AN EMPIRICAL ANALYSIS OF FACTORS AFFECTING PROFITABILITY OF SMES

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

In a competitive marketplace, to achieve a satisfactory level of profitability must be learned by the business owners. Profitability is the ratio to measure the performance of the company. It is a main aspect in a company’s financial reporting. The profitability of a company shows a company’s ability to generate earnings for a certain period at a rate of sales, assets and certain of capital stock. Understanding the determinant profitability is the key factor that helps managers in developing an effective profitability strategy for their company (Gitman and Zutter, 2012).

According to Yazdanfar (2013), one of the importance preconditions for long-term firm survival and success is firm profitability. The achievement and other financial goals of the firm are significantly affected by the profitability determinant of the firm. Those factors are important because it give an effect to the economic growth, employment, innovation and technological change. The primary goal of the company is to maximize their profitability. Without profitability a firm could not attract outside capital and the business will not survive in the long run. By knowing and understanding firm profitability, it will give the feedback for the firm. The firm can find a policy that should be taken to solve the problem and minimize the negative impact for business continuity.

SMEs just as other businesses have the primary objective of maximizing profit. The skills, role and contribution of SMEs differ from industries to industries and from countries to countries. Similarly to other businesses, SMEs also face miscellaneous problems which in some instances affect their profitability and growth. In order to cope with the constant rapid changes in business environment, having a well versed and good business managerial skill is vital to the organization. Given the above scenario, the relevant and the interesting issue for consideration, at this stage, would be factors to ensure the success and profitability of SMEs sector in Nigeria. Therefore, this study will examine an empirical analysis of factors affecting the profitability of SMEs.

1.2 Statement of the Problem

There is a rising increase in the failure of SMEs in Nigeria as most SMEs in Nigeria die within their first five years of start-up while a few stay longer for six to ten year and five percent grow into maturity (Basil, 2015 cited in Aremu & Adeyemi 2011). A key factor identified as likely contributing factors to the premature death is the lack of adequate profitability. Therefore, the relative importance of small and medium scale enterprise in advanced and developing countries has led and would continue to lead to a reconsideration of the role of Small and Medium Scale Enterprises in the economy of nations. The need to improve the performance and profitability of SMEs in Ilorin metropolis is very important if the economy of the state must thrive.

1.3 Research Questions

This research work attempts to answer the following questions:

I. What relationship exists between profitability and firm’s internal factors (managerial efficiency, business knowledge) among SMEs?

II. What relationship exists between profitability and firm’s external factors (consumer taste, government policies) among SMEs?

1.4 Justification of the Study

Several studies have been conducted on the factors affecting the profitability of organization. Yahaya and Susela, (2011) examined the factors that influence outsourcing of accounting functions and the effect of outsourcing on firm performance in Iranian manufacturing small and medium enterprises (SMEs). The result from a survey of 658 SMEs show that outsourcing is positively associated with owner/manager knowledge and the technical competence, but a positive relationship between outsourcing and the size of the firm was not found. It was found out that outsourcing has a positive impact on SME performance.

Also, Farah and Nina, (2015) examined factors affecting profitability such as firm size, firm age, growth, lagged profitability, productivity, and industry affiliation of SMEs firm listed in Indonesia Stock Exchange. Source of data used in the study was secondary data based on index PEFINDO 25. The results showed that firm size, growth, lagged profitability, productivity and industry affiliation significantly have effect on profitability, while the variable firm age does not significantly influence profitability. The results of the regression coefficient indicates that the variable firm size, growth, lagged profitability have a negative effect on profitability, while the variable productivity and industry affiliation have a positive impact on profitability. Therefore, to further improve company’s performance the manager should define a strategy to increasing profitability with focusing on productivity and industry affiliation.

It has still been observed that given all the recommendations they offered at the end of their work, the failure rate of SMEs still keep growing and showing no trace of prospective improvement. This, as formerly expressed in the background to this work, gave rise to the researcher’s intention to come up with better recommendation which will go a long way in assisting and reducing to a minimal, this great deal of business failure brought about by poor business knowledge, application of ICT and Government policies.

The gap this research work intends to fill is to find out the factors (e.g. Internal Factors such as Business Knowledge, Educational Qualification, Source of Finance, Strategic Planning e.t.c and External Factors such as Government Policies, Application of ICT, Political Instability, Inadequate Infrastructural Development e.t.c) on the profitability of SMEs in terms of it continuous competitive advantage, market share and the overall profitability of SMEs.

1.5 Objectives of the Study

The main objective of this study will be to examine the empirical analysis of factors affecting profitability of SMEs.

The specific objectives are to:

i. examine the relationship which exists between profitability and firm’s internal factors (managerial efficiency, business knowledge) among SMEs.

ii. examine the relationship which exists between profitability and firm’s external factors (consumer taste, government policies) among SMEs.

1.6 Research Hypothesis

In order to provide solution to the research problem identified above and to achieve the purpose of this study, the following hypotheses will be developed and tested empirically.

Hypothesis One

H0: There is no relationship between profitability and firm’s internal factors (managerial efficiency, business knowledge) among SMEs

Hypothesis Two

H0: There is no relationship between profitability and firm’s external factors (consumer taste, government policies) among SMEs

1.7 Scope of the Study

This research work would lay emphasis on the empirical analysis of factors affecting the profitability of SMEs in Ilorin, 2015. This study will cover the activities of some selected firms in the SMEs sectors in Ilorin, 2015.

1.8 Definition of key terms

Business Knowledge: Thorough understanding of the general business functions and the specific areas under analysis.

Government Policy:  Government plan or course of action intended to influence and determine decision, actions, and other matters.

Consumer Taste: Are measured in terms of the choice of the consumer.

Managerial Efficiency: Measures how well manager work at the lowest cost to the company.

Operational Performance: This is measured against standard or prescribed indicators of effectiveness, efficiency and environmental responsibility such as growth in profit, liquidity, cycle time, productivity, waste reduction and regulatory compliance.

Profit:  Excess of revenue over cost

Profitability: State or condition of yielding a financial profit or gain. It is often measured by price to earnings ratio.

Small and Medium-sized Enterprises (SMEs): Also called Small and Medium Enterprises or Small and medium-sized businesses. SMEs are businesses whose personnel numbers fall below certain limits.

1.9 Plan of the Study

The research work will be organized into five chapters. Chapter one will cover the background to the study, objectives of study, statement of the problem, research questions, hypotheses of the study and scope of the study. Chapter two reviews the relevant and related literatures with the aim of highlighting the major area of the study. Chapter three is the research methodology which entails, research design, types and sources of data, population of the study, sample size and sampling method, instrument of data collection and analysis. Chapter four covers data presentation, analysis and discussion of result to be obtained. Chapter five will cover the summary, conclusion, and recommendation based on the findings of study.