0.4483
Source: own computation through EVIEWS 9 based on random effects estimation result

As shown in table 18 above, the probability of chi-square statistics for a hausman test is 0.1092,
which is insignificant to reject the null hypothesis, in support of random effects estimator. So,
regression analysis and discussion of results in the next sections of this paper were made based on a
random effects model of panel estimation.

4.4.2 CLRM Assumptions and Diagnostic Tests

One last step before discussing the results of a regression analysis thereby to conclude about what
factors to determine financial performance of MSEs was to assure that whether the model was
consistent with classical linear regression model (CLRM) assumptions. Basically, there are five
major assumptions underlying CLRM as described by Brooks (2008). The first of this assumptions
required that the average value of an error terms to be zero. This assumption is no more vulnerable
for violation, if a constant term is included in the regression equation. The second assumption holds
that variance of the error terms is constant. This second assumption is known as the assumption of
homoscedasticity. If the variance of the errors is constant, it is said to be homoscedastic. On the

54
other hand, the violation of this assumption is known as heteroscedasticity. The test associated with
this assumption also called heteroscedasticity test. The third assumption stated that covariance
between the error terms is zero over time for time series data or over individual cross sections, for
cross sectional data. Similarly speaking, this assumption holds that the errors are uncorrelated with
one another. If the errors are correlated with one another, they are known to be ‘autocorrelated’ or
‘serially correlated’ and the test to detect such problem is called autocorrelation tests. The fourth
major assumption that underlies CLRM stated that the explanatory variables are not correlated with
the errors of an estimated model. Whereas, the fifth and the last major assumption of CLRM hold
that the disturbances are normally distributed. To check whether the disturbances are normally
distributed, a normality tests can be made.
Beyond the above five major assumptions, there are also other few important implicit assumptions
that bounds CLRM. The first one is that the explanatory variables are not correlated each other. If
there is no relationship between the explanatory variables, they are known to be orthogonal each
other. If explanatory variables highly correlated each other, it is called a multicllinearity problem.
This problem can be checked by running a multicollinearity test. The second implicit assumption
holds that the appropriate ‘functional form’ is linear. This implies that the appropriate model is
assumed to be linear in the parameters as well as in the bivariate case, the relationship between the
dependent and independent variables can be depicted with a straight line. The linearity and
appropriateness of a functional form can be tested using Ramsey reset test. The third implicit
assumption of CLRM is that the parameters or coefficients of regressors are constant for the whole
sample, both for the data period used for model estimation, and for any subsequent period used in
the construction of estimations. This assumption can be tested using parameter stability tests
(Brooks, 2008).
The researcher of this study employed four diagnostic tests with respect to four major CLRM
assumptions. These four tests were normality heteroscedasticity, autocorrelation, and
multicollinearity tests. Consequently, the following section presents the discussion of results from
such diagnostic tests.

4.4.2.1 Normality Test

The assumption of normality holds that the disturbances of a regression equation are normally

distributed. The normality can be fulfilled with a bell shaped distribution which has a kurtosis of 3

55
and a skeweness value of 0. As per brooks (2008), the most widely applied test for normality is a

Bera Jarque or BJ test. Accordingly the researcher employed this test in order to check normality by

using random effect regression output.

Figure 1 Normality Test- BJ

50
Series: Standardized Residuals
Sample 2009 2011
40 Observations 228

Mean 1.22e-16
30 Median -0.003778
Maximum 0.284573
Minimum -0.186157
20 Std. Dev. 0.090822
Skewness 0.221097
Kurtosis 3.057745
10
Jarque-Bera 1.889258
Probability 0.388824
0
-0.2 -0.1 0.0 0.1 0.2 0.3

Figure 3 Normality Test- BJ

Source: Own computation through EVIEWS 9 based on random effects regression result
The normality can be safe until the probability of BJ is in excess of 0.05, which means the null
hypothesis of normally distributed error terms is not to be rejected. On the other hand, if the p-value
of a BJ test is below 0.05, the null hypothesis of normally distributed error terms to be rejected.
Thus, as figure 1 depicts above, the probability of BJ is 0.389, which is sufficiently in excess of 0.05.
So, the null hypothesis was not to be rejected, confirming that the residuals were normally
distributed.

4.4.2.2 Heteroscedasticity Test

In order to assure whether the model used for this study is in line with the assumption of
homoscedasticity, a heteroscedasticity test was conducted by the researcher. Specifically, the
researcher conducted the most popular test for hetroscedasticity; namely white’s general test for
hetroscedasticity. As per Brooks (2008), white’s test is particularly useful because it makes fewer
assumptions about the possible form of heteroscedasticity. Table 19 below presents a white’s general

56
test for hetroscedasticity, with a null hypothesis (H0): variance of the error terms is constant (i.e.
there is homoscedasticity) by using 5% significance level of test.

Table 19 Heteroskedasticity Test: White

F-statistic 7.943802 Prob. F(50,9) 0.0012

Obs*R-squared 58.67057 Prob. Chi-Square(50) 0.1875

Scaled explained SS 44.79032 Prob. Chi-Square(50) 0.6819

Source: own computation through EVIEWS 9 based on a regression result

As it is shown above, table 19 presents three different versions of a heteroscedasticity test; including
F-test, chi-square (LM), and Scaled explained SS‟ versions of tests. P-value for the F-version of the
test was 0.0012, which is significant even at 1% level, implying that the null hypothesis of
homoscedasticity is to be rejected. While the other two versions of the test; chi- square (LM) and
Scaled explained SS‟ versions were not significant to reject the null hypothesis of homoscedasticity
because they were in excess of 0.05. In other word, based on F- test there was a problem of
heteroscedasticity; whereas based on the chi-square (LM) and Scaled explained SS‟ versions there
was no evidence for heteroscedasticity problem. According to Brooks (2008), if only one of the three
versions of white‟s heteroscedasticity test is significant, the decision of the test will be ambiguous.
But, as used by various empirical studies including Solomon (2012) and Abate (2012), the most
widely employed and dependable test is the chi-square (LM) version. Thus, depending only on the
LM version of a test presented in table 19, the null hypothesis of homoscedastic error terms is not to
be rejected, indicating that heteroscedasticity was not a serious problem for this study.

4.4.2.3 Autocorrelation Test

Autocorrelation test is a test that can be used to check whether the errors are uncorrelated each other,
thereby to assure whether the model was in line with the fourth assumption that required not serially
correlated error terms. The researcher of this study applied a Durbin Watson or DW test in order to
detect the problem of autocorrelation. As per Brooks (2008), DW test is a valid test until three
conditions are met. First, there must be a constant term in the regression equation. Secondly, the
explanatory variables of a model must be non-stochastic (i.e. not correlated with the error terms).
The third and final condition to be met, in order to use a DW test as a valid test for autocorrelation is

57
that there must be no lags of the explained variable in the equation. The model used for the purpose
of this study met the above three conditions. As a result, DW test was used by the researcher to
detect autocorrelation.
As Brooks (2008) stated, the non-rejection region for a DW test is between the upper limit (i.e. dU)
and 4 minus the upper limit (i.e. 4-dU). More specifically if DW is equal or near to 2, there is no or
little evidence of autocorrelation between the residuals. Similarly speaking, the null hypothesis
would not be rejected if DW is equal or near 2. On the other hand, if the DW test falls between dL
and 0, the null hypothesis of no autocorrelation is to be rejected in favor of positive autocorrelation.
If DW falls between 4-DL and 4, the null hypothesis of no autocorrelation will be rejected in favor
of negative autocorrelation of residuals. However, if the DW test result is between the upper critical
value dU and the lower critical value of dL, the null hypothesis of no autocorrelation will neither be
rejected nor not rejected.
The DW test value from the random effect regression output of this study as presented in table 21
was 1.89. From DW table, critical values of dL and dU for 6 regressors and 228 observations at 5%
significance level, is 1.43 and 1.83 respectively. Thus, the DW stat of 1.89 falls beyond dU of the
upper boundaries. Consequently, the null hypothesis of no autocorrelation was not rejected.

4.4.2.4 Multicollinearity Test

To recall that one of among implicit assumptions of CLRM is orthogonality, which required the
independent variables of the study to be uncorrelated each other. In order to assure this implicit
assumption, the researcher of present study used a correlation matrix of explanatory variables as
presented in table 20 below.

Table 20 Covariance Analysis: binary

Sample: 2009 2011
Included observations: 228

58
Correlation
  CAP COST ENT FIN PO AGE
CS 1          
CMQ -0.44057 1        
ENT 0.010707 0.038023 1      
FIN 0.511295 -0.65241 -0.07786 1    
PO-LEG 0.055195 -0.45367 -0.09896 0.126532 1  
AGE -0.18131 0.1909 0.073706 0.060289 0.179936 1

Source: own computation through EVIEWS 9 based on financial statements of MSEs report
As per Gujarati (2004), multicollinearity is a severe problem if the correlation between two
independent variables is greater than 0.8. But, as it is shown in table 20 above, the highest
observed correlation for explanatory variables of this study was -0.65 between finance and cost
variables, which is below 0.8 and can be reasonably ignored. Thus, there was no evidence of near
collinearity among explanatory variables. In other word, multicollinearity was not a serious
problem for this study.

4.5 Regression Analysis and Discussion of Results

Here in this section of the study, the regression analysis presented which is followed by discussion
of results obtained from the analysis based on random effects model of panel estimation. Thus, the
next sections represent regression analysis and discussion of results from which conclusion to be
made about factors influencing the Financial Performance of MSEs Arada Sub City of Addis
Ababa.

To recall from chapter three the model used throughout this study which equates explanatory
variables with the dependent variable is:

Yit β 0 + β 1 X it + β 2 X it + β 3 X it + β 4 X it + β 5 X it + β 6 X it +єi +Uit

Where:
Y Financial performance (Dependent Variable) represented by total revenue minus total
cost for i MSE at time t

59
X1-X6 Independent Variables
X1 Availability of entrepreneurial skills MSE i, in year t

X2 Capital structure of the MSE i, in year t

X3 Cost management quality of the MSE i, in year t
X4 Access to Finance MSE i, in year t
X5 Political- Legal business climate of the MSE i, in year t
X6 Age of MSE i, in year t

β0 Coefficient of the model

β 1–β 9 Beta Coefficient of Determination
ei Random disturbance term for each cross section which is constant over time
ui,t An error term which varies across each cross section and throughout time

In order to choose from the most widely used panel estimation models of random effects and fixed
effects models, the researcher employed a hausman test of correlated random effects. The hausman
test result as it is shown in table 18, suggested that random effects model was appropriate and
preferable than the fixed effects one. So, the regression analysis as well as discussion of results
regarding factors that influence financial performance of MSEs Arada Sub City of Addis Ababa was
made based on the random effects estimation results which is presented in table 21 below.

Table 21 regression analysis

Dependent Variable: PROFIT
Method: Panel Least Squares
Sample: 2009 2011
Periods included: 3
Cross-sections included: 76
Total panel (balanced) observations: 228

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 Variable Coefficient Std. Error t-Statistic Prob.  

C -0.089134 0.005443 -16.37614 0.0000

CS -0.083520 0.010475 -7.973526 0.0000
CMQ 0.058072 0.002369 24.50963 0.0000
ENT 0.009775 0.001869 5.230075 0.0000
FIN 0.614117 0.022927 26.78555 0.0000
PO-LEG 0.053345 0.004883 10.92513 0.0000
AGE 0.000463 0.000145 3.200952 0.0016

R-squared 0.843441    Mean dependent var 0.038201

Adjusted R-squared 0.839190    S.D. dependent var 0.010570
S.E. of regression 0.004239    Akaike info criterion -8.058955
Sum squared resid 0.003970    Schwarz criterion -7.953668
Log likelihood 925.7209    Hannan-Quinn criter. -8.016475
F-statistic 198.4342    Durbin-Watson stat 1.895950
Prob(F-statistic) 0.000000

Table 21 above displays the estimates of the multiple regression of financial performance against its
variables for the sample of 228 observation. The question which states that the internal
environments, the external environment and age of MSEs whether affect or not the financial
performance of MSEs sectors of Arada sub city is tested at p-value is less than 0.05. It was
discovered that the all independent varable included in the model do play a significant role in
determining the financial performance of MSEs at A p-value of 0.01 percent.
Table 21 further shows that, all the explanatory variables included in this study can significantly
explain at 99% confidence level to the variation on the dependent variable. In a model summary, the
R-Square value is used to indicate the strength and direction of the relationship between the
variables. The closer the value gets to 1, the stronger the relationship. In this case as shown above,
R-Square = 0.8434. This means there was an overall strong and positive relationship between the
variables. This value indicates that the independent variables (entrepreneurial skill, accesses to
finance, capital structure, cost management quality, political legal business climate, and age) can
explain 84.34% of the variance in the financial performance of businesses in Arada sub city. The
remaining 15.66 % of the variance is explained by other variables not included in this study. The
Coefficients of determination under the Coefficients column in table 21 were used to substitute the
unknown beta values of the regression model. The beta values indicated the direction of the
relationship. A positive or negative sign indicates the nature of the relationship. The significant

61
values (p-value) under prob. column indicate the statistical significance of the relationship or the
probability of the model giving a wrong prediction. A p-value of less than 0.05 is recommended as it
signifies a high degree of confidence.
From the results it can be seen that a p-value of entrepreneurial skill, accesses to finance, capital
structure, cost management quality legal and regulatory framework, and age are less than 0.01.
These variables have direct and strong relationship with micro and small enterprises financial
performance. Besides, Capital structure, with p-value of -0.0000 was significant at 1% level to affect
financial performance and had a negative impact on financial performance
As these are standardized we can compare them. Thus, the largest influence on the financial
performance of MSEs is from the financial factor (0.614) and the next is capital structre factor
(0.083). On the other hand cost management quality with the beta value of (0.058) and political legal
factor has the beta value of (0.0533). age as factor of expirance has the poorest predictor of
performance when it is compared with the other explanatory variables under study.

CHAPTER FIVE

CONCLUSION AND RECOMMENDATOINS

5.1. Summary
This study was undertaken to assess the financial performance of MSEs. To this end, the study
examined relevant literature, the national micro enterprise development strategy and programs and
carried out primary study to attain the intended objective.
The study was mainly on MSEs, which actively engaged business activity in Arada sub city in Addis
Ababa. Accordingly, 76 MSEs were included in the study and the nature of data used by this study
ware primary data which collected through quesionary and interview and secondary a panel data
mainly composed of financial statements of sample MSEs over the period of 2009-2011 EC.

62
 The study measured the performance of enterprises in terms of financial profitability. Detailed
description and analysis together with multiple regression analysis was applied using financial profit
as the dependent variable and entrepreneurial skill, accesses to finance, capital structure, cost
management quality, political legal business climate, and age as independent variables. The results
showed that all variables were statistically significant at 0.05 significance level and had positive
relationship with the financial performance of enterprises.

5.2. Conclusion
This research was conducted with the prime intent of critically assessing the factors influencing the
financial performance of MSEs engaged in manufacturing, construction, service and trade sectors
working in Arada Sub City of Addis Ababa. Specifically, the study attempted to examine the
External facters (Access to Finance, Political- Legal business climate), Internal factors (management
capacity (Capital structure and Cost Management quality), Entrepreneurial skills) age of the firm
affecting the performance of MSEs.
It can be concluded that the good financial performance of MSEs in their occupied business was the
result of generation of higher revenue from their business than costs incurred. As the findings of this
study indicates that the mean score of 0.658 birr profit generating form a birr of revenue, with 0.2
deviations from its mean. However, it can be concluded that there exists a gap of financial resources
for the startup and expansion of MSEs which is not easily and equally accessible to all entrepreneurs
in the sub city under this study. The formal financial institutions are not easily accessible because of
their large collateral requirement and high rate of interest, and these situations led MSE owners and
operators to use more of the informal financial resource mobilization mechanisms and personal
savings. The lack of financial resources to finance business enterprises is the major factor affecting
the performance of MSEs owned or managed by many entrepreneurs in the area.
Business startup environment and registration process found to be simple specially, getting trade
license and trade name considered as very simple and simple; In addition to this VAT registration,
process measured as simple. However, respondents confirmed that TIN issuing and getting
certificate of competence cited to be the most pressing challenges. The requirements of getting
certification of competency is not clearly know by the respondents and/ or there are different mixed
messaged directed in this matter; as a result, majority of the respondents noted that VAT registration,
getting TIN identification number, certification of competency as a challenging tasks. Government
legislation and directives either not clear or copiously applied to all micro and small enterprises.

63
When I observe the entrepreneurial characteristics of MSEs, the data result indicates that most of the
enterprises are not entreprenrual oriented. As shown in the data analysis, they agree with the mean
score of 4.07 as they have not initiative to assess their strength and weakness;’ more than half of the
respondents are at agree the mean score of 3.87 and 3.82 on question about Lack of persistence and
courage to take responsibility for their failure and Lack of tolerance to work hard respectively

Capital structure variable measured with debt-to-equity (D/E) ratio (debt divided by equity); found
to have a positive and statistically significant impact on financial performance MSEs in Arada Sub
City of Addis Ababa. The results of the study show that capital structure variable had a significant
negative effect on MSEs financial performance. This means when debt equity ratio increase, their
financial performance would decrease. So it implies that, most profitable MSEs were those
maintaining a low proportion of debt in their capital structure. This may resulted due to high lending
interest rate. The result also consistent with some of previous empirical studies conducted in
Ethiopia.

Regarding cost management quality variable the empirical evidence from this study infers that
expenses as a percentage of revenue (efficiency ratio )has significant and positive effect on the
financial performance of MSEs. Thus, results of the empirical analysis direct us the existence of
efficient cost management practices lead to financial success of the MSEs.
The outputs of this research also reveal that age enables MSEs to develop organizational practices to
be able to perform their activities with more efficiency and better performance. Nevertheless,
younger companies suffer from missing consolidated practices meaning that innovation needs
further attention and work from the organizational learning process. This finding was consistent
with the previous study. Aiken & Hage, (1971)

5.3. Recommendations
On the basis of the major findings of the study, the following recommendations are forwarded with
the view to improve the contributions of MSEs to the country in general and to the study area in
particular.
Although savings are one of the means of accumulation of capital, often savings alone cannot be
sufficient for running and expanding business operations. Thus, there is a need for creating lines of
credit. In order to facilitate access to credit for women owned and operated MSEs, banks and MFIs
need to allocate a certain portion of their loanable funds for women MSE entrepreneurs. This has to
be supported by special lending and repayment arrangements. Thus, in order to address the problem

64
of credits financial institutions, the Federal government, the city administrations and development
partners should jointly devise ways to create lines of credit and special windows for assisting MSEs.
It is very important that the regulatory framework that affects business activities and those
influencing MSEs, be revisited regularly to create an enabling environment. MSEs should also be
quick enough to adapt themselves with the competitive and dynamic environment in which they are
operating. The strengthening of government institutions at different levels would play a major role in
positively influencing the development of MSEs, thus to reduce delays in processing legal
requirements. The government through various relevant departments should specialize more in
taking up a facilitative role, especially by reviewing all the blockings by laws, to address issues of
getting a license or getting a premises on which to operate. A number of factors should be
considered in designing all-encompassing policy for the promotion of the sectors.

The analysis indicated that MSEs utilized lower debt for their growth opportunities and lower long
term debt proportion in their capital structure. Considering the current growth opportunity for MSEs
in Ethiopia, internal sources of fund might not be enough. Therefore, it is advisable not depending
on only internal sources of fund available. Since having reasonable proportion of long term debt in
the capital structure is considered as a priority for growth in developing countries and it helps them
to utilize the market opportunity available.
To summarize, even if the majority of enterprises found in the study area currently survived and run
their business, the survival status of the enterprises is the primary and necessary condition to exist in
the business, but it is not sufficient and satisfactory condition to transform them into medium and
higher level of enterprises. High level of performance builds the capacity of enterprises to attain the
intended goals of tangible reduction of unemployment and poverty alleviation. Therefore, concerned
government authorities should strengthen their efforts in such a manner that a continuous follow ups
and backstopping of enterprises is ensured until they can stand by their own and grow to the next
level.
The above-mentioned recommendations have been suggested by the researcher. Thus, MSE business
owners/ managers and concerned stake holders should consider them as part of a solution to prevent
or minimize MSEs ran from failure and to keep these basic economic entities on a sustained in their
respective sectors of operation.

65
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7. Appendices
Appendices 1 Questionnaire

ETHIOPIA CIVIL SERVICE UNIVERSITY

COLLEGE OF FINANCE, MANAGEMENT AND DEVELOPMENT
DEPARTMENT OF PUBLIC FINANCIAL MANAGEMENT AND
ACCOUNTING
Part One Introduction

I am a graduate student in Civil service University. Currently, I am undertaking a research entitled

‘Factors Influencing the financial Performance of Micro and Small Enterprises in Arada subcity of

73
Addis Ababa’. You are one of the respondents selected to participate on this study. Please assist me in
giving correct and complete information to present a representative finding on the current status of the
factors affecting the performance of Micro and Small enterprises in Arada sub city of Addis Ababa. Your
participation is entirely voluntary and the questionnaire is completely anonymous.
Finally, I confirm you that the information that you share me will be kept confidential and only used for
the academic purpose. No individual’s responses will be identified as such and the identity of persons
responding will not be published or released to anyone. All information will be used for academic
purposes only. Thank you in advance for your kind cooperation and dedicating your time.
Sincerely,
Mulugeta Wondimu

Part Two: Biographic details

1. State your gender: A Male B Female
2. In what age group below do you belong?
A Under 20 years B 21 – 35 years C 36 – 50 years D over50 years
3. Indicate your educational qualification below:
A Read and write B High school complete
C Certificate D, Diploma E Degree and above
4. Marital status
A Married B Single C Divorced D Widowed
5. How many years work experience do you have?
A. 0 - 5 B. 11 – 20 C 6-10 20 D above
Part Three: Status of the Enterprise
1. . Type of business (sector and sub-sector), Circle one of the below choose
A. Manufacturing sector B. Trade sector
C. Construction sector D. Service sector
E Other service, Specify ----------------------------------------------------
2. Indicate the number of employees working in your business
A. 0 - 5 B. 6 - 30 C. Above 30
3. Is the business formally registered? A, Yes B, No
4. What was your Start- up capital?
A. Less than birr 50,000 B. Between 50,000 to 100,000
C. Between 100,000 to 1,500,000 D Above 1,500,000 D I do not know
5. . What is the current capital of your business
A. Less than birr 50,000 B. Between 50,000 to 100,000
C. Between 100,000 to 1,500,000 D Above 1,500,000 D I do not know

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 6. Ownership form of the current enterprise? Circle one of the list below
A. Sole proprietorship B. Partnership
C. MSE s Cooperative D. Private limited co. (PLC)
E. share company F. other, please specify------
7. Number of owners of enterprise currently? Male _________ Female_________
Part Four Research Related Questions
1. How many years your company been in operational? -----------years
2. How do you label the pattern of growth of the enterprise?
A. Growing B. Stagnating C. Declining
D. bankrupted E. don’t know the status
3. Have you ever taken any loan? A. Yes B. No
4. If your answer for the above question number 3 is “B=No”. Please explain why
A. Do not want to take loan B. No institution willing to provide loan for MSE
C. Higher interest rate D. High collateral requirements
E. Short time for loan repayment F. Don’t know where to ask
G. Other, Specify -------------------
5.. If you get loan, where have you get loan? You can choice more than one answer (Circle your
choice)
A. MFIs B. Loan from family
C. debt association (iquib) D. saving and credit cooperatives
E. From Commercial Bank F. Other, Specify -------------------
6. What are the top three challenges in accessing loan?
A. high interest rate B. high collateral requirements
C. long bureaucracy to secure loans D. short time for loan repayment (<
three years, Very short
E. difficulty in developing business plan and feasibility study F. do not know where to ask
G. No/limited institution willing to give loan H. Other, Specify ------------------
7. How would you rank each of the following business registration process? Rank from 1 to 5 on the
black space
Trade licensing ________ 1. very simple
Trade Name ________ 2. simple
TIN issuing ________ 3. difficult
VAT ________ 4. very difficult
Certification of Competency (COC) _______ 5. I do not know

8. Refer question # 7 and for the most difficult, and very difficult can you explain why?
Trade licensing ________ 1. high time consuming
Trade Name ________ 2. requires a lot of money
TIN issuing ________ 3. misunderstand of requirements for registration

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VAT ________ 4. mixed message from government office
Certification of Competency ___ 5. other specify---------------------------------

The major factors that determine the financial performance of MSEs are listed below. Please indicate
the degree to which these factors are affecting the financial performance of your business enterprise.
After you read each of the factors, evaluate them in relation to your business and then put a tick
mark (√) under the choices below. Where, 5 = strongly agree, 4 = agree, 3 = undecided, 2 = disagree
and 1= strongly disagree.

9. Please indicate the degree to which you agree with the following statements concerning Management and
expertise skills factors.

No Management and expertise skills 5 4 3 2 1

1 Lack of clear division of duties and responsibility among employees

2 Poor organization and ineffective communication

3 Lack of well trained and experienced employees
4 Lack of low cost and accessible training facilities
5 Lack of strategic business planning

10. Please indicate the degree to which you agree with the following statements
concerning Entrepreneur factors.
No Entrepreneur factors 5 4 3 2 1
1 Lack of motivation and drive
2 Lack of tolerance to work hard
3 Lack of persistence and courage to take responsibility for ones
failure
4 Absence of initiative to assess ones strengths and weakness
5 Lack of entrepreneurship training
6 Lack of information to exploit business opportunities

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 11. Please indicate the degree to which you agree with the following statements
concerning Cost Management quality
Cost Management quality 5 4 3 2 1
1 We charge lower price than our competitors
2 We heavily invest in sales promotion
3 We do not emphasize on cost cutting and internal efficiency program
4 Our major expenditure is on technology based delivery system to lower costs
5 We outsource functions to control costs
12. Please indicate the degree to which you agree with the following statements concerning
Politico-Legal Factors
Politico-Legal Factors 1 5 4 3 2 1
The tax levied on my business is not reasonable
Bureaucracy in company registration and licensing
Lack of government support
Political intervention
Lack of accessible information on government regulations that
are relevant to my business
13. How do you rate the profitability of the MSEs
Indicator of financial performance 5 4 3 2 1
1 The business is Profitable
2 There is a good Sales turnover
3 There is capacity to pay obligations
14. Please indicate the degree to which you agree with the following factors that have a direct influence on the
financial performance of your business?

No General Factors 5 4 3 2 1
1 Management and expertise skills
2 Entrepreneur factors
3 Cost management quality
4 Capital structure factor
5 finance
6 Politico- legal

Appendices 2 Interview Questions Interview questions with MSE operators

1. What problems did you face while running MSEs in relation to:

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  Management and expertise skills (lack of clear division of duties and responsibility among
employees , lack of well trained and experienced employees, lack of strategic business
planning , poor organization and ineffective communication)

 Entrepreneur factors (lack of motivation and drive, lack of persistence and courage to take
responsibility for ones failure, lack of entrepreneurship training, absence of initiative to
assess ones strengths and weakness)

 Resources and finance(inadequacy of credit institutions, shortage of working capital , Lack of

cash management, high collateral requirement from banks and other lending institutions
skills ,high interest rate charged by banks and other lending institutions

 Politico-legal (bureaucracy in company registration and licensing, corruption is as facilitator

in business,)

2. What are other problem(s) faced regarding the overall functioning of business activity?

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