financial management practices and financial characteristics

financial management practices and financial characteristics

A THESIS SUBMITTED TO THE GRADUATE COLLEGE OF MANAGEMENT IN PARTIAL FULFILLMENT OF REQUIREMENTS FOR THE DEGREE OF

DOCTOR OF BUSINESS ADMINISTRATION AT SOUTHERN CROSS UNIVERSITY, N.S.W., AUSTRALIA

I certify that the substance of this thesis has not already been submitted for any degree and is not currently being submitted for any other degree or qualification

I also certify that, to the best of my knowledge, any help received in preparing this thesis, and all sources used have been acknowledged in this thesis

Signature: Kieu Minh Nguyen Date: _

I owe a debt of gratitude to many people who helped me complete this thesis I would like to acknowledge the help of all First of all I would like to express my deepest acknowledgement to my supervisor, Professor Geoffrey Grant Meredith from the Graduate College of Management (SCU), for his valuable advice and recommendations

I acknowledge Dr Lyndon Brooks, his assistants from the Graduate Research College (SCU), and Mr Tho Dinh Nguyen from the School of Marketing (UTS) for their support with statistical techniques and data analysis I also acknowledge Ms Rosemary Graham from the International Office (SCU) for her comments on English in earlier drafts of my thesis

In the process of data collection for this research, many people contributed to the task and I am particularly grateful for their contributions I am greatly indebted to Dr Pham Van Nang, Dr Le Bao Lam, and Dr Le Thanh Ha from Ho Chi Minh City University of Economics for their introduction to contacts with the small and medium enterprises (SMEs) community located in Ho Chi Minh City

I also wish to thank Mr Nguyen Trong Hanh, Vice Director of Department of Taxation, Mr Du Quang Nam, Vice Director of Statistical Office – Ho Chi Minh City; and Mr Tran To Tu, Managing Director of Investment Consulting Corporation for providing secondary data related to the current practices of SMEs in Vietnam

I would like to thank the following organizations which supported me in completing my thesis and degree: the Swiss Agency for Development and Cooperation (SDC), the Swiss – AIT – Vietnam Management Development Program (SAV), the Mekong Project Development Facility (MPDF), the Small and Medium Enterprise Promotion Centre (Vietnam Chamber of Commerce and Industry – VCCI), HCM City University of Economics, HCM City Statistical Office, HCM City Department of Investment and Planning, HCM City Department of Taxation Specially, I would like to extend my sincere gratitude to the Government of Switzerland and Dr Hans Stoessel, Director of SAV for granting the scholarship which enabled me to participate in a doctoral degree at Southern Cross University, New South Wales, Australia

Truong Doan Company Limited, Mr Hoang Trong from Ho Chi Minh City University of Economics, Mr Vo Sy Nhan from Ho Chi Minh City Department of Investment and Planning, and all my students who worked as fieldworkers for data collection

Finally, to my parents and my wife, I wish to extend my loving thanks for their encouragement My greatest debt of gratitude is to my wife, Mrs Que Thi Tran, who was patiently waiting me during my study in Australia This thesis could not have been written without her daily encouragement

After a decade of reforming policy, building and developing the multi-sector market economy, Small and Medium Enterprises (SMEs) in Vietnam have developed strongly and contributed to creating employment, increasing GDP, and raising the nation’s volume of exports However, SMEs have found difficulties on the way to development due to lack of management experience and financial resources, and due to uncertainty within the business environment As a result, SMEs often faced obstacles during their operations This thesis examines the relationship between financial management and profitability of SMEs to determine whether financial management practices and financial characteristics impact on SME profitability

Objectives of the thesis are (1) to investigate and describe features of financial management practices and financial characteristics of SMEs in Vietnam, (2) to develop and test a model of SME profitability, and (3) to contribute knowledge of the relationships between financial management and characteristics to improve SME profitability by using tools of efficient financial management

In terms of structure, the thesis has six chapters The thesis begins by defining the research problem and questions, and providing a justification for the research study Chapter one also reviews the research background, and presents definitions of terms, significance and scope of the study Chapter two examines the economic background, business structure and the development of SMEs in Vietnam This chapter also reviews previous research related to financial management for SMEs in Vietnam to identify gaps between financial management for SMEs in Vietnam and financial management for SMEs worldwide

Chapter three reviews financial management including financial management practices, financial characteristics and profitability of SMEs around the world, especially in the developed economies such as the United States of America (USA), the United Kingdom (UK), Australia and Canada This review emphasizes profitability and the impact of financial management practices and financial characteristics on SME profitability Objectives of this chapter are to review previous research related to the areas of financial management practices, financial characteristics, and profitability of

Chapter four discusses aspects of the research methodology including research design, data collection and data analysis methods, and hypothesis testing to support the model Objectives of this chapter are: (1) to justify the research methodology of this study, (2) to explain research methodology used in the study, and (3) to demonstrate how research design, and data collection and analysis can be utilized in this study to answer the research questions outlined in the chapter 1

Data analysis and findings are presented in chapter five This chapter presents descriptive findings of financial management practices, financial characteristics and SME profitability and findings of the research study related to testing the model of SME profitability Objectives of this chapter are (1) to systematically present the descriptive findings of the research study, (2) to interpret significance of these findings based on data analysis, (3) to present the results of testing the model of SME profitability, and (4) to explain how the model, developed from a literature review, was supported by data analysis Finally, the thesis ends with chapter six where conclusions are summarized and applications of the research findings are indicated for the financial management practitioners

The thesis provides descriptive findings of financial management practices and financial characteristics and demonstrates the simultaneous impact of financial management practices and financial characteristics on SME profitability In addition, the research study provides a model of SME profitability, in which profitability was found to be related to financial management practices and financial characteristics With the exception of debt ratios, all other variables including current ratio, total asset turnover, working capital management and short-term planning practices, fixed asset management and long-term planning practices, and financial and accounting information systems were found to be significantly related to SME profitability

With the findings as presented above, this research study provides many implications for financial management practices and contributes to knowledge of financial management of SMEs The model of SME profitability can be used as guidance for actions to improve the profitability of SMEs in Vietnam

AFTA ASEAN Free Trade Agreement

ANOVA Analysis of variance

APEC Asia Pacific Economic Cooperation ASEAN Association of South East Asian Nations

CED Committee of Economic Development

CF Cash flows

CUR Current ratio

DER Debt ratio

E.q Equation

EBT Earning before tax

EBIT Earning before interest and taxes

EFF Efficiency of financial management practices

EOQ Economic order quantity

FAIS Financial and accounting information system

FALP Fixed asset management and long-term planning practices

FDI Foreign direct investment

FSSB Financial Studies of the Small Business

GDP Gross domestic products

GSO General Statistical Office

IFC International Financial Corporation

IRR Internal rate of return

MIRR Modified internal rate of return

MPDF Mekong Project Development Facilities

ROS Return on sales

SBA The Small Business Administration (United State of America) SBV The State Bank of Vietnam

SME Small and medium enterprise SMENET Small and Medium Enterprise Net

SPSS The Statistical Package for Social Science

VCCI Vietnamese Chamber of Commerce and Industry

VIDB Vietnam Investment and Development Bank

LIST OF TABLES xiii

LIST OF FIGURES xvii

CHAPTER ONE: INTRODUCTION TO THE STUDY 1.1 INTRODUCTION 1

1.5 JUSTIFICATION FOR THE STUDY 8

1.6 DEFINITIONS OF TERMS USED IN THE STUDY 10

1.7 SIGNIFICANCE AND SCOPE OF THE STUDY 13

1.8 ANALYTICAL MODEL FOR THE STUDY 13

1.9 STRUCTURE OF THE STUDY 15

1.10 CONCLUSIONS 16

CHAPTER TWO: THE ECONOMIC STRUCTURE AND SMEs IN VIETNAM 2.1 INTRODUCTION 17

2.2 VIETNAM: BACKGROUND INFORMATION 19

2.2.1 Overview of the country 19

2.2.2 The Vietnam economy 23

2.2.3 The Vietnam population and labour 38

2.3 VIETNAM BUSINESS STRUCTURE 40

2.3.1 Types of business in Vietnam 41

2.3.2 Overview of enterprises in Vietnam 43

2.3.3 Small and medium enterprises in Vietnam 44

2.3.4 Policies for supporting SMEs 50

2.4.2 Use of finance 53

2.4.3 Financial management for SMEs 54

2.4.4 Problems in financial management 55

2.5 BUSINESS STRUCTURE AND SMEs IN HO CHI MINH CITY 56

2.6 CONCLUSIONS 58

CHAPTER THREE: FINANCIAL MANAGEMENT AND PROFITABILITY OF SMEs 3.1 INTRODUCTION 59

3.2 DEFINITIONS OF SMEs 61

3.2.1 Qualitative definitions 61

3.2.2 Quantitative definitions 64

3.2.3 The forms of ownership of SMEs 65

3.3 FINANCIAL MANAGEMENT FOR SMEs 67

3.3.1 Defining financial management 68

3.3.2 Objectives of financial management 69

3.3.3 Major decisions of financial management 71

3.3.4 The specific areas of financial management 72

3.4 FINANCIAL MANAGEMENT PRACTICES 76

3.4.1 The context of financial management practices 76

3.4.2 Accounting information systems 77

3.4.3 Financial reporting and analysis 83

3.4.4 Working capital management 89

3.4.5 Fixed asset management 95

3.4.6 Capital structure management 100

3.5 FINANCIAL CHARACTERISTICS OF SMEs 104

3.5.1 Identifying financial characteristics 104

3.5.2 Measuring financial characteristics 107

3.5.3 Previous findings related to financial characteristics 111

3.6 SME PROFITABILITY 119

3.6.1 Importance of profitability 119

3.6.2 Defining and measuring profitability 120

3.6.3 Factors influencing profitability 123

3.7 RELATIONSHIPS BETWEEN FINANCIAL MANAGEMENT AND SME PROFITABILITY 126

3.8 MODEL OF THE IMPACT OF FINANCIAL MANAGEMENT ON SME PROFITABBILITY 128

CHAPTER FOUR: RESEARCH METHODOLOGY

4.1 INTRODUCTION 132

4.2 APPRAISAL OF PRIOR RESEARCH METHODOLOGIES 134

4.3 RESEARCH DESIGN 137

4.3.1 Classification of research design 137

4.3.2 Selecting research design or paradigm 140

4.3.3 Selecting research methods or techniques 141

4.4 VARIABLE DEFINITIONS, SURVEY INSTRUMENT AND MODEL DEVELOPMENT 144

4.4.1 Variable measurements and survey instrument 144

4.4.2 Model development 162

4.4.3 Hypothesis statements 165

4.5 DATA COLLECTION METHODS 168

4.5.1 Secondary data collection 169

4.5.2 Primary data collection 170

5.3.1 Sample descriptions and SME characteristics 187

5.3.2 Descriptive findings of financial management practices 190

5.3.3 Descriptive findings of financial characteristics 206

5.3.4 Descriptive findings of profitability of SMEs 211

5.4 ASSOCIATIVE ANALYSIS AND FINDINGS OF THE RESEARCH STUDY 215

5.4.1 Factor analysis and principal components of financial management practices 216

5.4.2 Bivariate analysis and findings 221

5.4.3 Multiple regression analysis and findings 225

5.5 CONCLUSIONS 236

CHAPTER SIX: CONCLUSIONS AND IMPLICATIONS 6.1 INTRODUCTION 237

6.2 CONCLUSIONS RELATED TO RESEARCH QUESTIONS AND TESTING THE MODEL 239

6.2.1 Conclusions related to financial management practices 239

6.2.2 Conclusions related to financial characteristics 247

6.2.3 Conclusions of SME profitability 249

6.2.4 Summary of research question answers 255

6.3 IMPLICATIONS OF THE RESEARCH STUDY 258

6.3.1 Implications for financial management practices of SMEs 258

6.3.2 Contributions to knowledge of this research into financial management for SMEs 262

6.4 LIMITATIONS OF THE RESEARCH STUDY 263

6.5 IMPLICATIONS FOR THE FURTHER RESEARCH 264

Bibliography 266 Appendix 1

Appendix 2 Appendix 3 Appendix 4

Table Page

2.1 Changes in economic structure, 1986 – 1991 27

2.2 State-budget revenue, 1986 – 89 28

2.3 State-budget revenue, 1991 – 93 29

2.4 Financial institutions in Vietnam, 1995 30

2.5 GDP index by economic sector and rate of inflation 31

2.6 Index of exchange rate of USD/VND 32

2.7 GDP index by economic industry 32

2.8 Agriculture development over the years 33

2.9 Industry development over the years 34

2.10 Export and import value by major countries 35

2.11 Population by sex and areas 38

2.12 Population growth rates and structure 39

2.13 Labor force by economic sector 39

2.14 Labor force by the state and non-state sector 40

2.15 Unemployment rate of labour force in 1998 40

2.16 Number of businesses by economic sector and average capital 43

2.17 Number of businesses and employees on July 1, 1995 44

2.18 Definitions of SMEs in Asian countries 46

2.19 Number of enterprises in manufacturing industry by scale of employees and total capital 49

2.20 Business operation problems of SMEs in Vietnam 50

2.21 The kind of SME support programs 51

2.22 Some financial characteristics of SMEs in Vietnam 54

2.23 Business structure of SMEs in Ho Chi Minh City 57

2.24 Size of businesses in Ho Chi Minh City 57

3.1 Summary of the quantitative definitions of small business 65

3.2 Forms of SME ownership in the USA 65

3.3 Legal status of small firms in the UK 66

3.6 Responsibility for preparation and use of financial information 78

3.7 The results of survey of computer software application 79

3.8 The most important applications of computer software 79

3.9 The most important applications of computers 80

3.10 Percentage of awareness and utilization of costing systems 81

3.11 Evaluate the adequacy of accounting records 82

3.12 Accounting information prepared externally or internally 82

3.13 Summary of research areas related to the accounting system practices of SMEs 83

3.14 Use of financial statement techniques by small manufacturers in Quebec 84

3.15 Responsibility for financial statement interpretation 85

3.16 Proportion of respondents indicating use of selected financial ratios 86

3.17 Percentage of use of financial ratios 87

3.18 Percentage of preparing accounting information both internally and externally 88

3.19 Summary of the main research areas related to the financial reporting and analysis 89 3.20 Cash surplus investment practices 90

3.21 Instruments of short-term investment used 91

3.22 Awareness and utilization of credit control systems 92

3.23 Methods used by small and large enterprises to determine inventory level 92

3.24 Working capital management: Frequency (%) of using or reviewing 93

3.25 Summary of working capital management practices 95

3.26 Percentage of firms using capital project selection methods 96

3.27 The extent of use of formal methods of the capital investment evaluation 96

3.28 Primary method of investment analysis 97

3.29 Percentage use of different methods by small, medium, and large enterprises 97

3.30 Percentage of kinds of screening rate used to evaluate the capital projects 98

3.31 Methods of determining the required rate of return as using discounted cash flow 99

3.32 Summary of fixed asset management practices 99

3.33 Viewpoint guiding firms’ financing decisions 102

3.34 Factors influencing percentage of bank debt usage 103

3.37 Financial ratios used in the study of Meric and Meric (1997) 117

3.38 Comparison of liquid ratios between Korean and USA firms 118

3.39 Summary of measurement of SME profitability 123

4.1 Classification of research designs 139

4.2 Summary of advantages and disadvantages of the most typical surveys 143

4.3 Model classification 163

4.4 Number and percentage of SME sample and population 174

4.5 Summary of multivariate techniques for the analysis of dependence 181

5.1 Structure of SMEs in the sample by type of industry and form of ownership 187

5.2 Sample distribution by form of ownership within industry 189

5.3 Business characteristics of SMEs in the sample 189

5.4 Characteristics of accounting system organization 190

5.5 Responsibility – accounting information system 191

5.6 Using computer in accounting information system 192

5.7 Kinds of financial statements prepared 193

5.8 Frequency of preparing and analyzing financial statements 193

5.9 Responsibility – preparing and analyzing financial statements 194

5.10 Kinds of financial analysis and ratios used 194

5.11 Preparing cash budgets 196

5.12 Cash balance determination 196

5.13 Cash surplus or shortage 197

5.14 Sales on credit and credit polices 198

5.15 Frequency of reviewing receivable levels and bad debts 199

5.16 Percentage of bad debts compared to sales 199

5.17 Frequency of reviewing inventory levels and preparing inventory budgets 200

5.18 Basis of determining inventory levels and using EOQ Model 201

5.19 Frequency of evaluating investment projects and reviewing efficiency of using fixed assets after investing 202

5.20 Methods used to evaluate investment projects 203

5.23 Responsibility – preparing financial budgets 205

5.24 Frequency of comparing between budgeted and actual results 205

5.25 Descriptive statistics of financial ratios 207

5.26 Test for difference of means of financial ratios between two groups 208

5.27 Comparison of current ratios 208

5.28 Descriptive findings of SME current ratios 209

5.29 Descriptive findings of SME debt ratios 210

5.30 Descriptive findings of SME activity ratio 211

5.31 Overview of SME profitability 213

5.32 Relationship between profitability and types of business 213

5.33 Relationship between profitability and business characteristics 214

5.34 Total variance explained and three principal components of financial management practices 217

5.35 Factor analysis results for measuring financial management practices 219

5.36 Three principal components of financial management practices 218

5.37 Correlation matrix of PRO, ROS, ROA, and ROE 222

5.38 Correlation matrix of PRO and independent variables 223

5.39 Correlation matrix of ROS and the independent variables 224

5.40 SME profitability regression model using profitability as dependent variable 226

5.41 Descriptive finding of relationship between profitability and current ratio 227

5.42 Relationship between SME profitability and the efficiency of financial management practices 230

5.43 Regression model of SME profitability after removing debt ratio 231

5.44 SME profitability regression model using return on sales as dependent variable 232

5.45 Descriptive statistics of profitability of two groups of SMEs 235

5.46 Independent group test of mean profit difference 235

6.1 Summary of conclusions related to financial management practices 246

6.2 Summary of conclusions related to financial characteristics of SMES 249

6.3 Summary of research questions and answers 257

Figure Page

1.1 Structure of chapter 1 2

1.2 Fields of the research problem 5

1.3 Analytical model for the research 14

1.4 Structure of the study 15

2.1 Structure of chapter 2 18

2.2 Political structure of Vietnam 23

2.3 Business structure in Vietnam 41

2.4 Breakdown of business by size 42

2.5 SME financial management practices and the gap 56

3.1 Structure of chapter 3 60

3.2 The central position and role of financial management 68

3.3 The relations among objectives of financial management 70

3.4 A model of financial management 74

3.5 Interaction between theories and practices of financial management 75

3.6 Financial ratios linked to return on equity 125

3.7 Model of the impact of financial management on SME profitability 130

4.1 Structure of chapter 4 133

4.2 Survey instrument for measuring accounting information system 148

4.3 Survey instrument for measuring financial reporting and analysis 150

4.4 Survey instrument for measuring cash management practices 152

4.5 Survey instrument for measuring receivable management practices 154

4.6 Survey instrument for measuring inventory management practices 156

4.7 Survey instrument for measuring fixed asset management 157

4.8 Survey instrument for measuring financial planning 159

4.9 Analytical model for the research study 165

4.10 Structure of SMEs in Vietnam and the target population 171

4.11 A classification of multivariate methods 179

5.3 Distribution of sample by ownership 188

5.4 Relationship between profitability and debt ratio 229

6.1 Structure of chapter 6 238

6.2 The revised model of SEM profitability 254

Section 1.1 provides a general introduction to the chapter and section 1.2 examines the research background where the research problem is identified Section 1.3 defines the research problem, presents a statement of the problem and expands the research problem in two subsections 1.3.1 and 1.3.2 Subsection 1.3.1 addresses the research questions that will be respectively answered in chapters of the study Subsection 1.3.2 presents research objectives that the study covers in the process of solving the research problem defined

Section 1.4 briefly discusses the general aspects of research methodology such as selecting from alternative types of research and research design, whereas the details of research methodology will be discussed in chapter 4 Section 1.5 provides some justifications for the study including the rationale and arguments for the study

Section 1.6 explains the context of specialized terms used in the study and section 1.7 points out the significance and scope of the study Section 1.8 presents the analytical model of the study fully developed in chapter 3 Section 1.9 describes overall structure of the thesis, and finally section 1.10 summarizes conclusions drawn from the research Figure 1.1 provides a visual representation of the structure of the chapter

Figure 1.1: Structure of chapter 1

1.3 Research problem

1.3.1 Research questions 1.3.2 Research objectives

1.4 Methodology

1.5 Justification for the study

1.6 Definitions of terms used in the study

1.9 Structure of the study

1.10 Conclusions

1.8 The analytical model for the study 1.7 Significance and scope of the study

1.2 Research background 1.1 Introduction

Source: Developed for the thesis

1.2 RESEARCH BACKGROUND

In the mid-1980s, Vietnam could be characterized as having a strong economy system However, difficulties from 30 years of war and the inefficiency of the command-economy system had led the national economy to the brink of disaster Faced with stagnant growth, a severe shortage of food, deficit budgets, increases in inflation and chronic trade imbalances, the Government of Vietnam initiated an economic renovation policy in December 1986

command-Economic reform has taken place in many areas but typically has focused on four main areas (Le, 1992) The first was to change from a centrally planned and controlled economy to a market economy regulated by the government The second involved a shift from the policy of giving priority to the state and collective sectors to the policy of developing multi-sector businesses and promoting private businesses The third was to change investment policy that had formerly emphasized heavy industries into policies of priority for development of food and consumer goods production, and goods production for exports In terms of international economic relations, the government has encouraged all economic sectors to diversify exporting products and markets instead of focussing on the traditional ones such as the former Soviet Union and Eastern European countries (Le, 1992)

It is apparent that since the government introduced the series of economic reforms known as doi moi (renovation), the private sector has rapidly grown in terms of the number of businesses, capital and employees From the base of zero in 1991, the number of private businesses and limited companies had quickly risen to 28,811 in 1998 (Tran, 1998, p 54) and almost all are small and medium enterprises (SMEs) SMEs have contributed considerably to growing GDP and creating jobs for labour-age people Vu (1998, p 18) summarizes SME contributions as follows:

• providing a large number of diversified products, occupying 26 percent of GDP and 30 percent of industrial outputs,

• creating jobs for 4.5 million people,

• mobilizing temporarily unused resources such as land, capital, labour and management skills to develop production, and

• increasing export volume and lessening trade deficits

In addition to achievements and contributions as mentioned above, SMEs in Vietnam are currently being faced with many serious difficulties such as shortage of capital for expanding and renovating equipment and technology, low productivity and competitiveness, lack of experience in terms of marketing, production management, and financial management Of these difficulties, lack of financing resources and experience of financial management is currently one of the most serious issues (Ebashi, Sakai and Takada, 1997) Inefficient financial management may damage SME profitability and, as a result, the difficulties of SMEs will become greater Conversely, efficient financial management will help SMEs to strengthen their profitability and, as a result, these difficulties can partly be overcome Most commercial banks refuse to offer loans for SMEs because the banks think SME profitability could not cover loan risks However, to date there has not been any research on SME profitability conducted in Vietnam Conducting such research will enable commercial banks to evaluate SME profitability and make decisions on granting loans for SMEs In addition, when the stock exchange is established in Vietnam, conducting research on SME profitability will help SMEs to improve their performances and reinforce financial management as a preparation to participate in stock exchange listing

Originating from recognition of the increasingly important role and contribution of SMEs as well as the recent promotion and supporting policy on developing SMEs, this research study is considered a contribution to improvement of financial management practices and profitability of SMEs in Vietnam Firstly, it investigates financial management practices and financial characteristics of SMEs, and then, examines the impacts of financial management practices and financial characteristics on SME profitability

1.3 RESEARCH PROBLEM

Problem definition is essential before conducting a research project, especially quantitative research Zikmund (1997, p 82) recommends that formal quantitative research should not begin until the problem has been clearly defined In Vietnam, defining the research problem of SMEs may begin with a consideration of the typical characteristics of management Most SMEs have not appointed financial managers to be in charge of financial management of the company Usually, the owner-managers

with the assistance of the chief-accountant control financial matters of the company However, most owner-managers have no formal training in management skills, especially financial management Moreover, the concepts of financial management have also only been recognized in Vietnam since the beginning of the 1990s when the economy was converted into a market economy Currently, financial management is one of the challenges of SMEs

Lack of knowledge of financial management combined with the uncertainty of the business environment often lead SMEs to serious problems regarding financial performances Regardless of whether owner-manager or hired-manager, if the financial decisions are wrong, profitability of the company will be adversely affected Consequently, SME profitability could be damaged because of inefficient financial management SMEs have often failed due to lack of knowledge of efficient financial management Moreover, undercapitalization and uncertainty of the business environment cause SMEs to rely excessively on equity and maintain high liquidity and these financial characteristics probably affect SME profitability (Vuong, 1998)

In summary, the problem that SMEs in Vietnam face appears to be that inefficient financial management practices have adversely affected their profitability Therefore, the problem to be addressed in this research is to investigate the simultaneous effects of financial management practices and financial characteristics on SME profitability, and then, to determine the best measures for improving SME profitability in Vietnam by using efficient financial management tools Figure 1.2 represents the fields of research problem in this study

Figure 1.2: Fields of the research problem Financial management practices

SME profitability

Financial characteristics

Source: Developed for the thesis

1.3.1 Research questions

Research questions involve the research translation of “problem” into the need for inquiry (Zikmund, 1997, p.88) The research problem defined above leads to the following research questions:

• How important are SMEs in Vietnam and are they profitable? (answered in chapters 2 and 5)

• How have researchers in the literature review, identified the context of financial management practices and financial characteristics, and how have they proposed to measure SME profitability? (answered in chapter 3)

• How important are financial management practices and financial characteristics to SME profitability? (answered in chapter 3)

• What are the relationships between financial management practices, financial characteristics and SME profitability? (answered in chapters 4 and 5)

• How do financial management practices and financial characteristics affect SME profitability? (answered in chapters 4 and 5)

• What action can improve financial management and profitability of SMEs in Vietnam? (answered in chapters 5 and 6)

1.3.2 Research objectives

A research objective is the researcher’s version of a business problem Objectives explain the purpose of the research in measurable terms and define standards of what the research should accomplish (Zikmund 1997, p 89) In solving the research problem and answering the research questions mentioned previously, this study has the following objectives:

to collect descriptive evidence on financial management practices, financial characteristics and profitability of SMEs in Vietnam

• • •

to develop a model of the impacts of financial management practices and financial characteristics on SME profitability

to contribute to knowledge of the relationships of financial management practices, financial characteristics and SME profitability

Selecting research design is the next step after choosing type of research There are four types of research design from which to select: survey, experiments, observation and secondary data (Zikmund, 1997) Selection of research design is based on the advantages and disadvantages of each kind of research designs and circumstances in which the research problem is defined In this research, both survey and secondary data methods are used in combination

Survey was chosen as a research technique in this study to investigate and describe financial management practices of SMEs in Vietnam Questionnaires were designed and directly delivered to SMEs to collect data related to financial management practices The argument for choosing survey was twofold Firstly, surveys provide quick, efficient and accurate means of assessing information about the population Secondly, surveys are more appropriate in cases where there is lack of secondary data

The secondary data method was used to examine the financial characteristics of SMEs The variables such as liquidity ratios, financial leverage ratios, activity ratios, and profitability ratios are derived from financial statements These financial statements are available from taxation departments of Vietnam and sometimes from businesses directly

One of the objectives of collecting data related to financial management practices, which are collected from the survey, and data related to financial characteristics of SMEs, which are derived from the financial statements, was to test hypotheses This research study was designed to test two kinds of hypotheses The first was the hypothesis of the simultaneous impacts of financial management practices and financial characteristics on SME profitability The second was the hypothesis related to differences in the average profits between SMEs with efficient financial management practices and SMEs with inefficient practices

1.5 JUSTIFICATION FOR THE STUDY

Concerned with financial management practices, most previous researchers have concentrated on examining, investigating and describing the behaviour of SMEs in practising financial management Five specific areas of financial management practices including accounting information systems, financial reporting and analysis, working capital management (including cash management, receivables management, inventory management and payables management), fixed asset management and capital structure management have long attracted the attention of researchers (McMahon, et al 1993) Their findings are mainly related to exploring and describing the behaviour of SMEs towards financial management practices Although they provided much descriptive statistical data and empirical evidence on SME financial management practices, it appears that there still are some gaps in the literature, which need to be addressed

• Firstly, most empirical evidence comes from the developed economies such as the United States of America (USA), the United Kingdom (UK), Canada and Australia (McMahon et al 1993) There seems to be a lack of evidence from emerging economies, especially from transiting economies such as Vietnam and China

• Secondly, most previous researchers focus on investigating and describing financial management practices whereas there has been little research examining the impact of financial management practices on SME profitability (McMahon et al 1993)

These are major gaps and it is difficult to convince business financial management practitioners of the need for changes in practices until evidence of the effects of financial management practices on SME profitability is provided and the relationship between the two variables are discovered

In addition to financial management practices, previous researchers provided valuable findings related to financial structures/characteristics of SMEs Four variables including liquidity, financial leverage, activity and profitability are popularly used by previous researchers to identify and measure financial characteristics of SMEs (McMahon et al, 1993) There are many studies on financial characteristics of SMEs conducted by researchers over several decades However, there still exist gaps in the literature related to financial characteristics of SMEs, which need to be supplemented

• Firstly, it appears that the financial characteristics of SMEs in developing countries, especially in transiting economies such as Vietnam and China have not been investigated and empirical data has not been produced

• Secondly, to date, there is no study, which examines the relationship or the impact of three variables: liquidity, financial leverage, and activity on profitability variable

This lack of empirical evidence from emerging economies and the lack of examination of the impact of financial management practices and financial characteristics on SME profitability are major gaps in the knowledge of financial management practices and financial characteristics of SMEs Based on previous research findings and recognition of these gaps, a study of the impact of financial management on SME profitability is justified and a model of the impacts of financial management practices and the financial characteristics should be developed and tested by using the empirical data from emerging economies Vietnam is one of many

appropriate countries to provide such data Therefore, this study will extend previous studies by focusing on examining the simultaneous impacts of financial management practices and financial characteristics on SME profitability using the empirical evidence from Vietnam

1.6 DEFINITIONS OF TERMS USED IN THE STUDY

Specialized terms used in this study include SMEs, private company, limited company, stock companies, efficient financial management and profitability These

terms are adopted for Vietnamese context In this study, SMEs refers to small and

medium enterprises Currently, Vietnam has not uniformly defined which criteria a business has to fulfil to be viewed as an SME In this study, SMEs are understood to have the same definition given by the Vietnamese Chamber of Commerce and Industry (VCCI, 1998) According to VCCI, a SME is defined as a business unit that fulfils the following criteria, depending on its size:

• Small business:

− Manufacturing: less than 200 employees and VND5 billion capital − Trading and services: less than 200 employees and VND5 billion capital • Medium business:

− Manufacturing: 200 – 500 employees and VND5 – 10 billion capital − Trading and services: 50 – 100 employees and VND5 – 10 billion capital As will be examined in more detail in chapter two, SMEs include many forms of business organization such as private enterprises, limited companies, joint stock companies, cooperatives and business households or family businesses However, this study only focuses on the forms of business that set up a formal system of financial management Based on this criterion, private enterprises, limited companies, and joint stock companies are the objects of this study whereas others such as cooperatives and family businesses are beyond the study Also, the term “company” is used

synonymously with the term “enterprise” in this study Private enterprises are

companies that are registered under the Vietnam Private Business Law These

companies have one owner who is responsible for all his or her assets Limited companies are companies that are registered under the Company Law and they have

larger initial capital than private enterprises Owners’ liability is limited to the initial capital that they have to invest in full at the time of establishment of the company If there are more than 12 owners, a formal owner meeting and boards of director meetings must be held

Financial management is concerned with all areas of management which

involve finance – not only the sources and uses of finance in the enterprise, but also the financial implications of investment, production, marketing or personnel decisions and the total performance of the enterprise (Meredith, 1986) Financial management is concerned with raising the funds needed to finance the enterprise’s assets and activities, the allocation of these scarce funds between competing uses, and ensuring that the funds are used effectively and efficiently in achieving the enterprise’s goals (McMahon, Holmes, Hutchinson and Forsaith, 1993) However, financial management, in this study, is limited to a framework of five specific areas: (1) accounting information system (2) financial reporting and analysis, (3) working capital management, (4) fixed asset management, and (5) capital structure management This limitation is necessary and appropriate to financial management practices of SMEs in Vietnam, given information available for research

Financial management objectives, in this research, refer to two main

objectives: profitability and liquidity 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 (McMahon, 1995) Liquidity management is concerned with avoiding any damage at all to a business’s credit rating, due to a temporary inability to meet obligation by anticipating cash shortages, maintaining the confidence of creditors, bank managers, pre-arranging finance to cover cash shortages (McMahon, 1995)

Efficient financial management, in this research, is defined as financial

management that achieves financial management objectives without wasting financial

resources Conversely, inefficient financial management is not to achieve financial

management objectives or achieve the objectives but wasting or without minimizing financial resource utilization Chapter 4 defines variables and criteria to measure the extent of efficiency of financial management In this study the context of financial management practices include accounting information systems, financial reporting and analysis, cash management, receivable management, inventory management,

fixed asset management and financial planning The extent of efficiency of each financial management component is measured by the sum of points of eight items on the nine-point scale (1 = not efficient at all, 9 = very efficient) If the sum of points of a financial management component of a business is greater than the average point of 40 (8 x 5 point average), the business is said to be “efficient” in practising that financial management component Conversely, if that sum is less than the average point of 40, the business is said to be “not efficient” or “inefficient” in practising that financial management component Lastly, a business is said to be “efficient” in financial management practices, if all components of financial management practices are efficient, that is, all sums of points of components are greater than the average point of 40

Manager refers to the person who is hired to run and manage the business whereas owner-manager refers to the person who plays the role of both owner and

manager

Financial characteristics of the enterprise are represented by financial ratios,

derived from financial statements This information can be used to quantify the position of SMEs in terms of their profitability, liquidity, and leverage and to compare them with other or large enterprises (McMahon et al 1993) In this study, financial characteristics are measured by three variables including liquidity, financial leverage and business activity, which are derived from financial statements

SME profitability is an abstract concept There are many different ways to

measure profitability This research limits the measures of SME profitability at the following ratios: (1) return on sales, (2) return on assets, and (3) return on equity This limitation is necessary to narrow the scope of the study and is suitable for financial management practices for SMEs in Vietnam In addition, in this study, the concept of profitability is defined as a comparative concept A business is said to be “profitable” if it produces annual average returns (average of return on sales, return on assets and return on equity) that are greater than the free-risk rate of interest, which was estimated as 5.4% percent at the middle of the year 2000 in Vietnam Conversely, if the annual average profit of a business is not greater than the free-risk rate of interest, the business is said to be “not profitable” The arguments for the concept of profitability will be explained in chapters 4 and 5

1.7 SIGNIFICANCE AND SCOPE OF THE STUDY

Completing this study brings together aspects of theory and practice For theory, this study is an expansion of previous studies on financial management practices and financial characteristics of SMEs by focussing on examining the simultaneous impacts of financial management practices and financial characteristics on SME profitability In addition, utilizing data from Vietnam, one of the emerging economies, contributes to the literature of SME financial management, which traditionally concentrates on SMEs of developed economies rather than SMEs in other economies Using data from Vietnam to test theories of financial management helps to confirm and expand the scope of theoretical applications

In practice, this study is significant for financial management practices in Vietnam Results will indicate relationships between financial management practices, financial characteristics and SME profitability and will assist owner-managers and financial managers to improve performance and profitability of their businesses by managing financial matters efficiently and effectively

1.8 ANALYTICAL MODEL FOR THE STUDY

The analytical model for this research, which is developed and justified in the literature review chapters, and which ultimately provides structure to the empirical chapters, is illustrated in figure 1.3 (page 14) This analytical schema represents the model of the effects of financial management practices and financial characteristics on SME profitability The model demonstrates that SME profitability is expected to be positively influenced by efficient financial management practices and financial characteristics

This analytical schema presented in Figure 1.3 can be expressed in mathematical notation as follows:

Pm = f(As, Fa, Wo, Fi, Cs, Ls, FLa, ACo) (Eq 1.1)

where:

Pm = SME profitability ratios, viewed as dependent variables

As = Accounting information system practices, viewed as independent variables Fa = Financial reporting and analysis practices, viewed as independent variables Wo = Working capital management practices, viewed as independent variables Fi = Fixed-asset management practices, viewed as independent variables Cs = Capital structure management practices, viewed as independent variables Ls = Liquidity ratios, viewed as independent variables

FLa = Financial leverage ratios, viewed as independent variables ACo = Activity ratios, viewed as independent variables

Figure 1.3: Analytical model for the research

Source: Developed for the study

Chapter 4 will present, in more detail, definitions and measures of dependent variable (profitability) and independent variables such accounting information system, financial reporting and analysis, working capital management (including cash management, receivables management, inventory management), fixed asset

Financial management practices:

• • • • • •

Accounting information system Financial reporting and analysis Working capital management Fixed asset management Capital structure management Financial planning

Efficient financial management

SME profitability:

• • •

Return on sales Return on assets Return on equity

Financial characteristics:

• • •

Liquidity ratios

Financial leverage ratios Activity ratios

management, capital structure management, and financial planning In addition, the model of simultaneous effects of financial management practices and financial characteristics on SME profitability will be developed from the literature review in chapter 3 and with variables defined in chapter 4 of the study

1.9 STRUCTURE OF THE STUDY

This research is structured into 6 chapters Chapter 1 introduces the research including research background, research problem, research questions, research objectives and justifications for the research Chapter 2 examines the economic structure, and the current practices and role of SMEs in Vietnam Chapter 3 provides a literature review of financial management practices, financial characteristics and SME profitability Chapter 4 discusses methodology utilized in the research Chapter 5 analyses the data collected and presents the findings of the research Chapter 6 points out conclusions and the implications of the research in the world of business administration Figure 1.4 (page 15) illustrates the structure of the study and the relationships between chapters

Figure 1.4: Structure of the study Chapter 1: Introduction to the Study

Chapter 2: The Economic Structure

and SMEs in Vietnam Practices, Financial Characteristics and Chapter 3: Financial Management Profitability of SMEs

Chapter 4: Research Methodology

Chapter 6: Conclusions and ImplicationsChapter 5: Data Analysis and Findings

Source: Developed for the thesis

1.10 CONCLUSIONS

This research examines the simultaneous impacts of financial management practices and financial characteristics on SME profitability using evidence from Vietnam To date, there is no significant research related to financial management practices and financial characteristics of SMEs conducted in Vietnam and there is also no research that examines the simultaneous impact of financial management practices and financial characteristics on SME profitability This research is designed as a combination of descriptive and explanatory research in which a sample of 160 SMEs are drawn from a list of over 14,000 SMEs in Ho Chi Minh City for personal interview

Gathered data will be processed by computer and the Statistical Package for Social Science (SPSS) is the main computer software utilized in data analysis In term of data analysis, this study applies both descriptive and inferential statistics Descriptive statistical techniques will be applied to describe characteristics of financial management practices and financial characteristics of SMEs in the sample Inferential statistical techniques such as bivariate analysis for measuring the association, bivariate analysis for testing the difference, factor analysis, and multivariate analysis will be applied to test the hypotheses of association and differences (chapter 5) Findings of this study will be applied to increase efficiency of financial management practices and improve profitability of SMEs in Vietnam (chapter 6) To provide an in-depth picture of business environment in which SMEs operate, chapter 2 will respectively examine and present information on background of the economy, business structure and SMEs in Vietnam whereas chapter 3 reviews the literature of financial management for SMEs around the world

This chapter is structured into 6 main sections Section 2.1 provides a general introduction to the chapter, including the objectives and structure of the chapter Section 2.2 examines information on Vietnam such as geographic location, history, political structure, the process of economic and financial development, and its population and labour force Section 2.3 concentrates on examining Vietnam business structures with special emphasis on SMEs and the support policy for SME development Section 2.4 analyzes all aspects of SME finance in Vietnam including types of finance, use of finance and financial management Section 2.5 provides an overview of business structure of SMEs in Ho Chi Minh City where SMEs are considered the largest groups in term of numbers and are representative of SMEs in the whole country Section 2.6 summarizes the conclusions drawn from reviewing the background of economy and SME performances in Vietnam Figure 2.1 (page 18) provides a visual outline of the structure of the chapter

Figure 2.1: Structure of chapter 2 2.1 Introduction

2.2 Vietnam: background information

2.2.1 Overview of the country

2.2.2 Vietnam economy

2.2.3 Vietnam population

2.2.4 Vietnam labour force

2.3 Vietnam business structure

2.3.1 Type of business 2.3.3 Small and medium enterprises

2.3.4 Policies for supporting SMEs 2.3.2 Overview of enterprises in VN

2.4 SME finance in Vietnam

Source: Developed for the thesis 2.5 Business structure and SMEs in

2.2 VIETNAM: BACKGROUND INFORMATION

Section 2.2 reviews information on Vietnam background including geographical location, historical overview, economic development process, population and labour This section is structured into three subsections Subsection 2.2.1 provides an overview of the country Subsection 2.2.2 examines the process of economic development since the country was reunified in 1976 Section 2.2.3 reviews population and labour force in Vietnam

2.2.1 Overview of the country

When asked about Vietnam many around the world probably answer that it is a “poor country” damaged seriously by conflicts That was the position in the late 1970s As of 2000, the country has seen increasingly remarkable changes Harvie (1996, p 1) presents a current impression of Vietnam since the country has introduced its market-oriented economic policy

Vietnam has only recently emerged as a participant in the most rapidly growing region of the world economy, the Asia Pacific economy It is poised to become one of Asia’s most vigorous market economies during the remainder of the 1990s and into the twenty-first century, having rejected central planning, and is widely tipped to become Asia’s next economic dragon

2.2.1.1 The geographical location

Schuwalow (1996, p.189) described Vietnam as the country that extends more than 1,600 kilometres along the east coast of Indochina, from the Chinese-border mountain and the Red River delta in the north, the Laotian and Cambodian borders, to the fertile Mekong River delta in the south Although in its extreme north the country is more than 500 kilometres wide, much of the middle section is a relatively narrow strip of coastal land For a considerable distance it is 80 kilometres wide, and in the south expands again to about double that width (see the map, page 20) Vietnam’s total land area is 325,360 square kilometres, and 75 percent is hill country or mountains Climate is typically monsoon, and the temperature varies considerably according to latitude In the tropical south, conditions are warm to hot throughout the year and the humidity is usually high In the north, particularly in the highlands, markedly warmer and cooler seasons occur and temperatures are much lower than those at sea level

2.2.1.2 Historical overview

After the government of South Vietnam fell on 30 April 1975, the north and the south of Vietnam were reunified by a national election held in April 1976 and in July of the same year the Socialist Republic of Vietnam was established This reunification came in an attempt to transform the south from a basically market economy to a planned economy Collectivization and nationalization respectively happened in agriculture and other industries In the meantime, trade with the western countries was greatly restricted due to the United States of America trade embargo Vietnam’s conflict with Cambodia during 1977 – 80 and border conflict with China in 1979 further hampered the country’s progress Throughout the 1980s most people associated Vietnam with the word “war” However this perception is slowly fading as a new image of Vietnam emerges Currently Vietnam is a country at peace with a vast variety of natural resources, a high literacy rate (90 percent), and an increasingly skilled and hard labour force Although an often-difficult business climate has been experienced in the past, Vietnam is currently changing and amending many of its laws in order to attract more foreign investment and trade opportunities (Vietnam Embassy in USA, 1999)

By the mid-1980s, a decline in the former Soviet Union aid and government’s tight control over economic policy proved to be an economic disaster leading to a decline of production in many sectors, and an increasing reliance on imports In response to this inefficiency, the Vietnamese Government initiated a series of

economic reforms known as doi moi ("renovation") in December 1986 The main

goals of doi moi were to improve lagging productivity, to raise living standards, and to curb rapid inflation, which reached almost 500 percent a year in mid-1980s (Kimura, 1993) Renovation process included macro-economic stabilization, the recognition of Vietnam’s private sector, and the promotion of foreign trade and investment Following this paradigm, Vietnam has attempted to transform itself into a market-oriented economy, and opened itself to the outside world After more than a

decade of doi moi, Vietnam has experienced huge growth in investment, industry and

an expansion of trade (20% per annum on average) and has had considerable success in restructuring the economy (Vietnam Embassy in USA, 1999) The government has opened the country to foreign investment, by allowing many joint venture and wholly foreign-owned enterprises to flourish Regulations and rules have more and more become liberalized

In July 1995, Vietnam became a full member of the Association of South East Asian Nations (ASEAN) On January 1st 1996, Vietnam became a member of the ASEAN Free Trade Agreement (AFTA) and in 1998 Vietnam was admitted into the Asia Pacific Economic Cooperation (APEC) and has since signed trade agreements with a number of countries and territories (Australian Department of Foreign Affairs and Trade, 2001) As of 2000, Vietnam is closer then ever to establishing a long-term trade relationship with the United States of America, and has submitted an application to enter the World Trade Organization (WTO) In recent years, the government has planned to establish a Vietnamese stock market and new laws on foreign investment are currently being promulgated and amended in order to make Vietnam more attractive to foreign investment After many years of preparation, the stock market was finally opened and launched the first transaction on 26 June 2000 (USA Department of Commerce, 1998)

2.2.1.3 Political structure

In Vietnam, leadership structure is divided into three levels The General Secretary is in charge of representing and dealing with issues concerning the Vietnamese Communist Party The Prime Minister is in charge of handling government affairs and day-to-day business of the country Finally, the President focuses on security issues and the armed forces Vietnam is a socialist country under the leadership of the Communist Party The Communist Party has nearly 2 million members and strongly influences every aspect and at every level of Vietnamese life The party holds a national congress every five years to outline the country’s overall direction and formalize policies (Commercial Chamber of Vietnam in USA, 1998)

The National Assembly, which includes 450 members, representing all walks of life throughout the country, and is open to non-party members, is the highest state authority and the only body with constitutional and legislative power The National Assembly elects the President of the State and the Prime Minister (figure 2.2, page 23). The Prime Minister is in charge of handling government affaires with assistance of 18 ministries At its meeting, the National Assembly examines reports and plans presented by the ministries involved, and National Assembly members have rights to ask ministries to clarify and answer questions raised by members (Commercial