The impact of financial literacy on SME performance

THE IMPACT OF FINANCIAL LITERACY ON SMALL AND MEDIUM ENTERPRISE PERFORMANCE.

INTRODUCTION

Both in emerging and developed economies, Small and Medium Enterprises (SMEs) remain to be the main engine that drives economic growth and job creation (Locke, 2012). As a result, SMEs are viewed as an integral part of the economy by various factions such as development economist, entrepreneurs, governments, venture capitalist firms, financial institutions and non-governmental organisations (Eniola & Entebang, 2014). It has been said that almost all enterprises in the world are SMEs (Capital Markets Authority, 2010). According to The world bank (2019) SMEs contribute up to 60% of formal employment and up 40% of the Gross Domestic Product (GDP) in emerging economies. Moreover, research conducted by the Economic and Social Research Council (2016), shows that in developed economies such as the UK, SMEs play a vital role in the economy, accounting for 60% of all private sector jobs and 47% of the GDP.

In South Africa, SMEs are estimated to make up to 74% of all formal businesses, while they also provide employment to about 60% of the work force and lastly contribute roughly 34% of the GDP (Susman, 2017). The performance of these SMEs should closely be managed to ensure a universal understanding of what needs to be achieved, how it is going to be achieved and the skills personnel needs to possess to be able to cement success (Armstrong, 2009). One skill that is absolutely imperative is the ability to understand and be proficient in all matters finance. This includes managing personal finance, money and being able to make good investments (Kenton, 2019).

Financial literacy is about making good judgements and effective decisions on managing finance (Gavigan, 2010). Financial literacy provides key knowledge and understanding of financial concepts in order to make sound decisions across a multitude of financial contexts, which will ultimately improve the financial health of SMEs (Hogarth & Hilgert, 2002). Entrepreneurs are regularly involved in making decisions about where to acquire resources, where to allocate them and lastly how to effectively use them. These regular decisions have multiple repercussions hence it is vital for the entrepreneur to be financially literate in order to operate effectively and efficiently (Kim, 200).

According to Sickei (2013) managing credit upgrades the performance of SMEs through acquiring credit financing and diverse portfolios. This coupled with budgeting skills for growing sales and profit, whilst minimizing loan interests and expenses, make for a smooth running of the enterprise. A major problem of growth of sustainable SMEs is a lack of skills to utilize finances of an organisation in an efficient way. Joo & Grabble (2000) have pointed that people who lack financial knowledge and the knowledge of various financial products, prevent the SMEs from gaining access to different financing provisions and credit facilities. Financial literacy has proven critical in maintaining transparency, efficiency, accountability and accuracy within organisations and in turn, ensuring that the objectives of that organisation are achieved (Koitaba, 2013).

Problem Statement.

A majority of governments around the world have acknowledged the importance of SME growth and its potential to drive job creation. Benzing et al (2009) found that developed economies such as UK, South Korea, Japan and Turkey were predominantly made up of SMEs which accounted for 59%-80% of jobs. With the high rate of joblessness in South Africa, its government has also jumped on the bandwagon, to encourage a culture of developing a sustainable SME sector. The government through the National Development Plan has estimated that through sustainable SMEs, they can decrease unemployment rates to as low as 6% by 2030 and go on to further say that they expect 90% of new employment to come from the SME sector (National Planning Commission, 2012).

However, with poor education levels and low entrepreneurial activity, SMEs in South Africa continue to have a high failure rate, with as high as 75% before they can complete their second year (Robert et al, 2010). Previous studies have shown that there is a positive relationship between financial literacy and the performance of SMEs (Neneh, 2016; Eniola & Entebang, Cherugong, 2015; Musie, 2016;

 Umogbaimonica, Agwa & Asenge, 2018). Although these studies have found a link between financial literacy and SME performance, there is still not enough empirical data to support this claim, as a result, there is still no certainty that financial literacy does indeed positively influence SME performance.

From the above it is clear that sustainable SMEs are imperative to job creation and economy growth in South Africa and as a result, it becomes equally important to conduct research into understanding the key factors needed for SMEs to grow and flourish. The problem addressed in this study is understanding how the financial literacy of the entrepreneur can facilitate the performance of SMEs.

Research Question

Does financial literacy of entrepreneurs contribute to the high performance of SMEs?

Research Objectives

Primary Objectives

• This study will investigate the impact of financial literacy on SME performance

Secondary Objectives

• The study will review prior literature on financial literacy
• The study will assess the studies conducted on SMEs
• The study will determine the factors that affect performance of SMEs
• The study will provide recommendations on how financial literacy can impact the performance of SMEs.

Contributions of the study

There is general understanding on the importance of SMEs within the economic context of South Africa. With high unemployment rates, poverty and inequality, sustainable SMEs are key component in turning the tide around. Therefore, the purpose of this study is to fill in the gap in literature of financial literacy and its impact on SME performance. It will explore the extent to which entrepreneurs use financial knowledge to manage enterprises. It will provide academics and policy makers the knowledge to design training and developmental programmes that enhance the entrepreneurs’ ability to make use of financial concepts more effectively.  

Research Methodology

Kothari (2011) has defined research methodology as a way of systematically defining problems, developing hypothesis or suggested solutions, collecting, analysing and organising data in order to give answers to the research questions. Through the methodology we study the various steps used by the researcher in studying the research problem and its influences.

Research Design

The research design refers to the overall strategy used to combine components of the study in a logical way in order to effectively solve the research problem. It provides the blueprint for collection, measurement and analysis of data (De Vaus, 2006). There are three types of research design: qualitative, quantitative and mixed research design. Qualitative research design is used to understand the themes or relationship between collected data. It is concerned with theories related to naturally existing social or human phenomenon. Quantitative research design focuses on determining the relationship between variables and formulating statistical conclusions using measurements, mathematical and computational techniques and numerical collection of data. Mixed method research design employs techniques from both quantitative and qualitative research methods within one study (Creswell, 2014).

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