UNIVERSITY OF ZIMBABWE

GRADUATE SCHOOL OF MANAGEMENT

DISERTATION TITLE: The impact of financial management practices on the

performance and growth of SMEs in Zimbabwe a case study of Harare.

PROGRAMME: MBA 3.1 (Strategic Management)

STUDENT NAME: Chengetai Zviuya (R113773Y)

SUPERVISOR: Dr. T Zinyama

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 Chapter II

LITERATURE REVIEW

2.1 Introduction

This chapter reviews the literature on past researches that have been conducted and

academic sources from authorities that write on issues surrounding the financial

management of SMEs. This literature review provides theoretical and conceptual

frameworks in financial management and the empirical evidence for the study. This

enhances the understanding of the problem area. Ultimately, the literature review will also

be relevant to the research objectives and questions.

2.2 Explanation of the search strategy for the literature

Creswell and Creswell (2017) postulated that the major purpose of reviewing literature is

to determine what has already been done that relates to the research topic. It should be

defined by a guiding objective, or problem being discussed. Literature review also surveys

books, scholarly articles and other sources which the researcher is going to use that are

relevant to this particular area of research or theory and by so doing, will provide a

description, summary and critical evaluation of these works in relation to the research

problem being solved (Berg and Lune, 2017). The literature review for this study has been

gathered mainly from secondary sources such as academic journals, past research studies,

government publications, newspapers and books.

2.3 Definition of phenomenon.

SMEs play an ever-increasing role in both industrial structures of developed and

developing countries in the current global economy including the Zimbabwean economy.

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There is consensus among economists and academics that the development of SMEs in

Zimbabwe will catapult economic growth and poverty alleviation (Chinakidzwa and Phiri,

2020). SMEs make significant contribution to the economies of both developing and

developed countries (Nyoni and Bonga, 2018; Manyati and Mutsau, 2019; Sithole, Sithole

and Chirimuta, 2018). However, there is a gap in information regarding the dynamics of

SME performance and growth in Zimbabwe. In the present uncertain market conditions,

considerable focus has been put on the survival of SME businesses. One of the critical

issues encountered by SMEs is the lack of professional financial expertise to guide their

decision-making. Many promising SMEs have burnt out because of not managing their

cash flows properly. An understanding of the impact of financial management practices

constraining the performance and growth of SMEs in Zimbabwe therefore warrants

investigation.

Definition of key terms

2.3.1 Small and Medium-sized Enterprises

There is no universally accepted definition of SMEs (Sallem et al, 2017), from the Africa

perspective, an SME is a firm employing 0-250 employees (Mamman et al, 2019). A

business with a turnover of less than US$2million with a maximum number of 100

employees.

2.3.2 Entrepreneur

One who assumes the financial risk of the initiation, operation and management of a given

business undertaking. Someone who organises a business venture and assumes the risk for

it (Honohan and Beck, 2017).

2.3.3 Financial Management Practices

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These can be defined as the planning, organizing, directing as well as controlling the

financial activities including procurement and the adequate use of the funds of the

enterprise (Bilal, Naveed, and Anwar, 2017).

2.3.4 Financial Prudence

Having complete knowledge about the money you have and how you can make it grow

best (Klyton and Rutabayiro, 2018).

2.3.5 Growth

The process of developing or of increasing in size.

2.3.6 Performance

The accomplishment of a given task measured against present known standards of

accuracy, completeness, cost, and speed (Eniola. & Entebang, 2015).

2.3.7 Portfolio

It is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash

equivalents, as well as their fund counterparts, including mutual, exchange-traded and

closed funds.

2.3.8 Impede

Delay or prevent.

2.3.9 Sustainable

To be maintained at a certain rate or level.

2.3.10 Payables

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 These are debts owed by a business i.e. liabilities.

2.3.11 Profitability

It is the ability of a business to make a profit after taking into account all the operating

costs.

2.3.12 Maximisation

The act of raising to the highest possible point or condition or position.

2.3.13 Critical Success Factors

These are areas of activities that should receive constant and careful attention from

management (Bilal, Naveed, & Anwar, 2017).

2.3.14 Risk Management

Process of identifying and analysing risks to the achievement of the organisation's

objectives and of determining the appropriate response to mitigate the risks.

2.4 Theoretical Framework

A theoretical framework is the ‘blueprint’ or guide for a research (Creswell and Creswell,

2017). It is a framework based on an existing theory in a field of inquiry that is related

and/or reflects the hypothesis of a study. It is a blueprint that is often ‘borrowed’ by the

researcher to build his/her own house or research inquiry. It serves as the foundation upon

which a research is constructed. Cao and Shi (2021) compared the role of the theoretical

framework to that of a map or travel plan.

The theoretical framework offers several benefits to a research work. It provides the

structure in showing how a researcher defines his/her study philosophically,

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 epistemologically, methodology and analytically (Blackbur, Carey, and Tanewski, 2018).

Huerta, Petrides, and O’Shaughness (2017) concur that the theoretical framework assists

researchers in situating and contextualizing formal theories into their studies as a guide.

The theories evaluated in this research are financial management theories, which attempt to

describe how entrepreneurs can better manage their business finances to ensure the success

and growth of their businesses. The following theories are going to be discussed;

I. The Pecking Order Theory,

II. Modern Portfolio Theory, and

III. The Contingency Theory.

The chosen theories, especially the Pecking Order Theory and Contingency Theory try to

bring out how managing the financial aspect of SMEs will have on performance and

growth of these SMEs. These theories are also expected to help in bringing out the

importance of financial management practices, although most SMEs tend not to adopt

these practices.

2.4.1 The Pecking Order Theory

Myers & Majluf (1984) developed the Pecking Order Theory, which states that firms have

a preferred hierarchy for financing decisions. According to this theory, managers follow a

hierarchy to choose sources of finance. The hierarchy gives first preference to internal

financing. If internal financing were not enough, then managers would have to shift to

external sources. They will issue debt to generate funds. After a point when it is no longer

practical to issue more debt, equity is issued as a last option. The highest preference is to

use internal financing which includes retained profits before resorting to any form of

external funds.

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The hierarchy for the Pecking Order Theory is illustrated in Figure 2.1 below:

Source: Myers & Majluf (1984).

Figure 2.1: Hierarchy for Pecking Order Theory

The pecking order theory assumes that there is no target capital structure. The firms choose

capital according to the following preference order: internal finance, debt, equity. Myers &

Majluf (1984) argued the existence of information asymmetry between managers (insiders)

and investors (outsiders). They argued that managers have more inside information than

investors and act in favour of old shareholders.

Myers & Majluf (1984) argue that internal funds incur no flotation costs and require no

additional disclosure of proprietary financial information that could lead to more severe

market discipline and a possible loss of competitive advantage. If a firm must use external

funds, the preference is to use the following order of financing sources: debt, convertible

securities, preferred stock, and common stock.

The pecking order theory suggests that firms have a particular preference order for capital

used to finance their businesses (Myers & Majluf, 1984). Owing to the information

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asymmetries between the firm and potential investors, the firm will prefer retained earnings

to debt, short-term debt over long-term debt and debt over equity.

Honohan and Beck (2017), argued that if firms issue no new security but only use its

retained earnings to support the investment opportunities, the information asymmetric

could be resolved. This implies that issuing equity becomes more expensive as asymmetric

information insiders and outsiders increase. Firms which information asymmetry is large

should issue debt to avoid selling under-priced securities. The capital structure decreases as

events such as new stock offering leads to a firm’s stock price decline.

As the firms grow, their requirement of finance tends to increase. The capacity to finance

the increasing demand depends on internal finance. If a firm entirely relies on internal

fund, then its growth may be restricted. Managers may forgo some profitable projects. If a

firm goes for external finance, then chances of risk increases. Isensee et al (2020) argues

that firms with growth potential will tend to have less capital structure. Growth

opportunities can produce moral hazard effects and push firms to take more risk. In order

to mitigate this problem, growth opportunities should be financed with equity instead of

debt and in doing so Honohan and Beck (2017) noted the predicted negative relation

between debt and growth opportunity.

On the other hand, firms with high growth will tend to look to external funds to fit the

growth (Esubalew, Amare and Raghurama, 2020). Growth is likely to put a strain on

retained earnings and push the firm into borrowing. Firms would look to short-term, less

long-term for their financing needs. Studies found growth positively related to capital

structure (OECD, 2020).

Haddad et al, (2019) assert that small firms strive for external sources of finance only if the

internal sources are exhaust. Small firms try to meet their finance needs with a pecking

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 order of personal and retained earnings, debt and issuance of new equity. The pecking

order theory can be easily applied in small firms because small firms borrow as their

investment needs grow rather than attempt to achieve an optimal capital structure

(Kautonen et al, 2020)

Growth interacts with size. In small firms, managers who are usually also the owners want

to remain in control of their companies because they obtain private benefit over the

financial return on their investment. They need to forgo some growth opportunities if the

opportunities are too extensive to be realized and rely more on debt.

The growth of small firms is more sensitive to internal finance than that of larger firms

(Yacine et al, 2018). In small firms, the probability of facing financial constraints is higher

and that makes it harder to gain access to banking resources. They are prepared to pay

higher interest rates for additional loans and do not consider issuing external equity in

order to stay in control.

Although the Myers & Majluf (1984) theory does not sufficiently stand to explain the

impact of financial management on the performance and growth of SMEs in developing

countries due to the unique circumstances. It does, however, provide a plausible

explanation on the various forms of financing options available at the firm’s disposal in

assisting with their financial requirements. Therefore, the Pecking Order Theory as

articulated in this study enables the understanding of how capital structures of SMEs can

best be formulated (Allini et al, 2018).

2.4.2 The Modern Portfolio Theory

Markowitz proposed the Modern Portfolio Theory of financial management. This theory

was developed between the 1950s through to the early 1970s and is seen as an essential

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 advance in the mathematical modelling of finance. This theory helps in understanding how

financial management practices in organisations are undertaken, particularly the financial

risk management decisions. Qamruzzaman and Wei (2019) propounded that the theory

quantifies the difference between the overall risk of the portfolio and the risk of portfolio

assets taken individually.

The theory states that a portfolio will only be considered efficient when available assets

give either high returns or low risks exposure. Estimating the risk and return levels is

essential in order to reduce the occurrence of negative returns. This enables choosing

different assets in order to mitigate the risk of loss (Bilal, Naveed, and Anwar, 2017). The

expected returns may be accessed by measuring the expected output over the utilised

resources whilst taking into consideration the risks being exposed (Okello et al, 2017).

The implication of the theory to the study is that organisations, SMEs included, should not

only invest widely in different types of financial instruments but should also assess the

various risks involved. This implies that financial management is very critical in ensuring

that there is diversification in case any financial management practice fails. The theory thus

acts as a guideline in enhancing reliability in financial management practices in SMEs in

order to ensure positive influence on financial performance as well as growth.

2.4.3 The Contingency Theory

Pike (1986) developed the Contingency Theory aimed at explaining the various financial

management concepts. The contingency theory has been widely used in studies predicting

performance and effectiveness of enterprises and the theory argues that the most

appropriate structure for an enterprise is one that greatly fits a given operating contingency,

such as technology or environment (Huerta, Petrides, and O’Shaughness, 2017).

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 Contextual factors such as these will affect the organisation’s structure which will then

influence the design of the financial system (Blackbur, Carey, and Tanewski, 2018).

The Contingency Theory holds that efficiency in operations will only be attained by having

a fit between the corporate settings and how the financial system operates. The theory

concentrates mainly on three aspects of the corporate aspect, which are assumed to have an

association to operation, design of aspects in the financial system. This entails the ordinary

investment outcome history, professional competency degree and capital budgeting control

policy.

While the contextual factors describe why accounting systems vary based on the particular

organisation, the theory assumes that organisations do not have similar accounting systems

and thus attain different financial performances. This may be explained by the different

contextual factors surrounding firms. Therefore, resource allocation to financial

management practices should be made whilst considering these factors (Acikdilli et al,

2020).

The theory’s proposition to the study is that there are certain financial management

practices that may work well with certain firms but not with others. This is due to the

difference in corporate setting and external factors. This thus implies that there are no

standard financial management practices to be applied by the SMEs. Therefore, financial

management practices should be chosen after evaluating the particular business setting to

ensure that it is appropriate in achieving its intended purpose. A positive influence on the

SMEs’ financial performance will only be attained when a balance is met between the

corporate setting and financial system operations.

2.5 Importance of the subject

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 The Zimbabwean economy is widely dominated by SMEs with the formal sector having

shrunk dramatically due to company closures with many workers losing their jobs through

retrenchments and finding other means of survival through starting businesses. The

Government of Zimbabwe (GoZ) joined this bandwagon and by the end of the 1990s, the

Department of the Informal Sector was established in the President’s Office in recognition

of the emergence of the informal sector. In 2002, the Department of Informal Sector was

upgraded to the Ministry of Small and Medium Enterprises Development (MoSMED), with

the mandate to oversee the development of the SME Sector, (MoSMED, 2002) and now

known as the Ministry of Women affairs, Community, Small and Medium Enterprises. The

SME sector has not experienced the anticipated growth as they are constrained by a

number of factors, chief among them being access to credit. The SME sector is that sector

of the economy that helps many countries of the world to wither economic decline. SMEs

are also expected to go beyond the borders and look for other markets within the region

and across other regions, but this is becoming very difficult as there are numerous factors

and challenges being faced by SMEs that need to be addressed with financial management

being at the core of it all.

Efficient financial management practices therefore are essential in order for SMEs to reach

the growth stage of the firm as it has a major effect on performance. The ability of SMEs to

develop, grow, sustain and strengthen themselves is heavily determined by their capacity to

access and manage finance (Demirguc et al, 2018). Inefficiencies in financial management

practices result in poor financial performance and eventually lead to failure of SMEs.

Hence the importance of this study, to analyse the impact of financial management

practices on the performance and growth of SMEs in Zimbabwe.

2.6 Conceptual Framework

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A conceptual framework is a structure, which the researcher believes can best explain the

natural progression of the phenomenon to be studied (Bird, 2019). It is linked with the

concepts, empirical research and important theories used in promoting and systemizing the

knowledge espoused by the researcher (Halim, Ahmad and Ramayah, 2019). It is the

researcher’s explanation of how the research problem would be explored.

The conceptual framework presents an integrated way of looking at a problem under study

(Eniola and Entebang, 2017). In a statistical perspective, the conceptual framework

describes the relationship between the main concepts of a study. It is arranged in a logical

structure to aid provide a picture or visual display of how ideas in a study relate to one

another (Al Mamun, Fazal, and Muniady, 2019). Interestingly, it shows the series of action

the researcher intends carrying out in a research study (Shamsuddin, 2017).

The framework makes it easier for the researcher to easily specify and define the concepts

within the problem of the study (Okello et al, 2017). Ahmad et al (2018) opine that

conceptual frameworks can be ‘graphical or in a narrative form showing the key variables

or constructs to be studied and the presumed relationships between them.

The conceptual framework offers many benefits to a research. For instance, it assists the

researcher in identifying and constructing his/her worldview on the phenomenon to be

investigated (Rahbi and Abdullah, 2017). It is the simplest way through which a researcher

presents his/her asserted remedies to the problem he/she has defined (Ng and Kee, 2018). It

accentuates the reasons why a research topic is worth studying, the assumptions of a

researcher, the scholars he/she agrees with and disagrees with and how he/she conceptually

grounds his/her approach (Ahmad et al, 2018). Shamsuddin (2017) posits that the

conceptual framework is mostly used by researchers when existing theories are not

applicable or sufficient in creating a firm structure for the study.

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 Under the conceptual framework of this study, the researcher will focus on the main

objectives of financial management including the key tools of financial management as

well as the impact of financial management practices on the business performance and

growth of SMEs. The researcher’s conceptual framework of this study is illustrated in

Figure 2.2 below:

Variables: Tools:

 Financial Record Keeping

 Planning  Working capital management
 Accounting Systems & Structures
 Banking  Capital budgeting

 Financing

FINANCIAL MANAGEMENT

Good Sustainable
Performance Growth

Figure 2.2: Conceptual Framework

Source: The Researcher

2.6.1 Main Objectives of Financial Management

The strong points of financial management practices in the SME sector have long attracted

the attention of researchers. Depending on different objectives, researchers emphasize

different aspects of financial management practices as well the ultimate objectives of

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 financial management. According to Badu, and Appiah (2018), the major cause of business

enterprise failure is careless financial management. The intended goals of financial

management are the foundations upon which the efficiency and effectiveness of financial

management are evaluated and compared. The efficient and effective acquisition and use of

finance in any enterprise leads to proper employment of the enterprise’s finance.

Karadag (2017) posits that objectives of financial management are foundations or bases for

comparing and evaluating the efficiency and effectiveness of financial management.

Hence, the intended goals of financial management are grouped into two main components

and these are maximization of profit and wealth (Asante, Kissi, & Badu, 2018).

These main objectives are illustrated in Figure 2.3 below:

Source: (Florido, Adame, and Tagle, 2015)

Figure 2.3: Objectives of Financial Management

2.6.1.1 Profit Maximisation

The primary goal of financial management is to earn the highest possible profit for the

firm. Profit according to According to Bilal, Naveed, and Anwar (2017) profit, is the

residual income which is equal to the difference between the total revenue and the total

cost of production. The main aim of any kind of economic activity is earning profit.

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2.6.1.2 Wealth Maximisation

Another broad goal of the firm is to maximise the wealth of the firm’s shareholders.

Klyton and Rutabayiro (2018), state that shareholders as the owners of a corporation

purchase stocks because they are looking for a financial return. Whilst Durst and Pavlov

(2021) postulate that, the final goal of financial management is to maximise the wealth of

the business owner. This general goal can be viewed in terms of two much more specific

objectives: profitability and liquidity.

(i) Profitability management is concerned with maintaining or increasing a business’s

earnings through attention to cost control, pricing policy, sales volume, stock

management, and capital expenditures. This objective is also consistent with the

goal of most businesses. Ikebuaku and Dimbabo (2018) stated that:

Any financial decision taken by the managers in any enterprise should benefit the
owners and maximising profit for the business enterprise is critical because firms
operate in highly competitive financial market environment that offers individual
entrepreneurs many alternatives for investing their funds.

This implies is that without smart financial management techniques and access to financial

markets, firms are unlikely to survive, let alone achieve the long term goal of maximising

the value of the firm.

(ii) Liquidity management, on one hand, ensures that the business’s obligations (wages,

bills, loan repayments, tax payments amongst others) are paid. The owner wants to

avoid any damage at all to a business’s credit rating, due to a temporary inability to

meet obligations by anticipating cash shortages, maintaining the confidence of

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 creditors, bank managers, pre-arranging finance to cover cash shortages. On the

other hand, liquidity management minimizes idle cash balances, which could be

profitable if they are invested (Popescu, Raluca and Popescu, 2019).

2.6.2 Key Tools of Financial Management

According to (Pulawska, 2021), financial managers are concerned with three fundamental

types of decisions: capital budgeting decisions, financial decisions and working capital

management decisions. Each type of decisions has a direct and important effect on the

firm’s balance sheet and on the firm’s profitability, financial management decisions

include working capital management, investment decision (capital budgeting decision),

financial decision (capital structure) and dividend decision. Abera et al (2019) posits that

typical financial management practices in organisations include accounting information

systems, fixed assets management, working capital management, financial reporting and

analysis, capital structure management.

Therefore, financial management as used in this study is composed of five (5) constructs

and these include working capital management, which is subdivided into cash

management, receivables management and inventory management. Other constructs

include investment, financing, accounting information systems and financial reporting and

analysis. These five financial management practices will be discussed together with their

impact on the performance and growth of a business.

2.6.2.1 Working Capital Management

Working capital refers to the capital required in the day-to-day operations of the business

and thus acts as the driver to the organisation’s growth (Adil, Fareeha and Abdul, 2020.

According to (Durst and Pavlov, 2021), it is simply defined as “current assets less current

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liabilities”. A common definition of working capital deals with the efficient management

of the firm’s investment in current assets and liabilities: such as cash, marketable

securities, accounts receivable and inventory.

Working capital is essential to a firm’s long-term success and development, and the greater

the degree to which the current assets cover the current liabilities, the more solvent the

company. According to Ibor et al (2017), working capital management is the enterprise’s

short-term asset and liabilities. There is the need for owner-managers to comprehend the

management of the short-term capital so that current assets and liabilities are managed

efficiently.

According to modern theories, working capital has alternatively two strategies, namely:

aggressive funding strategy and conservative funding strategy (Harith and Samujh, 2020).

Aggressive working capital strategy is a financing strategy that uses short-term debt to

finance the firm’s seasonal capital requirement. Conservative working capital strategy is

when the enterprise uses long-term debt to finances its permanent and seasonal capital

requirements.

Working capital management is a significant area of financial management, and its

administration or management has a significant impact on the profitability and liquidity of

the firm (Fitane, 2020). Literature review from (Esubalew, Amare and Raghurama, 2020)

shows that working capital management has significant impact on SMEs performance and

it is concluded in the various studies that owner-managers can increase the value of their

wealth and return on asset by reducing their inventory size, cash conversion cycle and net

trading cycle. Increase in liquidity and the time-period to pay up suppliers will also lead to

firms’ overall performance. Authorities also posit that the effective management of

working capital in SMEs is very pivotal to their solvency and liquidity.

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 Despite the importance of working capital management in enhancing SME performance,

some SMEs are still failing. Literature has consistently referenced inadequate working

capital decisions and accounting information as causes of SME failures. Ajide (2017)

asserts that some firms do not manage their working capital as expected and this has

affected the viability of their businesses. Firms fail because they do not maintain sufficient

liquidity. SMEs rely on manual methods of inventory and the majority do not know

anything about economic order quantity. Credit management in some SMEs falls beyond

best practice. Poor working capital flow precludes SMEs from competing effectively.

Therefore, Bomani, Ziska, and Derera (2019) point out that there exists a direct

relationship between working capital management and firm liquidity. Effective working

capital management provides the firm with adequate liquidity both to pay its short-term

maturing obligations as they fall due and to conduct the firm’s day-to-day operations.

Consequently, inability to manage working capital efficiently is a major cause of SME

failure.

2.6.2.2 Capital budgeting

Capital budgeting is the process of appraising and picking out long-term investments that is

in consonance with the goal of increasing the value of owners. According to (Kotler et al,

2019), capital budgeting is the process of putting an enterprise’s scarce resources into long-

term investment. Whilst postulate that capital budgeting is a process that is modelled to

achieve the greatest firm profitability and cost effectiveness. Haleem, Jehangir and Baig

(2017) agree and asserts that the ultimate success of the firm is enabled by the use of sound

capital budgeting techniques.

The two main expenditures under capital budgeting are capital expenditure and operating

expenditure. Capital expenditure is dealt with when the funds invested in the enterprise are

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expected to yield profits over a period not less than one year. Operating expenditure is also

dealt with when the benefit that would be received after the initial funds outlay is within

one year.

Techniques of capital budgeting include payback period, net present value and internal rate

of return. Payback period talks of the amount of time that the enterprise needs to recoup its

initial capital/funds invested. This is calculated from the cash flow. The difference between

the value of a project and its cost constitute net present value. A project’s rate of return is

the discount rate that gives a zero net present value. This discount rate according to

Bocconcelli et al (2018), is known as the internal rate of return or discounted cash flow.

Ayandibu and Houghton (2017), suggested that capital budgeting might be more important

to a smaller firm than its larger counterparts because of the lack of access to the public

markets for funding. Capital budgeting has attracted researchers over the past several

decades.

Dadzie et al (2017), note that capital budgeting and planning positively impact on the

performance of small businesses. SMEs engaged in detailed strategic planning are more

likely to use formal capital budgeting techniques, including the net present value method,

which is consistent with the goal of maximisation of firm value. Perceived profitability and

success in achieving organisational objectives are positively associated with planning

detail, suggesting that strategic planning is a key component in improving performance.

Planning is very important because of the constantly changing and volatile business

environment. Mabenge, Ngorora and Makanyeza (2020) noted that due to inaccessibility to

the capital markets, the allocation of capital in small firms is very important. Capital assets

involve a large amount of money. The result of capital budgeting decisions continues to

impact on the firm for many years. Effective capital budgeting can improve asset

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 acquisitions. Meyer and Meyer (2020) point out that the appraisal of new and existing

capital investment projects is fundamental to the success of the small firm.

In a perfect market, the value of the firm is maximized when the projects with the highest

net present value are selected. Literature has it that some SME owner-managers agree that

the use of investment appraisal techniques has a significant positive impact on their firms’

profitability. SME owners must therefore get more training and skill development in order

to use the techniques accurately.

However, some studies contend with the idea that use of sophisticated capital budgeting

techniques enhances a firm’s performance. Buul and Omundi (2017) state that

sophisticated capital budgeting techniques are neo-classical and are more relevant to the

larger firms. Employment of these techniques will result in losses because the SMEs have

to hire expensive skilled personnel or spend more funds on getting training and

consultation. SMEs’ way is to adapt to their situation and use past experience and advice

from peers to get the most out of the funds they have to dispose in terms of investment.

2.6.2.3 Financing

Small companies frequently suffer from a particular financial problem of lack of a capital

base. Their owners usually manage small businesses and available capital is limited to

access to equity markets, and in the early stages of their existence owners find it difficult in

building up revenue reserves if the owner-managers are to survive.

In an attempt to explain small firm financing behaviour, other scholars have relied on the

agency theory. Agency theory holds that investors who have equity or debt in a firm

require costs to monitor the investment of their funds by management or the small business

owner (agency costs). This view suggests that financing is based on the owner-manager

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being able to assess these agency costs for each type of financing, and then select the

lowest cost method of financing the firm’s activities. One weakness of this explanation is

that no one has yet been able to measure agency costs, even in large firms (Abiodun and

Kolade, 2020).

Sadiku-Dushi, Dana and Ramadani (2019), suggested that the following characteristics

must be accounted for in any explanation of firm financing decisions: behaviour at the firm

level, fact that the capital structure decision is made in an open systems context by top

management, and decisions reflect multiple objectives and environmental factors, not all of

which are financial in nature.

The firm’s financing decision, then, appears to be a product of many internal and external

factors, as well as managerial values and goals. Manyati and Mutsau (2019), examined

small-scale industries and its financial problems in Zimbabwe. They underscored that

SMEs of small scale industries in Zimbabwe find it extremely difficult to get outside credit

because the cash inflow and savings of the SMEs in the small-scale sector is significantly

low.

Hence, bank and non-bank financial institutions do not emphasise much on credit lending

for the development of the SMEs in the small-scale sector in Zimbabwe. Nyoni and Bonga,

(2018) highlighted that study underscored that financing is the most difficult problems of

the SMEs in Zimbabwe. In this regard external finance is more expensive than internal

finance. Due to lack of access to external finance (private placements and initial public

offerings of varying sizes), SMEs rely on bank loans as compared to their larger

counterparts (Makiwa and Steyn, 2019).

Mamman et al, (2019), lists factors that have discouraged banks from lending to SMEs.

Among them are poorly compiled records and accounts; low levels of technical and

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 management skills; outdated technologies; lack of professionalism and networking; lack of

collateral; lack of market outlets due to poor quality and non-standardized products; poor

linkages and limited knowledge of business opportunities.

2.6.2.4 Accounting Information Systems

Accounting information is information provided by accountants and accounting systems.

This information is usually presented in financial statements such as the income statement

and the balance sheet. It also includes any financial ratios extracted from these financial

statements (Makhitha, 2019).

Kanu (2019), defines an accounting information system as the recording of transactions

using computers with the aid of accounting systems and techniques, which are used to

record and analyse business transactions for preparing a financial statement for users.

According to Lamb and Mcdaniel (2018), accounting systems provide a source of

information to owners and managers of small businesses operating in any industry for use

in the measurement of financial performance. It is crucial therefore that the accounting

practices of small businesses supply complete and relevant financial information needed to

improve economic decisions made by entrepreneurs. Kanu (2019), in the context of small

businesses, highlighted that accounting information is important as it can help the firms

manage their short-term problems in critical areas like costing, expenditure and cash flow,

by providing information to support monitoring and control.

Mabenge, Ngorora and Makanyeza (2020) point out that accounting information is also

useful for firms operating in a dynamic and competitive environment as it can help them

integrate operational initiatives within long-term strategic plans. They also highlight that

SMEs lack of access to capital and high interest rates charges are partially the result of

incomplete (or no) accounting records, and the inefficient use of accounting information.

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 Poor record keeping and accounting information make it difficult for financial institutions

to evaluate potential risks and returns making them unwilling to lend to SMEs. Small and

medium enterprise publications and research have highlighted the importance of

management of accounting systems for SMEs. In their literature, Harith and Samujh (2020)

concluded that management of accounting systems has a positive effect on the performance

of SMEs.

2.6.2.5 Financial Reporting and Analysis

Botes and Sharma (2017), postulate that improved financial reporting is part of a broader

competence in business management which, taken together with other factors, is likely to

lead to effective and efficient management of the business.

Lamb and Mcdaniel (2018), propound that bookkeeping alone, without preparing financial

reports, is unlikely to be a fundamental factor in aiding decision-making. As such, the

efficiency of financial planning is dependent on the type of accounting system used in a

business. The balance sheet, income statement, cash flow statement and flow of fund

statements are the most important documents for reporting and analysis.

Financial analysis is an instrument to evaluate the firm’s financial performance in light of

its competitors and determine how the firm might improve its operations. Financial ratios

can be used as an analytical tool to help managers to identify strengths and weaknesses of

the firm.

Quality of financial accounting information utilised within the small business sector has a

positive relationship with an entity’s performance. Accurate analysis indicates whether the

firm has enough cash to meet its obligations, a sound inventory management system and a

reasonable credit policy-all of which contribute to the achievement of the ultimate goal of

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 the firm of maximising its value. Hence, financial analysis can be used as a monitoring

device and it plays an effective role in planning.

2.6.3 Barriers to Financial Management Practices

Abera et al (2019) indicated that ‘poor’ or ‘careless’ financial management is a major cause

of small business failure. Thus, inefficient financial management may damage business

efficiency and this will continuously affect the growth of SMEs. Various factors can be

cited as plausible reasons why SMEs do not keep accounting record, let alone adopt

financial management practice. In Zimbabwe, some of the barriers to financial

management practices by SMEs include:

I. Lack of Financial Resources

Most SMEs have maintained that qualified accountants are too expensive to maintain. The

majority of the owner-managers they are scared of the consultancy fees that qualified

accountants charge for their services. Consequently, these qualified accountants also

complain that these small firms have a poor payment culture despite the fact that they

spend a lot of time when it comes to the auditing of small companies (Sithole, Sithole and

Chirimuta, 2018). As a result, owners tend to manage the financial aspect of the businesses

themselves as a measure of reducing operational costs.

II. Limited Financial Background

Various studies have cited the financial illiteracy of some entrepreneurs as a barrier to

proper financial management practices. According to Nielsen (2018), a significant number

of SMEs stated that accounting records are too difficult to understand. He further buttresses

this assertion by highlighting that the lack of accounting knowledge on the part of

owner/managers accounts for this situation. In Zimbabwe, this is true as most entrepreneurs

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 started their small business without engaging any formal training or awareness regarding

record keeping. They tend to put aside the records, as they do not understand the

importance of it. Most of these entrepreneurs assume that record keeping is troublesome.

This observation is consistent with the findings of Abera et al (2019) who concluded that

management involved in the running of small businesses lack education and experience on

financial management and this was a cause for concern for the survivability of these firms.

For this reason, effective record keeping will be the best way to ensure a successful

financial management as the flow of income and every cent counts.

III. Lack of Internal Accounting Staff

The inability of these small firms to pay good salaries to their employees makes it very

difficult to attract qualified accounting staff. The lack of internal accounting staff as an

inhibiting factor for the practice of sound financial management system collaborates with

the findings of Sallem et al, 2017.

2.6.4 Impact of Financial Management Practices on the Business Performance and

Growth of SMEs

In order to be a successful entrepreneur in the extremely challenging business world of

today, all required knowledge is as essential as the tools in order to remain relevant,

competitive and profitable. According to Addo (2017), financial management practices act

as a tool for the organisations to remain profitable while ensuring they do not become

bankrupt or insolvent. He further establishes that this is particularly important to the SME

sector where any mismatch in financial management practices is probable to negatively

affect the performance to a high extent.

Nevertheless, the degree of financial resources management of an enterprise may well

affect its overall business performance, both in the context of young and small enterprises

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and the process of launching new products, which will eventually have an impact on

performance.

The success of any company big or small is measured by two variables, which are the sales

volume and the propensity to grow physically in terms of size or product or service

diversification. Klyton and Rutabayiro-Ngoga (2018) debate that firms with larger

financing needs are more likely to rely on different sources of external finance.

In line to the pecking order theory of Myers & Majluf (1984) the adverse selection in the

market for external finances makes it efficient for the firm to access equity last after all

other sources of external finance are levered. Therefore, Abor and Adjasi (2017), examined

financing source as the proportion of investment financed by external sources which are

bank debt (includes financing from domestic as well as foreign banks), equity, leasing,

supplier credit, development banks (including finance from both development and public

sector banks), or informal sources.

Abera et al (2019), also examine different sources of financing which includes external

financing, external equity capital, external debt capital and trade credit, and their findings

indicate that growth-oriented enterprises are more likely to apply for financial capital.

Harith and Samujh (2020) argued that firms’ growth cycle influences the source of finance.

Considering small firms with high growth, venture capital, we can say that trade credit,

short and intermediate-term financial institution loans and mezzanine fund financing are

the most typical sources of finance used. Taking medium-sized and large firms into

consideration, then public equity, commercial paper, medium term notes and public debt

could be used.

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 However, these two last resources are not adjusted to finance. Their results are consistent

with the findings of Mabenge, Ngorora and Makanyeza (2020), which show that financial

needs depend on which stage the firms are. In experimental and active stages, financial

export activities are more complicated, for example because of higher risk of payment from

foreign buyers and the lack of international experience, and therefore, they should seek

venture capital rather than traditional financing. By the other hand, in committed stages,

activities require large investments in working capital, and usually banks are the major

sources of credit for SMEs.

Mamman et al (2019) examined the relationship between management of the cash

conversion cycle and firm profitability. They found a significant relationship between

profitability and the cash conversion cycle, although this was influenced by the firm’s size,

age and industry. Their key findings from their study is that managers of SMEs can

enhance their firm’s profitability by improving their management of working capital.

Because working capital is the liquid assets found within the firm, the ability to improve

the speed at which cash is generated from invoices will help enhance profitability.

The importance of effective financial management for SMEs, specifically in the areas of

cash flow and working capital, cannot be underestimated. Many young firms suffer from a

lack of working capital and poor cash flow during their start-up phase, and growing firms

have a high demand for working capital. The study of financial management and how it

affects the performance, survival and growth of SMEs, is a field of research that deserves

greater attention. It is clear from this review of recently published research that there is a

positive relationship between effective cash flow and working capital management and the

profitability, survival and growth of SMEs.

2.6.5 Critical Success Factors of Financial Management Practices

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Dynamic, fast-growing organizations must develop financial management solutions that

can quickly adapt to their changing business needs while helping them reduce costs, make

smarter decisions, and continuously innovate. Financial success for a business consists of

maintaining a strong cash position, building a healthy balance sheet and sustaining profits.

However, these things do not just happen. They come because of practicing financial

discipline. Making the best use of one’s finances should be a key element in business

planning and assessing new opportunities.

The implementation of an accounting system and the regular review of financial statements

have been perceived to be two of the most important factors that lead to company success.

A complete and accurate accounting system or the keeping of financial records are crucial

to the success of the business for a number of reasons. For instance, good accounting

systems provide financial data that help the company operate more efficiently, thus

increasing profitability (Johnson, Scholes and Wittington, 2018).

Accurate and complete records enable the company, and their accountant, to identify

business assets, liabilities, income and expenses. This information, when compared with

appropriate industry averages, helps the company identify both the strong and weak phases

of its business operations.

Good financial records, such as the income statement (profit and loss) and cash-flow

projection, are essential for the preparation of current financial statements (OECD, 2017).

These statements, in turn, are critical for maintaining good relations with the company’s

banker. They also present a complete picture of the company’s total business operation

(Cao and Shi, 2021). Only a profitable organisation can remain in business, and employ

qualified people in rewarding positions. A company can empower the predictable profit

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margins only if it employs a project cost control system that provides employees with a

framework to control expenditures effectively on all of its contracted work (Addo, 2017).

Many techniques and systems integrate with accounting systems to support the control of

the financial commitment of an organisation. Among the most important techniques are the

estimating cost models and cash flow forecasting techniques (Greener, 2018). In today’s

credit tight economy it is more important than ever for an owner-manager to control cash

flows. A company must plan and monitor its cash requirements (De Backer and Flaig,

2017). It is essential for companies to review the basics of their business, and the best

place to start is the all-critical item called cash- flow.

Financial failures still occur and they can often be traced back to the lack of effective cost

control by the management team. Applying these cost control techniques correctly will

provide the small business with the means to keep its business decision- making on track

and their account purchasing in control. It will also act as an early warning indicator when

their expenditures are running out of line or their sales targets are not being met.

To be successful a company must balance its cash flow. It is important to review the all-

financial management functions to plan properly for appropriate controls and techniques.

This will increase cash flow and allow for the consideration of alternative sources of

finance on a timely basis. Returning to focus on the basics will greatly enhance an owner-

manager’s future success (OECD/UNCDF, 2019).

In Zimbabwe, some of the critical success factors for financial management practices

include:

i. Producing Accurate and Timely Financials

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Producing accurate and timely information is the most critical role of the accounting

function. Decisions based upon inaccurate or incomplete information will lead to flawed

decision making. Competency can only be assured by:

 Accurate month-end closing and financial reporting. This ensures that the month-end

close checklist has been adhered to and management receives financial reports in a

timely manner (a good target would be within 15 working days of month end).

 Weekly (or even daily) updated revenue and cash reporting. When applicable, bank

accounts should be consolidated and interest income/cash management heightened by

using only one bank and banking platform. Program reporting based upon accurate

time allocations should be done quarterly, if not monthly. Program managers and the

organization’s department managers need actual-to-budget reports.

ii. Proactive Forecasting

Many in accounting have been trained to report on what happened in the past, but

perceptive teams place a premium on forward-looking planning and proactive forecasting.

They study future goals to determine financial impact, prepare accurate forecasts and

compare actual versus budget at least monthly. These forecasts and budgets are adjusted

throughout the year to reflect new programs, new hires, membership and revenue changes,

marketplace shifts and other factors.

iii. Mitigating Risks and Setup Internal Controls

Hindsight has taught us that some SMEs do not have tight enough internal controls to

properly mitigate risks. The owner-manager is often the one actively identifying all risks

and recommending solutions to mitigate risks.

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 Many SMEs overlook the basics (well-documented procedures on process and authorized

personnel for check approvals, contract execution, opening bank accounts, hiring or firing),

but it should not stop there. Owner-managers must take an enterprise approach to risk

management, from examining insurance needs to mitigating talent loss through

performance management programs.

2.7 Empirical Evidence

The researcher conducted the study in order to analyse the impact of financial management

on the performance and growth of SMEs in Zimbabwe. Empirical evidence showed that

there is a growing recognition of the important role that SMEs play in economic

development. It further showed that SMEs face a myriad of challenges in managing their

day-to-day operations with financial mismanagement being at the pinnacle.

Maow (2021) regenerates that despite their simplicity in operation; most SMEs tend to

struggle in performing financially. This has led to numerous studies being conducted both

locally and internationally trying to establish the factors undermining the financial

performance of SMEs.

2.7.1 Accounting Practices of SMEs in Asia: An Investigative Study of Record Keeping

for Performance Measurement (A case study of Thailand).

A research conducted by Arunruangsirilert and Chonglerttam (2017), investigated

accounting record keeping practices for performance measurement employed by SMEs in

Asia, using Thailand as a case. The survey research design was used and the target

population comprised of different SMEs operating retail shops, manufacturing firms and

suppliers of various services in Thailand.

The study revealed that the majority of SMEs do not keep complete accounting records

because of a lack of accounting knowledge and as a result, there is inefficient use of

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 accounting information in financial performance measurement. Through their study,

Arunruangsirilert and Chonglerttam (2017), further elaborated that accounting systems

provide a source of information to owners and managers of SMEs operating in any industry

for use in the measurement of financial performance. Their conclusion was that the

importance of financial performance measurement to any business entity, big or small,

could not be over-emphasized.

Therefore, according to Arunruangsirilert and Chonglerttam (2017), it is crucial that the

accounting practices of SMEs supply complete and relevant financial information needed

to improve economic decisions made by entrepreneurs. The study recommended that

national regulators must develop specific accounting guidelines for SMEs and develop

accounting training programmes for entrepreneurs in small businesses. The study also

recommended mandatory record keeping, to improve accounting practices of SMEs in

Asia. Thus Arunruangsirilert and Chonglerttam (2017), concluded that accounting systems

and performance are closely related.

2.7.2 The Effect of Financial Management Practices of Top 100 Small and Medium

Enterprises in Kenya.

A study by Addo (2017) sought to determine the effect of financial management practices

on the financial performance of top 100 small and medium enterprises in Kenya. All SMEs

under study were found to have financial management practices incorporated in their

operations.

The financial management practices had positive Pearson correlations implying that all the

variables had a positive effect on the SMEs’ performance. This means that an increase in

any of the variables will cause an increase in the organisation’s returns. However, all the

variables were less significant expect cash budget management practices meaning they had

33
 to be combined for them to be able to predict the changes in the performance of these

SMEs.

The effect of the combined variables had a strong relationship with the SMEs’ financial

performance based on the regression analysis. The study recommended that management

should carefully evaluate their companies’ structures before adopting the financial

management practices. The study also concluded that adding and integrating financial

management practices highly improves how SMEs will perform overall.

2.7.3 An Investigation into the Financial Management Practices of New Micro-

Enterprises in South Africa

Makhitha (2019) conducted a research, which investigated the financial management

practices of new micro-enterprises in South Africa. The research focused on six financial

management practices namely financial planning and control, financial analysis,

accounting information, management accounting, investment appraisal and working capital

management.

The findings indicated that most new micro-enterprises do not engage in financial planning

and control, financial analysis and investment appraisal. For accounting information most

new micro-enterprises keep certain accounting books such as sales book and purchases

book but do not keep other books such as drawings book indicating a mixed result. The

pricing strategy of new micro-enterprises is mainly cost plus and pricing similar to

competitors. Recommendations to improve financial management practices included

training of the owners of new micro-enterprises.

2.7.4 Financial Management and Profitability of Small and Medium Enterprises

Rand and Tarp (2020), in their book looked at the simultaneous effects of financial

management practices and financial characteristics on SME profitability. The book further

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 determines the best measures for improving SME profitability in Vietnam by using

efficient financial management tools. In addition, the book provided a model of SME

profitability, in which profitability was found to be related to financial management

practices and financial characteristics.

Rand and Tarp (2020), established that with the exception of debt ratios, all other variables

including current ratio, total asset turnover, working capital management, short-term

planning practices, fixed asset management, long-term planning practices, and financial

and accounting information systems were found to be significantly related to SME

profitability. The book provided many implications for financial management practices and

contributed to knowledge of financial management of SMEs.

2.7.5 Business Growth and Performance and the Financial Reporting Practices of

Kenya SMEs

Buul and Omundi (2017) undertook a study on the impact of financial reporting practices

upon business growth and performance outcomes amongst small and medium ‐sized

enterprises (SMEs) engaged in manufacturing in Kenya. The study was able to establish

some statistically significant bivariate associations between the extent and frequency of

financial reporting undertaken and certain measures of SME growth and performance.

However, the state of financial reporting practices becomes subsumed by other important

influences in multivariate analysis.

Management is a complex activity affected by a myriad of interacting internal and external

factors, and must inevitably be undertaken in a holistic manner in SMEs. Particular

practices contribute to the whole task without necessarily standing out as all ‐embracing

solutions to problems generally encountered.

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 Thus, it is argued that improved financial reporting should be realistically viewed as simply

part of a broader competence in financial management which, taken together with other

functional capabilities, is likely to lead to more effective and efficient management of

SMEs and significantly improve their prospects.

2.8 Literature Gap

Researchers have conducted many studies on financial management practices of SMEs

over several decades. Section 2.6 of this study was concerned with the comparative studies

of these SME financial management practices and indicated that most researchers focused

on examining whether or not owner-managers practiced financial management in the

running of their businesses. However, there still exist gaps in the literature on the impact of

financial management on the performance and growth of SMEs, which need to be

examined.

This study takes a different approach to the various studies cited above. Given that

financial management is one of the key aspects of the well-being and survival of a

business, it is important that this topic be explored in depth. In the context of Zimbabwe,

there have been quite a number of case studies done on the challenges facing SMEs but

very few studies on the financial management practices of SMEs. Despites the availability

of these studies on SMEs, none of them focused on the impact of financial management

practices on the performance and growth of SMEs, which this study aimed at addressing.

As such, the lack of empirical evidence from the emerging economies and the absence of

examination of the impact of financial management practices on SME performance and

growth, are gaps that this review found from the literature.

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Although, the problem of finance and for that matter financial management has been

identified as one of the major constraints to growth of small businesses (Rabia, Rasheed

and Siddiqui, 2019), most of the researches do not establish the association between

financial management practices and performance. Therefore, the problem to be addressed

in this research is to examine financial management practices and their association with the

performance and growth of SMEs in Zimbabwe.

Furthermore, a search of the literature available on the financial management of SMEs in

Zimbabwe once again reveals a gap on the impact of financial management practices on

the performance and growth of SMEs. In general, the emphasis of the studies on SMEs in

Zimbabwe have concentrated on observing the problems and constraints faced by these

SMEs (Manyati and Mutsau, 2019). Hence, to the best of the researcher’s knowledge, there

has not been any study that specifically focuses on the impact of financial management

practices on the performance and growth of SMEs in Zimbabwe. Therefore, this study will

enrich the empirical literature on the impact of financial management practices on the

performance and growth of SMEs.

2.8 Chapter Summary

This chapter provided the theoretical and conceptual frameworks as well as the empirical

evidence of the study. The literature review discussed herein is relevant to the subject

under investigation. To conclude, there is a large degree of consensus in the above studies

that financial management practices are one of the key exploratory determinants of the

growth and survival of small businesses. Critically the five aspects of financial

management practices discussed are key to the performance and growth of the firm.

37