CHAPTER ONE

1.1 Background to the Study

Financial management is an important element of the management of any business. It is a

key part of the management function focusing on the management of a business' assets. In
the long term, the type of assets owned by a business charts out the direction of that
business during the life of these assets. A business might not see its long term if it cannot
carefully plan and lay out a policy to effectively manage its finances. As a result, ineffective
financial management altogether is the main cause of the underlying problems facing Small
and Medium Enterprises (SME) financial management (Jindrichovska, 2003).

Many, if not all of those who start a business do not engage themselves in financial matters.
This is because they do not have enough knowledge about recording transactions,
preparation and analysis of financial statements. Sometimes they get deeply engrossed in
other aspects of business like managing people, sales purchasing and production to have
any interest in carefully managing finances. Such entrepreneurs end up relying on their
accountants to run the financial side of their business. Otherwise, they decide to do the
management themselves making the business vulnerable to collapse (Atic, 2010).

Financial Management is about planning, organizing, directing and controlling the financial
activities in a firm. Such activities involve the procurement and utilization of funds of the
enterprise. Financial management refers to the application of general management
principles to financial resources of the enterprise (Weston and Brigham, 1996).

According to (Gitman, 2000), other than application of management principles to financial

resources, financial management deals with financing decisions and investment decisions.
Financing decisions relate to whether a firm needs financing and how the financing will be
done. Financial management is about identifying various sources of finance and how much
needs to be raised from each of the sources. The sourcing will depend on the type of source,
period of financing, cost of financing and the expected returns.

Investment decisions are also called capital budgeting and include investment in fixed
assets. Investment in current assets is also a part of investment decisions called as working
capital decisions. The finance manager of any firm has the responsibility of carefully
selecting the best investment alternatives in order to achieve reasonable and stable returns.
The finance manager has to concentrate on safety, liquidity and profitability while investing
capital. This is also to be done with the aim of wealth maximization (Singh, 2007).

In Europe, despite the sometimes challenging economic conditions, SMEs have retained
their position as the backbone of the European economy. By 2012, there were some 20.7
million SMEs accounting for more than 98 per cent of all enterprises. 92.2 per cent of the
SMEs were the small ones with less than ten employees. These SMEs accounted for 67 per
cent of total employment (Wymenga et al., 2012).

1.3 Purpose of the Study

To establish the effect of financial management practices on financial performance of small

and medium enterprises in Kiambu Town in Kenya.

1.4 Objectives of the Study

i. To assess the effect of working capital management on the financial performance of Small
and Medium Enterprises in Kiambu town.

ii. To find out how investment decisions contributes to financial performance of Small and
Medium Enterprises in Kiambu town.

iii. To examine the effect of financing decisions on the financial performance of Small and
Medium Enterprises in Kiambu town.

1.5 Research Questions

i. What is the effect of working capital management on the financial performance of Small
and Medium Enterprises in Kiambu town?

ii. What is the contribution of investment decisions towards the financial performance of
Small and Medium Enterprises in Kiambu town?

iii. How does financing decisions affect the financial performance of Small and Medium
Enterprises in Kiambu town?
1.6 Significance of the Study

This research is significant to the owners of SMEs in Kiambu town, policy makers in the
government of Kenya and financial management researchers. The owners of SMEs in
Kiambu and elsewhere will get information concerning how best to finances in their
businesses to improve the financial performance of their businesses. This is an input that
can be used to come up with methods of improving the financial efficiency and profitability
of the SMEs.

Policy makers will use the information obtained from this research for their policy
formulation concerning financial management of SMEs. The research highlighted the
relationship between the financial management and financial performance of SMEs. This
relationship indicated the importance of financial management as a contributor to financial
performance of SMEs.

Research concerning the contribution of financial management on financial performance of

SMEs in Kiambu town is rare, if available at all. This research provides a scholarly
contribution to the effect of financial management in SMEs with focus on Kiambu town.
Future researchers will, therefore, use the findings of this study to further arguments and
future research projects that will find this research relevant.

1.7 Scope of the Study

First this research did not cover all the SMEs in Kenya in their varied nature. It only focused
on SMEs in Kiambu Town. The study limited itself to finding out the effects of working
capital management, investment and financing on financial performance of the SMEs in
Kiambu town.

1.8 Limitations of the Study

This research was expected to have several limitations. Being a survey, the findings would
be as true as the time when the data was collected. Therefore, findings may not be
applicable to later times. Secondly, the data required for the research was qualitative
indicating the possible influence of opinions and attitudes of the respondents. Focusing on
SMEs in Kiambu town only, the findings may not be applicable to the whole country.

To address limitations the study had three approaches. First, the sampling was as much as
possible to replicate the distribution of SMEs in Kiambu town according to the industries
they serve and the sizes. Secondly, to address the issue of opinions, the researcher only
focused on the owners of the SMEs which are likely to give the most accurate information
concerning their businesses. Finally, the construction of the questionnaire was such that it
was not only simplified, but there was reduced variation of the responses from the
respondents by applying closed ended questions.

1.9 Assumptions of the Study

This research assumed that financial management practices significantly contribute to the
financial performance of SMEs in Kiambu town. It also assumed that the owners of SMEs
have strategies they use to manage finances in their businesses. Further, the researcher
assumed that the owners of the SMEs in Kiambu would be willing to provide the
information required for this study and that the information they provided would be
accurate.