Financial determinants of SMEs performance. Evidence from Kenya leather industry

Publish Date: 6/16/20
Last Updated: 6/7/21


Keywords: SMEs; performance; taxation; financial literacy; credit access
JEL Classification: E22; E43; E52; F21; G24; G32


Small and medium-sized enterprises (SMEs) are one of the buoyant businesses in the global economy with abundant resources that have not been fully exploited. Despite several revelations on the challenges of SMEs, little to none have comprehensively captured financial factors affecting the performance of SMEs, particularly, in the Kenyan leather sector. This study explores financial factors that are affecting the performance of SMEs using the case of the leather industry sector in Kenya. The study data was collected by administering questionnaires to 300 respondents who were randomly chosen from SMEs within Kenyan leather sector. The study found that financial literacy, credit access and tax are statistically significant financial factors affecting the performances of SMEs. As a result, the study recommends that Government should increase its commitment to develop SMEs by offering favorable tax rates and tax exemptions to SMEs especially those in the leather sector of Kenya. Also, SMEs should heighten their financial literacy which will help augment their access to credit.

1. Introduction

Small and medium-sized enterprises (SMEs) are undoubtedly the key drivers of the global economy. In both third world and developed nations, small and medium enterprises (SMEs) are frequently viewed as an engine that fuel the prosperity of the economy based on their crucial role they play in terms of employment generation (Staelens et al., 2018). Thus, the capability of SMEs to ignite economic growth cannot be overemphasized because they do not only lead to generation of employment opportunities, increment of tax revenue collection, but also act as incubators of innovation.

Recent empirical studies indicate that SME‘s contributes to over 55% of GDP and over 65% of total employment in high-income nations. In the European Union countries, for example, there are some 25 million small businesses, constituting 99% of all businesses; they employ almost 95 million people, providing 55% of total jobs in the private sector. Key contribution is also on productivity growth and exports expansion (OECD, 2004). SMEs and informal firms in low-income nations represent over 60% of GDP and over 70% of aggregate employment, while in middle-income countries, SMEs contribute over 95% of aggregate employment and approximately 70% of GDP. For instance, SMEs in several sub-Saharan African countries accounts for not less than 78% of employment opportunities which forms a greater percentage of job opportunities in a developing economy (KNCCI, 2018). According to Wanjohi (2010), SMEs in Kenya form about 80 percent of the country's total employment. Thus, if an economy fails to include SMEs in its country’s industrialization process and economy sustainability prowess, the undesirable resultant effects are obvious. In accordance with SME Performance Review (European Commission, 2009), between the years of 2002 and 2008, the total of jobs in SMEs grew at an average yearly rate of 1.9 percent while the total of jobs in large companies rose by only 0.8 percent. In absolute terms, 9.4 million jobs were created in the SME sector in EU-27 between 2002 and 2008.

Given the profound position of SMEs in championing sustainable, long-term and diversified economic growth, they have, in fact, attracted revived attention after the 2008 financial crisis. As such, the creation and growth of SMEs are currently at the heart of many economic policy agenda. It is evident that considerable resources are needed to run any business most especially SMEs efficiently in order to cushion them from collapsing. Good performance enhances enterprises’ ability to lower production costs and enhance customer satisfaction and wade off the competition.

Despite the prominence of SMEs in creation of jobs coupled with other profound economic benefits, most of the SME literature opines that unlike larger corporations, SMEs face more diverse prime obstacles which are dependent on their region of establishment. These obstacles include insufficient market demand, securing finance, unfavorable government regulations, competition and macroeconomic instability (Ayyagari et al., 2007; International Finance Corporation (IFC), 2009; Rocha et al., 2011). European Commission (2009) expounds evidence indicating insufficient market demand as the prime obstacle faced by SMEs in the European countries, followed by difficulties in accessing finance. Similarly, a study published by Statista Research Department on January 20, 2021, named attracting customers as the key challenges for SMEs in the United States. Senegal and Botswana are classical example of countries in sub-Saharan African that possess conducive conditions for the survival of private-sector growth. However, inadequate financial system and absence of sound policy remain the biggest impediment (Carbó‐Valverde et al., 2016).

Certainly, the term “SME” can be defined from different perspectives. Previous studies reveal that different organizations together with different countries establish their definitive guidelines for classifying SMEs is normally pegged on the size of the workforce employed, the worth of intangible and tangible property and sales. World Bank defines SMEs as enterprises with less than or equal to 300 workforce, and assets value and annual revenue pegged at $15 million each. Specifically, in Kenya context, according to the Micro and Small Enterprises Act 2012, a Micro enterprise must attain average annual sales of less than Ksh.500, 000 (approximately $4,600) and engages fewer or exactly 10 individuals. A Small sized enterprise must achieve annual sales level of between Ksh.500, 000 and Ksh. 5 million (approximately $4,600 - $46,000) and employees more than 10 but less than 50 persons. Lastly, a medium enterprise engages more than 50 persons and less than 99 persons accompanied with an average yearly turnover of between Ksh.5 million to Ksh.800 million ($45,646.85 - $ 7,304,442.42) and with employees ranging between 50 and 99.

Interestingly, in Kenya, SMEs involvement is not restricted to a single segment of the economy but rather operates virtually in every sector of the economy since they are the source of sustenance for the larger portion of the citizen. However, very little is known regarding the operations, ownership structure, source of finance and other impediments that these SMEs face in their effort to realize full potential. It is against this backdrop that the study is enthralled in investigating the financial factors (access to credit, financial literacy and tax) that affect SMEs performance using the Kenyan leather industry. These financial factors are the crucial financial variables established to be significant among other factors influencing SMEs operation and growth in separate extant literature. Most importantly, these financial factors are recognized in literature to have a direct and immediate impact on the financial performances of businesses (García-Pérez-de-Lema et al., 2021; Liu et al., 2021; Oladejo, 2015; Tee et al., 2016).

For this study, access to credit can be seen as the absence of both price and non-price barriers in the use of financial services. Due to the inability of most SMEs to access the formal financial services, they end up going to the informal financial institutions such as Savings and Loan Companies, traditional money lenders, friends and relatives for credit. This subsequently reduces their access to credit for expansion and growth (Nkuah et al., 2013). Financial literacy is the familiarity of all the basics of finance and understanding of financial concepts which is used by an individual or company for decision-making (Remund, 2010). Previous research suggests that managers with a good financial literacy participate more actively in financial markets, by reducing information restrictions and achieving more favourable access to credit. Financial literacy, therefore, alleviating financial constraints, may be an important antecedent of technological innovation (García-Pérez-de-Lema et al., 2021). Taxation is an imposition of compulsory levy on individuals or entities by governments of a given economy. The readjustment of the tax system to the particular SME growth needs can be viewed as critical plan for the policy makers because high tax and tax complicity can stagnant the growth of SMEs which in turn affect economic growth of the country (Akinboade & Kinfack, 2012).

The main objective of this study is to examine whether these three financial factors, access to credit, financial literacy and tax affect the performance of SMEs in the Kenyan leather industry. The study makes use of primary data which was attained through distribution of questionnaires to targeted respondents. The use of questionnaires provided the researchers with first-hand and detailed information on matters underpinning the research objectives. Using the random sampling without replacement technique, 300 respondents were drawn from the population of all SMEs in Kenya, and with the help of statistical tools, analysis were made to establish the impact of access to credit, financial literacy and tax on the performance of SMEs in Kenyan leather industry.

Many researchers have focused on performance by looking at profitability of firms and industries using the DuPont analysis which include ROI and ROA. However, inadequate studies have been carried out on SMEs which is the major driver of today’s economy, and whose contribution cannot be ignored. Thus, this study contributes to literature firstly by estimating performance in terms of quality and cost minimization. Previous studies focused on ROA or ROI as the proxy for performance. However, SMEs are characterized with a lot of inefficiencies which may be attributed to the use of unskilled labour, inadequate technological equipment and others. Hence measuring SMEs performance in terms of quality and cost minimization appears to be appropriate especially in the leather industry where customers place much priority on quality instead of price. In addition, quality and efficient cost minimization mechanisms ensured by firms will translate into higher ROA or ROI. Therefore, the study deployed quality and cost minimization proxy which happens to be the root ingredients translated into ROA or ROI in the Kenyan SMEs leather industry. The study therefore sheds light on the association between quality practices and cost reduction strategies which eventually influence business practices and performance.

Lastly, this study adds to the literature on the challenges of SMEs in the developing countries using the case of Kenyan leather industry. Though a considerable number of studies have been conducted on the challenges of SMEs, a great deal of research work focused essentially on developed economies (Hutchinson et al., 2009; Wickramasekera & Oczkowski, 2004). Given the huge dichotomy in economic conditions, and systems between advanced and developing country it remains difficult in drawing a general conclusion on the challenges SMEs face. Thus, this study is tailored to help bridge this gap since studies in the developing countries particularly in the Sub-Saharan regions are scarce.

The succeeding section offers the supporting theoretical outline, review of pertinent literature and hypothesis development. Section 3 chats the research methodology, comprising the empirical model, data sources, and data sampling. Section 4 covers the analysis of empirical outcomes, and the last section contains the conclusion and recommendation.

2. Literature Review

The review in this section seeks to offer a synopsis of the previous body of knowledge on issues especially related to challenges of SMEs. It encompasses the theories underpinning the study and hypothesis thereof.

2.1 Theoretical framework

Given the purpose and nature of this research, a review of theoretical ideas underpinning the three financial factors are not misplaced.

2.1.1 Effects of credit access on performance of SMEs

The business environment today is influenced by strategic managerial decisions that firms implement to achieve competitive advantage. The managerial framework that helps businesses to exploit the resources available to them and remain competitive in the market is that resource-based view. The resource-based view of the firm emphasizes the resources firms need to develop to compete. Two forms of resources exist, property-based and knowledge-based. Property-based resources contribute most in stable settings, while knowledge-based resources have the greatest utility in uncertain environments (Levallet & Chan, 2016; Levy & Powell, 2005). This understanding provides the basis for development of new competencies that will support innovation and growth in an organization.

The resource-based view in the context of SMEs is of great concern for many researchers as SMEs are faced with lot of constraint in accessing both property-based and knowledge-based resources. Specifically, SMEs face lot of challenges in accessing credit and due to their small capital, are not able to invest more in capital equipment. They are mostly unable to hire a lot of skilled labour and therefore find is difficult to compete with large firms. This clearly indicate that, based on the resource-based view, SMEs are lacking both knowledge-based and property-based resources that will help improve their performance and growth. Since access to capital and credit play a significant role in meeting firms’ objective, this paper focused on how access to credit minimizes SMEs cost and improve quality.

The cost and availability of credit is a major issue facing SMEs (Mwangi, 2014). In Kenya, most SMEs are discouraged from obtaining bank loans due to the transaction costs charged by financial institutions which comprise administrative costs and default costs making the loans expensive. In addition, small enterprises do not own sufficient assets for collateral which in most cases is a requirement for borrowing. A study carried out by (Pais, 2004), revealed that most owners of small enterprises do not own enough capital assets or even maintain formal accounts that can act as security for bank loans. Moreover, those with accounts have no clear separation between the owner's account and that of the business and this makes credit access difficult (Wayua & Kagunyu, 2008).

According to Olatokun and Ayanbode (2009), the accessibility of funds influences the ability of firms in different manner especially the deciding the technology to be adopted, access to markets, and access to necessary resources which in turn incredibly influence the suitability and success of a business. When SMEs are able to access financial assistance from financial institutions and when terms of payments are favorable, business performance becomes good. Adequate finances enable businesses to obtain the capital needed for expansion, cover daily expenses, purchase inventory, hire additional staff and allows businesses to conserve the cash on hand to cover cost of doing business. Also, a study carried out in Nigeria to evaluate access of credit on tomato market performance by Oladejo (2015) revealed that finance is one of the most widely recognized difficulties facing tomato dealers in the study area. Similarly, the study (Dong et al., 2010) advocated for the removal of credit constraints in order to improve agricultural productivity rural household income since it is evident that credit constraints can negatively affect the agricultural productivity and rural household.

Banerjee et al. (2004) examined detailed loan data of 253 small and medium–size borrowers from a financial institution in India both before and after joining the e program. In 1998, the program was reformed to allow a new group of SMEs obtain loans at lower rates that had been subsidized. Normally these firms started to take up loan under this supported program, but instead of simply substituting subsidized credit for more exorbitant finance, they grew their sales to correspond with the additional loan sources which show that the firms must have previously been credit constrained. This is in line with the work of Barrett (2008), Fan et al. (2015), Demirgüç-Kunt et al. (2008) who found out that performance enhancement through financial access is central for SMEs in escaping poverty traps.

Hence, in line with these arguments, we propose the following hypothesis:

H1: Credit access have a positive effect on performance of SMEs.

2.1.2 Effect of financial literacy on performance of SMEs

Financial literacy is the familiarity of all the basics of finance and understanding of financial concepts which is used by an individual or company for decision-making (Remund, 2010). Aribawa (2016) explains further that financial literacy is the knowledge of financial concepts, abilities and skills in business management. The ability to make strategic business decisions comparatively precise and rapid in certain situations. Moreover, Financial Services Authority of Indonesia (OJK) in 2016 defines that financial literacy is not limited to the understanding the product and services in financial institutions. Thus, financial literacy is the capability of people to orchestrate the financial goals, to assemble financial planning, to oversee finances and be able to make a great financial decision in utilizing financial products and services.

In analyzing how SMEs performance could be enhanced through financial literacy, we integrate the human capital theory and upper echelon theory in support of our argument. Based on the human capital theory, as employees accumulate skills and other abilities through education and training, their value in the work environment is expected to increase as they bring their expertise on the job. The improvement in workers skills and ability could translate into better performance by the firm (Becker, 1962; Rosen, 1976; Xu & Fletcher, 2017; García-Pérez-de-Lema et al., 2021). Again, the upper echelons theory asserts that, top executives analyze situations based on their personalities, experiences, values and other human factors. This shows that, top executive personal attributes and believes affects the performance of the firm (Hambrick, 2007; Hambrick & Mason, 1984; Liu et al., 2021). Therefore, SMEs are more likely to be affected by leadership attributes, believes and experiences based on established norms and routines. Since entrepreneurs or the executives of SMEs are the key decision makes of SMEs, their personal attributes and thinking which are also influence by their financial knowledge, impact the performance of the firm.

As such businesses and in this case SMEs with good financial literacy will be able to make the proper business decisions, create a good business development orientation and be able to stay alive in their business. By implication SMEs will be able to improve their performance through the acquisition and application of financial knowledge by management and be able to survive business competition. Specifically, SMEs will be able to devise strategies to minimize cost and achieve financial stability which includes being able to invest and make proper financial decisions.

Financial literacy involves the ability to manage financial matters efficiently. Financial literacy equips business owners with the knowledge of making proper financial decisions, such as those on investment, insurance, budgeting and tax planning. As such, business owners that are financially educated are likely to have easier access to formal credit than owners with less financial education. Halabi et al. (2010) found in her study that financial management skills are beneficial for the survival of small firms and lack of financial literacy could be the reason for the failure of SMEs. This is because financial illiterate owners find it difficult to apply for financial assistance due to lack of financial records. Business owners with no skills on bookkeeping lack confidence of borrowing. Mostly, financial institutions require to know how SMEs are performing by analyzing their financial records before they can offer financial assistance. Halabi et al. (2010), Atkinson and Messy (2014) possession of financial literacy is one of the key determinants to great performance for small and medium size enterprises.

On the other hand, individuals with financial knowledge have easier access to finances that can make them acquire good quality raw materials, purchase modern machineries and expand their businesses which can lead to the enterprise's growth (Kumar & Francisco, 2005). Business owners with financial literacy have improved knowledge of investment and also proper money management skills which helps them to manage money effectively leading to reduced costs (Allen & Miller, 2010). According to the study of Chepngetich (2016), financial literacy is also associated with improved inventory management that leads to reduced costs and increased profit margins and in turn production of quality products. In Kenya, local innovations within the leather sector fail to be noticed in the global market because in most instances the innovators lack financial education to enable them to have a solid foundation for success. This results to poor performance that limits leather sector in commercializing their products. Therefore according to Musah and Muazu (2014), in order to produce products of good quality, SMEs need financial education that can help to improve financial decisions and minimize costs to boost their performance. The findings of Musah and Muazu (2014) is consistent with the work of several authors (Lusardi & Mitchell, 2014) who also found that financial knowledge has a positive effect on business performance within an economy.

Consequently, in formal terms, we predict as follows:

H2: Financial literacy has a positive effect on performance of SMEs.

2.1.3 Effect of tax on performance of SMEs

Numerous theories pertaining taxation are present in the study of public economics (Erreygers, 1995; Kaplow, 2010; Mankiw et al., 2009). All forms of governments in all levels must raise adequate revenue from different sources to finance public spending. Adam Smith in The Wealth of Nations (1776) stated that it is the duty of the government to defend its country and provide essential service such social system and governance for the benefit of the public. Thus, citizens are legally obliged to contribute towards meeting such expenditure in form of tax cost. The Taxation theory is anchored on the triple concepts of taxation demonstrated by ability to pay principle, benefit approach and equal distribution principle. However, for the purpose of this very study, we pay more attention to the first principle that involve financial resource; ability to pay principle. Ability to pay principle is one of the canons of taxation that suggestively means that taxation ought to be charged based on a person capability to pay. In other words, it states that public revenue should originate from those who have and not from those who do not have. The argument behind this principle is that the poor have nothing to be taxed as such the government can only collect so much from those with ability. By implication, relatively SMEs should be excused from huge tax burdens and better still should be given some level of subsidies or tax holidays.

Taxation is an imposition of compulsory levy on individuals or entities by governments of a given economy. Taxation plays a very vital function in the development of SMEs and especially in a middle-income economy such as Kenya where the SMEs are at the forefront in driving forward the socioeconomic development of the nation. Evaluating the impact of tax systems on SMEs normally capture various dimension such as rates, burden, incidence, timing, and multiple taxes. The considerations of these enterprises are to reduce administrative cost, observe compliance, and impacts of carrying out operations in the informal market. In this manner, readjustment of the tax system to the particular SME growth needs can be viewed as critical plan for the policy makers because high tax and tax complicity can stagnant the growth of SMEs which in turn affect economic growth of the country (Akinboade & Kinfack, 2012).

Tax incentives, such as tax exception enables individuals and businesses to reduce the costs of production since it reduces the amount of tax that business have to pay. Through the reduced tax costs, SMEs can have more money that they can use to improve the quality of their products. Business owners within the leather sector can purchase high quality hides and skins which would be used in production of high-quality leather products to boost their performance. High taxes can demean the performance of a business enterprise. According to the nexus theory of taxation, taxes should be progressive in nature. Mature SMEs with huge income should be charged more than those that are young and with low profit margins. Taxes reduce the profit margins and increase the operation costs of SMEs. High costs of production drain the finances of businesses most especially SMEs which might lead to production of poor-quality products. This proposition is affirmed by the studies of Klemm (2010), Tomlin (2008), Atawodi and Ojeka (2012), Tee et al. (2016), Mnenwa and Maliti (2008) who established that tax burden are major hurdles of SMEs because they increase operational costs of the business whereas tax incentives are great boosters for smaller firms.

Therefore, in line with these arguments, we propose the following hypothesis:

H3: Tax payment has a negative effect on performance of SMEs.


Filename: Example_File.pdf
# of Downloads: 1777


Volume: Issue:elocation-id: e389
DOI: 10.26784/sbir.v5i2.389


Copyright 2021 Arthur Benedict, Jackline Kinya Gitonga, Annette Serwaa Agyeman, Baffour Tutu Kyei

Creative Commons License

This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License.

Copy Article Cite

Benedict, A., Gitonga, J.K., Agyeman, A.S. and Kyei, B.T. 2021. Financial determinants of SMEs performance. Evidence from Kenya leather industry. Small Business International Review. 5, 2 (Sep. 2021), e389. DOI:
linkedin facebook pinterest youtube rss twitter instagram facebook-blank rss-blank linkedin-blank pinterest youtube twitter instagram