department of public administration and ......ikh – ikenga hotels ltd nsukka esmc – enugu state...
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GROWTH OF PUBLIC ENTERPRISES IN ENUGU STATE,
1
ODO, FREDERICK C.
REG. NO: PG/Ph.D/03/35329
INVESTMENT MANAGEMENT PRACTICES AND
GROWTH OF PUBLIC ENTERPRISES IN ENUGU STATE,
NIGERIA, 2006-2011
FACULTY OF SOCIAL SCIENCE
DEPARTMENT OF PUBLIC ADMINISTRATION
AND LOCAL GOVERNMENT
Ebere omeje Digitally Signed by: Content manager’s NameDN : CN = Webmaster’s nameO= University of Nigeria, NsukkaOU = Innovation Centre
REG. NO: PG/Ph.D/03/35329
INVESTMENT MANAGEMENT PRACTICES AND
GROWTH OF PUBLIC ENTERPRISES IN ENUGU STATE,
FACULTY OF SOCIAL SCIENCE
ADMINISTRATION
AND LOCAL GOVERNMENT
Digitally Signed by: Content manager’s Name DN : CN = Webmaster’s name O= University of Nigeria, Nsukka OU = Innovation Centre
2
INVESTMENT MANAGEMENT PRACTICES AND
GROWTH OF PUBLIC ENTERPRISES IN ENUGU STATE,
NIGERIA, 2006-2011
BY
ODO, FREDERICK C.
REG. NO: PG/Ph.D/03/35329
DEPARTMENT OF PUBLIC ADMINISTRATION
AND LOCAL GOVERNMENT
UNIVERSITY OF NIGERIA,
NSUKKA
SUPERVISOR: PROFESSOR FAB. O. ONAH
DECEMBER, 2014
3
UNIVERSITY OF NIGERIA, NSUKKA
INVESTMENT MANAGEMENT PRACTICES AND GROWTH OF PUBLI C
ENTERPRISES IN ENUGU STATE, NIGERIA, 2006-2011
BY
ODO, FREDERICK CHIROTE
PG/Ph.D/03/35329
A THESIS PRESENTED TO THE DEPARTMENT OF PUBLIC
ADMINISTRATION AND LOCAL GOVERNMENT, UNIVERSITY OF NIGERIA,
NSUKKA IN FULFILLMENT OF THE REQUIREMENTS FOR THE A WARD OF
THE DEGREE OF DOCTOR OF PHILOSOPHY (Ph.D) IN PUBLIC
ADMINISTRATION AND LOCAL GOVERNMENT
SUPERVISOR: PROFESSOR FAB. O. ONAH
JULY, 2014
4
CERTIFICATION
Mr. Odo, Frederick Chirote, a postgraduate student in the Department of Public
Administration and Local Government and with the Registration Number
PG/Ph.D/03/35329 has satisfactorily completed the requirements for research work for the
Degree of Doctor of Philosophy (Ph.D) in Public Administration and Local government.
The work embodied in this thesis is original and has not been submitted in part or
full for any degree of this or any other university.
………………………. …………………… Professor Fab. O. Onah Odo, Frederick Chirote Research Supervisor Student
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APPROVAL This thesis has been approved on behalf of the Department of Public Administration and
Local Government, University of Nigeria, Nsukka.
………………………. …………………… Professor Fab. O. Onah Dr. S.U. Agu Research Supervisor Acting Head of Department
………………………………… External Examiner
………………………………. Dean
Faculty of the Social Sciences
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DEDICATION
THIS WORK IS DEDICATED TO THE ALMIGHTY GOD
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ACKNOWLEDGEMENT
First and foremost, my gratitude goes to God Almighty who made it possible
for me to commence and complete this work. I also thank God for His unalloyed
mercy and love for me which made my academic pursuit possible.
My profound appreciation goes to my amiable and kind supervisor Professor
Fab. O. Onah (Eze Akwulugo-Ayo). Fab. O. Onah made me to drink from the
fountain of his knowledge through his supervision which enabled me to have
enormous insight into the subject of my work. My dear Professor Fab. O. Onah,
thank you very much.
My special thanks also go to Dr Mrs Sylvia Agu, Head of Department of
Public Administration and Local Government for her encouragement.
My big thanks go to professors R.C. Onah, Chikelue Ofuebe, Chika Oguonu
and F.C. Okoli for their words of encouragement.
I also recognize the special role played by Drs. B.A. Amujiri and C.
Agalamanyi during the pursuit of this work. I thank them very much. I also
appreciate the contributions of Drs. A.O. Uzuegbunam and M.O. Obi. I wish also to
acknowledge with thanks the role of Drs. Tony Onyishi, Chuka Ugwu and E.M.
Izueke.
I am grateful to members of staff of Nike Lake Resort Hotels Enugu, Ikenga
Hotels Nsukka, Enugu State Transport Company and Enugu State Marketing
Company. I thank my wife Mrs. Josephine N. Odo and Children Chiamaka, Chika,
Kaodili and Chidalu for their patience.
I am grateful to my brothers Odo, Sylvanus A.,Odo Agbedo Cyprian and Eze
Romanus. I must also appreciate the role of my Late father Odo Nwagbedo and my
Mother Omada Agbo. I thank in a special way Miss Jacinta Ugwu for typing this
work. May God reward you abundantly.
8
ABSTRACT
This study was on investment management practices and growth of public enterprises in Enugu state,
Nigeria. The objective of this thesis was to identify investment management practices employed in
public enterprises in Enugu State; and explain how the adoption of appropriate investment
management practices promoted the growth of the enterprises. The purpose of this study was to
analyse any observed growth of public enterprises in Enugu State in terms of the extent to which they
employed proper investment management practices. In the course of this study, we adopted a survey
research method. Three methods of data gathering namely; documents, questionnaire and oral
interviews were used. Hence, primary and secondary data were used to analyse the data. In applying
purposive sampling technique, responses from a total of 20 respondents were analysed. Mean score
statistics and single classification analysis of variance (ANOVA) were employed to analyse the data.
The data were presented in tables, bar chart, pie chart and graphs. Research revealed that the extent to
which: capital budgeting decision practices were applied in public enterprises in Enugu state was low
in ENTRACO, low in IKH, average in ESMC and high in NLR; control practices were adopted in
public enterprises in Enugu State was average in ENTRACO, average in IKH, high in ESMC and high
in NLR; and employees of public enterprises were motivated was low in ENTRACO, low in IKH,
average in ESMC and high in NLR. Consequently, auxiliary enterprises in ENTRACO was 0, in IKH
was 0, in ESMC was 1 and in NLR were 3. Internal rate of return in: ENTRACO was 19.8%, IKH was
10.2%, ESMC was 33.9% and NLR was 34.2%. ANOVA revealed that the application of appropriate
investment management practices in public enterprises in Enugu State influences their growth. This
analysis was in agreement with our empirical findings. Based on our findings, we recommended that
public enterprises should adopt; internal rate of return technique to ascertain the internal rate of returns
on investments; reappraisal of investment to determine whether value for money was being obtained
from any level of investment; and sponsoring of employees for studies on project initiation so as to
equip the employees with the skill of initiating investments.
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TABLE OF CONTENTS
CHAPTER ONE: INTRODUCTION … … … … … … 1
1.1 Background to the Study … … … … … … 1
1.2 Statement of the Problem … … … … … … 7
1.3 Objectives of the Study … … … … … … 9
1.4 Significance of the Study … … … … … … 9
1.5 Scope and Limitations of the Study … … … … … 10
CHAPTER TWO: LITERATURE REVIEW … … … … … 12
2.1 Introduction … … … … … … … 12
2.1.1 Features of a Business Enterprise … … … … … 12
2.1.2 Capital Structure Decisions … … … … … … 15
2.1.3 Capital Investment Decisions … … … … … 22
2.1.4 Working Capital Management … … … … … 45
2.1.5 Inventory Management … … … … … … 54
2.1.6 Receivables Management … … … … … … 63
2.1.7 Control in Public Financial Institutions … … … … 84
2.1.8 Investment Management Practices in Commercial Enterprises … 90
2.1.9 Synthesis of the Literature … … … … … … 96
2.1.10 Gap in the Literature … … … … … … … 97
2.2 Theoretical Framework for the Study … … … … … 97
2.2.1 Application of the Framework to the Study … … … … 99
2.3 Hypotheses … … … … … … … … 100
2.4 Operationalization of Key Concepts … … … … … 101
CHAPTER THREE: STUDY AND AREA RESEARCH PROCEDURE … 104
3.1 The Study Area … … … … … … … 104
3.2 Research Procedure … … … … … … … 108
3.2.1 Design of the Study … … … … … … … 108
3.2.2 Population, Sample Size and Sampling … … … … 109
3.2.3 Sources and Method of Data Collection … … … … 110
3.2.4 Reliability and Validity of Instrument … … … … 111
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3.2.5 Administration of the Instrument … … … … … 113
3.2.6 Method of Data Presentation and Analysis … … … … 113
CHAPTER FOUR: DATA PRESENTATION, ANALYSIS AND FINDI NGS … 115
4.1 Data Presentation … … … … … … … 114
4.2 Analysis … … … … … … … … 135
4.3 Findings … … … … … … … … 144
CHAPTER FIVE: DISCUSSION … … … … … … 149
5.1 Capital Budgeting Decision Practices in Public Enterprises in Enugu State. 149
5.2 Control Practices in Public Enterprises in Enugu State … … 153
5.3 Motivation Practices in Public Enterprises in Enugu State … … 155
CHAPTER SIX: SUMMARY, RECOMMENDATIONS AND CONCLUSIO N 157
6.1 Summary … … … … … … … … 156
6.2 Recommendations … … … … … … … 160
6.3 Conclusion … … … … … … … … 161
BIBLIOGRAPHY
APPENDIX 1
APPENDIX 2
APPENDIX 3
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LIST OF ABBREVIATIONS
ENTRACO – Enugu State Transport Company Ltd.
IKH – Ikenga Hotels Ltd Nsukka
ESMC – Enugu State Marketing Company Ltd.
NLR – Nike Lake Resort Hotels Ltd Enugu.
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LIST OF TABLES Tables
Table 2(1) Payback period of Unequal Annual Cash Flows … … … 26
Table 2(2) Payback Period of Unequal Annual Cash flows … … … 26
Table 2(3) Projected Profits for the Project … … … … … 33
Table 2(4) Projected Profits for the project … … … … … 35
Table 2(5) Calculation of Internal Rate of Return when the Project Extends
for three or More years … … … … … … 38
Table 2(6) Incremental Approach … … … … … … 41
Table 2(7) Capital Structure of a Public Enterprise in Enugu State … 42
Table 2(8) Calculation of the Weighted Average Cost of Capital in Table 2(7) 43
Table 2(9) Calculation of Simple Average Method … … … … 57
Table 2(10) Relationship of Credit Terms and Effective Per Annual Interest Rates 72
Table 3(1) Population and Sample Size … … … … … 109
Table 4(1) Profile of the Studied Public Enterprises in Enugu State … … 114
Table 4(2) Sources of Finance for Public Enterprises in Enugu State … 115
Table 4(3) Revenue Stand of Public Enterprises in Enugu State … … 116
Table 4(4) Auxiliary Enterprises in Public Enterprises in Enugu State … … 121
Table 4(5) Categories of Growth and Number of Enterprises in each Group 122
Table 4(6) Mean Scores of Respondents in Public Enterprises in Enugu State with
Regard to the Extent to which Capital Budgeting Decision Practices
have been Employed … … … … … … 124
Table 4(7) Mean scores of Respondents in Public Enterprises in Enugu State with
Regard to the Extent to which Control Practices have been adopted … 126
Table 4(8) Mean Scores of Respondents in Public enterprises in Enugu State with
Regard to the Extent to which their employees are Motivated for Investment
Generation and revenue Collection Strategies … … … 128
Table 4(9) Scores of Respondents in Public Enterprises in Enugu state … 131
Table 4(10) Single Classification Analysis of Variance (ANOVA) … … 131
Table 4(11) Scores of Respondents in Public Enterprises in Enugu State … 132
Table 4(12) ANOVA … … … … … … … … 132
Table 4(13) Scores of Respondents in Public Enterprises in Enugu State … 133 Table 4(14) ANOVA … … … … … … … … 134
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LIST OF FIGURES Figures
4(1) Bar Chart showing Annual Sales in Naira of Public Enterprises
in Enugu State (2006-2011) … … … … … … 117
4(2) Pie Chart showing Categories of Growth and Number of Enterprises in Each Group … … … … … … … … 118
LIST OF ABBREVIATIONS
ENTRACO – Enugu State Transport Company Ltd.
IKH – Ikenga Hotels Ltd Nsukka
ESMC – Enugu State Marketing Company Ltd.
NLR – Nike Lake Resort Hotels Ltd Enugu.
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CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The solidity of Nigeria’s public enterprises became significant immediately after
independence on 1st October, 1960. On assumption of power, the nationalists articulated a
clear role for public enterprises as instruments for promoting national development. The
indigenization policy of 1972 as enacted by the Nigerian Enterprises Promotion Decree of
1972, which took effect from 1st April 1974, with its subsequent amendment in 1976
provided a concrete basis for governments’ intensified efforts towards participation in the
ownership and management of public enterprises (Elijah, 2009). The government capital
investments in public enterprise totaled 23 billion naira between 1975 and 1985. In addition
to equity investments, government gave subsidies of 11.5 billion naira to various states for
the maintenance of their enterprises (Ogundipe 1986). Government has a lot of roles to play
in order to raise the standard of living of her citizens.
For instance, this developmental role of the state was provided for in the country’s
1979 constitution and also enshrined in the 1999 constitution. According to sections 16 of
1979 constitution and 24 of the 1999 constitution: The state shall:
– Harness the resources of the nation and promote national prosperity and an efficient,
a dynamic and self reliance economy.
– Control the national economy in such manner as to secure the maximum welfare,
freedom and happiness of every citizen on the basis of social justice and equality of
status and opportunity.
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– Without prejudice to its right to operate or participate in areas of economy other than
the major sectors of the economy, manage and operate the major sectors of the
economy.
– Without prejudice to the right of any person to participate in areas of the economy
within the major sector of the economy, protect the right of every citizen to engage
in any economic activities outside the major sectors of the economy. In the light of
the foregoing therefore;
The state shall direct the policy toward ensuring:
– The promotion of a planned and balanced economic development;
– That the material resources of the nation are harnessed and distributed as best as
possible to serve the common good;
– That the economic system is not operated in such a manner as to permit the
concentration of wealth or the means of production and exchange in the hands of few
individuals or groups; and
– Suitable and adequate shelter suitable and adequate food, reasonable national
minimum living wages, old age persons, and unemployment, sick benefits and
welfare of the disabled are provided for all citizens. In order to achieve the above
listed economic objectives, governments, at all levels-central, state and local
governments assumed the role of entrepreneurs by embarking on the establishment
of public enterprises.
As we stated at the beginning part of this chapter, public enterprises are some of the
agencies which colonial administration bequeathed to the people of Nigeria. These are
enterprises owned by the Federal, State or Local governments. They are established by
specific laws, which contain provisions relating to finance, personnel, method of achieving
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their objectives and other matters necessary for the realization of their goals. Public
enterprise is an institution operating services of an economic or social character on behalf of
government but enjoying an independent legal status. It is largely autonomous in its
management though responsive to the public through government and subject to some
directives by governments; is equipped on the other hand with independent and separate
funds and legal and commercial or non profit – oriented/ attributes of enterprises (Hanson
1960). There are many reasons that explain why African states have created and sustained
public enterprises. Nellis (2009:2) reasons thus:
Institutions and pre-dispositions inherited from centralized interventionists colonial regimes; a tendency to associate liberal capitalism with colonialism and imperialism; the post war ascendancy of leftist statist political ideologies; the apparent absence or embryonic nature of the indigenous private sector enterprises; the conversion of failing private enterprises into public enterprises to forestall increases in employment; the attractiveness of public enterprises to politicians who use them as patronage mechanisms to distribute jobs to both the mighty and the minor and to provide goods and service. These are but some of the more important historical, economic; social and political factors which have led almost every African state to create large public enterprise sector.
The fundamental reason for the establishment of public enterprises in all economies
is the provision of services which are too costly for individuals to provide. Modern
governments especially those in the transitional societies are expected to be committed to
the enhancement of economic and industrial growth and development for the provision of
social welfare services. They may directly establish and run industrial and commercial
enterprises under the country’s company law, obtain direct shares in private, industrial and
commercial enterprises, go into partnership with private businesses or institute agencies to
do so on behalf of the public. Thus public enterprises are being expanded to include the
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provision of essential services such as marketing, transport, housing, hospitability, games,
financial services and garbage removal. Public enterprises in Nigeria also undertake
development projects like market construction and reconstruction for the overall good of the
public, however with the aim of profit making.
There are various forms of public enterprises all over the world. In Nigeria for
example, Adamolekun (1982: 43) distinguished the groups thus:
– Statutory corporations which involve public utility corporations, development
finance corporations and the welfare and social service corporations;
– Mixed economy enterprises; and
– State owned companies.
Statutory corporations are created by special statutes. These statutes make provisions
for their operational guidelines. They are expected to provide infrastructure facilities such as
water, electricity and transport satisfactorily and at modest costs. They are also expected to
ensure that goods of adequate quality and quantity are made available to the people. Mixed
economy enterprises are those enterprises in which government co-operates with private
entrepreneurs to establish a commercial venture. The state puts in a greater share in the
enterprise. With the state putting in a greater share implies that she has an edge in the
ownership, control and management of the enterprise. State owned enterprises or companies
operate under the same company laws that regulate the activities of private sector
enterprises. In Enugu state for example, Enugu State Marketing Company; Enugu State
Transport Company, Ikenga Hotels, Nike Lake Resort Hotel, and Nigerian Construction and
Furniture Company belong to this category. These enterprises are expected to provide
services and at the same time maximize profits. This means that they are profit oriented.
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This study is specifically concerned with state owned enterprises that were created to
be generating wealth needed for the provision of public good, including employment
opportunities. Unfortunately, public expenditures attached to the upkeep of state owned
enterprises in most of the countries of the world and especially in Nigeria have been
observed to be less productive since they have failed to yield a corresponding positive return
both directly and indirectly (Uzochukwu, 2003). This fundamental problem of defective
capital structures is due to the application of inappropriate investment management practices
leading to unwise investment which generates losses, (Usman, 2002). Fekuru (2000),
presented evidence of poor performance of state owned enterprises with 60 percent of posted
net losses and 36 percent negative net worth which resulted to an astronomical rise of
accumulated losses in Nigeria. The government is therefore, finding it difficult to sustain the
requirements of its state owned enterprises, particularly since they performed below
expectations in terms of their returns on investments and quality of service delivery.
As public enterprises are confronted with the problem of application of inappropriate
investment management practices; the dwindling of their financial returns become manifest.
Public enterprises in Enugu State are established and funded by the government through
budgetary allocation and subventions. They also generate fund from the sale of their goods
and services and seek both long and short term loans from banks, especially from African
Development Bank as well as from other miscellaneous sources. But the funds are not
always enough to face the new challenges caused by expanded competition due to the
breaking of the government’s monopoly in some businesses by the private sector
organizations.
Hence, public enterprises in Enugu State are faced with the problems of managing
her limited finances in such a way that the objectives for which they were created could be
19
realized with some degree of efficiency. For quite a long time now, a call has been made on
how to improve the condition of public enterprises for their sustainability and public
satisfaction. Akpan (1982: 49) noted that:
Public enterprises should be run in a business like manner in the sense of conserving and utilizing available resource for the achievement of the best possible results; eliminating red tape; being fully and readily responsive to the needs of the public who constitute their ‘customers’ and employers; being expeditions in the dispatch of their functions, in short doing away with all the stigma usually associated with public service bureaucracy.
Up till today, public enterprises are challenged by improper investments leading to
their suppression and sale to private enterprises. This state of affairs in public enterprises
should not be allowed to persist. In the production of some of the consumer goods and
services by public enterprises, it is necessary to determine whether the capital outlays are
justified or not. This justification is determined by the rate of financial returns to investment
(Adeyemo, 2010).
If public enterprises in Enugu State are to perform their statutory obligations to a
reasonable standard they must be financially viable and their overall management must be
geared towards attaining efficiency in investment management. Improving the financial
State of public enterprises in Enugu State implies integrating right or modern investment
management practices which among others involve investing, the available funds in various
economically viable projects. In investing in projects, the use of appropriate capital structure
and investment management technique to enhance efficient investment in viable profits has
been advocated (Pandey, 1991). The adoption of modern investment management practices
such as capital budgeting decision practices (invesmtnt appraisal techniques), control
practices and motivation practices ensure that profitable projects are identified; project
20
monitoring, and customer quality are identified before credit transactions are made; and that
employees are encouraged so that they will be initiating investments that can promote the
growth of public enterprises in Enugu State, Nigeria. The adoption of appropriate control
mechanisms also creates efficient systems of controls that ensure that the businesses run by
the enterprises are carried out in orderly and efficient manner. This means adhering to
management policy, safeguarding assets and securing as much as possible the accuracy of
the enterprises’ funds.
1.2 Statement of the Problem
Public enterprises in Nigeria have failed in boosting wealth creation due to poor
investment management practices which resulted to unwise investment. The Nigerian public
enterprises suffer from gross mismanagement and consequently resulted to inefficiency in
the use of productive capital which in turn weakens the ability of government to carry out its
functions efficiently (World Bank, 1991). The issue of inefficiency in the use of productive
capital rotates on financial management principle (Uzochukwu, 2003). Public enterprises in
Enugu State are not exceptions. They are currently being challenged by a catalogue of
problems such as inadequate finance and the satisfaction of the members of public who are
their employers. Government budgetary allocations and subventions to public enterprises for
their maintenance have not been able to provide goods and services to a reasonable standard.
These problems have persisted over the years.
The management of public enterprises had always shifted the blame for these failing
features to their poor financial base without taking into cognizance the investment
management practices that are explanatory defence for poor performance in public
enterprises. Government had appreciated the fact that there is a relationship between
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investment management practices of public enterprises and the achievement of their growth
objectives which is dependent on high returns on invested capital. It is because of this
obvious relationship, that the government had always directed the management of public
enterprises to improve their investment management practices in order to invest in viable
projects for the enhancement of their financial returns. Quite a number of public sector-
enterprises are operated without respect to financial cost or returns (Adeyemo, 2010).
Investments in most public sector enterprises are not guided by conceptual and analytical
theories. This means that these public enterprises adopt traditional approaches which include
episodic financing and non-consideration of the relationship between financing – mix and
cost of capitals as investment management practices. Impliedly, investment decisions in
some public enterprises are made without instituting proper investment management
practices which include: capital budgeting decision practices, proper control practices and
motivation practices. Thus, the problem is that the management of public enterprises in
Enugu State, Nigeria failed to adopt appropriate investment management practices in their
investment portfolio.
Based on this problem therefore, we pose the following research questions:
1) To what extent have capital budgeting decision practices (investment appraisal
techniques) been instituted in public enterprises in Enugu State to enhance the selection
of profitable investment?
2) To what extent have proper control mechanisms been instituted in public enterprises in
Enugu State to promote financial and materials returns in the enterprises?
3) Are employees of public enterprises in Enugu State motivated to enhance their
commitment and participation in investment generation and revenue collection
strategies?
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1.3 Objectives of the Study
The broad objective of this study is to analyse any observed growth of public
enterprises in Enugu State in terms of the extent to which investment management practices
are employed. The specific objectives of this study are to:
1) Examine the extent to which capital budgeting decision have been adopted in public
enterprises in Enugu State for the enhancement of profitable investment.
2) Find out the extent to which proper control practices have been instituted in public
enterprises in Enugu State to enhance financial and materials returns in the enterprises.
3) Find out how the employees of public enterprises in Enugu State have been motivated to
enhance their participation in investment generation and revenue collection strategies.
1.4 Significance of the Study
Our studies have shown that many works have been done on financial management
of public enterprises, further work is still necessary as the works have shown that the issue
of financial management has centred on traditional approach and that most of the works
have clustered on matters relating to funding, autonomy and control of finances, among
others by the government. Therefore this study is significant in that it brings into focus the
modern approach to investment management techniques which if properly applied in public
enterprises can enhance their productivity and invariably their growth.
Modern approach to investment management focuses on analytical approach which
entails using modern financial management theories of project appraisal techniques, control
techniques motivation techniques among others (Pandey, 1991). Specifically the study is
significant in that it studies capital structure, expenditure planning phases, in vestment
idealization, cashflow estimation and evaluation of investment proposals in public
23
enterprises. Practically, the study is significant in that it uses the principle of capital
rationing for the allocation of resources to investment proposals. Capital rationing advocates
investing in economically viable projects whose net present value is greater than zero. This
will be demonstrated in the research findings. The institution and the adoption of appropriate
investment management techniques in public enterprises will promote the productivity of
public enterprises’ capital for the upliftment of the enterprises and the society they were
established to serve. The study is significant in that it collects information from public
enterprises on how, where, when and the type of the management practices they adopt in
investment for investment selection.
This work is of immense benefits to financial management practioners, public
administrators, public policy makers, public financial administrators, the managers of public
enterprises in general and the students. It can be a reference material for them.
1.5 Scope and Limitations of the Study
1.5.1 Scope
The study addresses investment management practices and growth of public
enterprises in Enugu State. The study specifically focuses on the management of capital
investment decisions, capital structure, working capital, inventory and receivables among
others. This means that the study covers the areas that guide how the resources of enterprises
are to be used for the maximization of the enterprises’ welfare as well as the welfare of the
society. The study covers the year 2006 to 2011. This period was chosen because the period
marked the era of turn-around maintenance of public enterprises. Turn-around maintenance
is not only restricted to physical reconstruction. It goes beyond that to capture turn-around
management of public enterprises. Turn-around management includes the adoption of
24
appropriate investment management practices in public enterprises for their growth for
efficient service delivery.
1.5.2 Limitations of the Study
In this work’s background and literature review, we used authors and empirical
studies from Nigeria and outside Nigeria. The empirical part of this thesis that is the
questionnaire and oral interview was strictly done from the perspectives of the workers of
public enterprises in Enugu State. This study was furthermore interested first and foremost
in the type and use of investment management practices and therefore did not perform any
investigation into if public enterprises in Enugu State actually complied fully with the result
obtained from the investment management practices adopted. Since we focused our study on
investment actions, we did not focus on the discussion of enterprises’ age and business
cycle. This work did not discuss the eventuality of gender differences in the answer, mainly
for two reasons: first this was not an aspect we included when choosing our respondents,
and secondly because there was a clear majority of men in executive positions in public
enterprises in Enugu State. This study is concerned with investment management practices
that were found in Public Enterprises in Enugu State and because of this, science of
probability was not used to analyse the data.
It was our intention to cover as many public enterprises as possible in Nigeria but
due to the economy of scope we were only able to use public enterprises in Enugu State.
Finally inspite of our efforts to involve all public enterprises in Enugu State, Nigerian
Construction and Furniture Company still declined from participating in the study. However
the remaining four surviving public enterprises in Enugu State were used for the study.
25
CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
The literature on investment management practices is reviewed under the following
sub-themes:
� Features of a Business Enterprise
� Capital Structure Decisions
� Capital Investment Decisions
� Working Capital Management
� Inventory Management
� Receivables Management
� Control in Public Financial Institutions
� Investment Management Practices in Commercial Enterprises
� Synthesis of the Literature
� Gap in the Literature
2.1.1 Features of a Business Enterprise
Every commercial enterprise acquires the capital it needs and uses it in activities
which generate returns on invested capital. These activities include financing, production
and marketing of goods and services. Public enterprises in Enugu State are also engaged in
these types of activities. They acquire funds from different sources and use these funds to
produce goods and services. They expect positive returns on investment.
Public enterprises need a number of real assets to carry on their business activities. There are
two types of assets, namely: tangible and intangible assets. Plant, machinery, office blocks,
factories, furniture and buildings are some of the examples of tangible assets, while
26
technical know-how, technological collaborations, patents and copyrights are examples of
intangible assets (Timeweb:2010). A commercial enterprise sells financial assets or
securities - such as shares and debentures, in the capital market in order to raise necessary
funds for investment. There are also other financial assets such as lease obligations and
borrowing from banks, financial institutions, thrift societies and other sources; for instance,
private money lenders. Funds applied to assets by a business enterprise are known as capital
expenditures or investments (Stock Basics: 2010). A commercial enterprise expects to
receive returns on its investments and distributes returns to investors. These processes of
raising funds, investing them in assets and distributing returns are known respectively as
financing, investment and dividend decisions (Pandey, 1991).
Public enterprises in Enugu State, just like any other business organization, can raise
two types of funds: equity funds and borrowed funds. A business enterprise sells shares to
acquire equity funds. Ownership of shares indicates the rights of their holders. Buyers of
shares are called shareholders and they are the legal owners of the business enterprise which
shares they hold. Shareholders invest their money in the shares of a company in the
expectation of a return on their invested capital (Brown, 2003). Shareholders make gains by
selling their shares. There are two types of shareholders, common shareholders and
preference shareholders (Groz, 1999). The rate of dividend of preference shareholders is
fixed and in addition, they are given priority over the common shareholders. On the other
hand, the dividend rate for the common shareholders is not fixed; it can vary from year to
year depending on the decisions of the Board of Directors (Tversky, 2006).
A public enterprise can also acquire equity funds by retaining a proportion of the earnings
available for shareholders. This method of obtaining funds internally is called earnings
retention, (Free Encyclopaedia, 2010). Retained earnings are profits (Returns on Equity) not
27
distributed to the shareholders; they are therefore, rightly a part of equity capital. (Free
Encyclopaedia, 2010). If an enterprise distributes all the earnings to the shareholders, then it
can acquire new capital from the same sources by issuing new shares (The Business Finance
Market, 2002).
An enterprise can also secure capital from money lenders. Unlike shareholders, money
lenders are not owners of the company. They make money available to the enterprise on
commercial basis and retain title to the funds (Free Encyclopaedia, 2010). The return on
loans or borrowed funds is referred to as interest. Loans are given for a specific period at a
fixed rate of interest (Free Encyclopaedia, 2010). A public commercial enterprise may
borrow funds from many sources such as banks, financial institutions, the public or the
government – or by issuing bonds or debentures (Free Encylopaedia, 2010). Public
enterprises in Enugu State can obtain funds from these sources and in the case of borrowing,
use government as their guarantor.
Another means through which an enterprise can obtain short-term funds is to sell its book
debts. Book debts in this context are accounts receivables. The sale of receivables to another
company that specializes in buying them to acquire short-term funds is called factoring (
Pandey, 1991). The companies that buy Receivables are known as factors. In factoring, the
firm enters into agreement with a factor. In the agreement, the factoring procedure is
specified. In most cases, the enterprise sends the customers’ order to the factor for the
evaluation of the customers’ credit worthiness and approval. Once the factor is satisfied
about the customers’ credit worthiness, and agrees to buy the receivables, the enterprise
dispatches goods to the customer. The customer will be informed that his account has been
sold to the factor and he is instructed to make payments directly to the factor. Once a factor
has purchased an enterprise’s receivables, the factor owns them and cannot look unto the
28
enterprise to protect her against any bad debt losses (Pandey, 1991). This source of funds
can simply be described as conversion of debt to cash. Hedge fund is another source from
which an enterprise can raise fund (Stock Basis: 2010). Hedge fund is the money collected
from those who are afraid to keep money at home. Public enterprises in Enugu State can also
embrace these various ways of raising funds for their operations.
The operations of all kinds of business enterprises, directly or indirectly, require the
acquisition and use of acquired money for the day to day activities of the enterprise (Cook,
2004). For instance, the operations like recruitment and promotion of employees in the
production unit is clearly a responsibility of the production department but it requires
payment of wages and salaries and other financial emoluments and hence involves working
capital. Other daily financial incentives and motivation needed by employees are also
prosecuted by the enterprise. This also needs immediate cash. In the same vein, buying a
new machine or replacing an old one for the purpose of increasing productive capacity
affects the flow of funds (Merton, 1992). There are other activities like sales policies which
are the duties of marketing departments but advertising and other sales promotional
activities like press releases, banners, special features of products and the provision of
loyalty card scheme as strategies for customers’ retention require outlays of cash and
therefore, affect financial resources of the enterprise (Dejager: 2008). Thus it is the duty of
public enterprises to institute proper investment management practices in order to perpetuate
these activities. These investment management practices are the determinants of the growth
of all enterprises including public enterprises.
2.1.2. Capital Structure Decisions
There are several categories of sources from which a company can build its capital
structure. The Pecking Order theory by Myers (1984) stipulates how a company should be
29
financed; a company prefers internal financing to external one in the same way that it prefers
debt to equity. The theory specifically states that companies prioritize their sources of
financing ( from internal financing to equity) according to the law of least effort or of least
resistance; preferring to raise equity as a financing means of last resort (Myers, 1984).
Hence, internal financing is used first; when that is depleted, then debt is issued and when it
is no longer sensible to issue any more debt, equity is employed (Myers, 1984). The theory
maintains that businesses adhere to a hierarchy of financing sources and prefer internal
financing to other forms when it is available. It also states that debt is preferred to equity if
external financing is required. The Pecking Order Theory is popularized by Myers (1984)
when he argued that equity is a less preferred means to raise capital to other means because
when managers who are assumed to know better about the true condition of the company
than the investors issue new equity, investors believe that managers think that the company
is over-valued and managers are taking advantage of this new investment opportunity, as a
result, investors will place a lower value on the new equity issued. Thus, the undervaluation
of the new equity is the cost of asymmetric information which is in existence in a company.
Symmetric information which flows between the management and the investors is necessary
for the growth of a company.
In corporate finance, capital structure refers to the way a corporation finances its
assets through some combination of equity, debt or hybrid securities (Kennon, 2005). An
enterprise’s capital structure is then the composition or structure of its liabilities (Kennon,
2009). It is the percentage of capital (money) at work in a business in any form. This implies
that it is a financing mix planned to enhance growth, acquisition or expansion of a company.
30
Components of Capital Structure
Capital structure decisions revolve around two main components, namely: the type
of securities to be issued and the relative ratio of the securities.
Types of Securities: The types of securities to be issued are equity shares, preference shares
and long-term borrowings (debentures) (Jeffery, 2002). Equity capital is the money put up
and owned by the shareholders. Typically, equity capital consists of two types, namely:
contributed capital which is the money that was originally invested in the business in
exchange for shares of stocks or ownership and the retained earnings which is the earnings
representing a portion of the PAT (Profit After Tax) set aside from the previous years and
have been kept by the company and used to strengthen, develop, fund, and to expand the
enterprise (Myers, 1968).
Debt capital in company’s capital structure refers to borrowed money that is at work
in the business (Lyanders, 2007). Lyanders (2007) also asserted that the safest type of debt
capital is generally considered to be long-term bonds because the company has years, if not
decades, to come up with the principal while paying interest only in the mean time.
Relative Ratio of Securities: The relative ratio of securities can be determined by the
process known as capital gearing (Joshua, 2009). On this basis of capital gearing, the
companies are segregated into two according to the extent of equity holdings.
Highly Geared Companies: These are companies in which the proportion of equity
capitalization is small. In other words, borrowed capital is greater than the owner’s capital
(ordinary shares). Highly geared company is a going concern. This implies that it is not a
one-project- or a-one-contract-stop firm; it is a corporate citizen that has perpetual
succession.
31
Low Geared Companies: These are companies in which their equity capital dominates total
capitalization (Mor, 2009). In other words, borrowed capital is less than the equity capital..
On the other hand, a low geared company is a firm that is tending towards financial distress
There are other types of debt capital such as short-term commercial papers from the
capital market and vendor financing. Commercial papers are utilized to meet the day-to-day
working capital requirements such as payroll and utility services. Vendor financing is
another form of capital to a business enterprise. In this way, a company can sell the goods
before they have to pay the bill to the vendor. This means that the return on equity will be
increased without costing the company anything. (Kennon, 2005). The vendor’s money is, in
effect, used to grow the company. This is in view of the fact that the company collects the
profits and returns the capital. This may not be the Net Present Value profits because there
was no cost of capital attached to the supply of the goods.
Features of Capital Structure
An appropriate capital structure adds value to the company by increasing the
profitability of the company (Ross, 1977). An articulated capital structure maintains a
culture of flexibility (Riddiogh, 2004). This is to enable the company to cope with the
changing conditions. A company should try as much as possible to adapt to capital structure
with a minimum delay if it is necessitated by a changed situation. A company should
provide funds whenever needed to finance its profitable ventures. The capital structure of a
company should be conservative in the sense that the debt capacity of the company depends
to a great extent, on its ability to generate future cash flows. There should be enough cash to
pay creditors’ fixed charges and principal sum. In financing mix, a debt that does not add
significant risk to the company should be used. Any debt that threatens the solvency of the
company should be discarded (Graham, 2000).
32
Factors Determining Capital Structure
The capital structure of a company is planned at the time the idea of establishing the
company is conceived. The management of the company should set a target capital structure
and the subsequent financing decisions should be made with a view to achieving the target
capital structure (Pandey, 1991). Pandey (1991) stated that financial management also has to
do with an existing capital structure. An enterprise requires funds to finance its business
continuously. Every time the funds have to be obtained, the trade and investment section
analyses the economic implications of various sources of finance and chooses the most
advantageous sources, keeping in view the target capital structure (Harris, 2007). In effect,
the capital structure decision is a continuous one and has to be taken whenever a company
requires additional finances for the promotion of its activities.
Ideally, the following factors should be considered whenever a capital structure
decision has to be made: trading on equity; degree of control; flexibility of financial plan;
choice of investors; capital market considerations; period of financing; cost of financing;
stability of sales and size of a company (Sheridan, 1988).
Trading on Equity: The word equity denotes the ownership of the company. Trading on
equity means taking advantage of equity share capital to borrow funds on reasonable cost
basis. It refers to additional profits that equity shareholders earn because of issuance of
debentures and preference shares. It is based on the thought that if the rate of dividend on
preference capital and the rate of interest on borrowed capital are lower than the general rate
of the company’s earnings, equity shareholders are at advantage which means that a
company should go for a judicious blend of preference shares , equity shares as well as
debentures. Trading on equity becomes more important when the expectations of
shareholders are high (Mao, 2005).
33
Degree of Control: In a company, the directors are the elected representatives of the
shareholders. These members have got maximum voting rights in a concern as compared to
the preference shareholders and debenture holders. Preference shareholders have reasonably
less voting rights while debenture holders have no voting rights at all (Cunning, 2006). If the
company’s management policies are such that they want to retain their voting rights in their
hands, the capital structure consists of debenture holders and loans rather than equity shares.
Flexibility of Financial Plan: In an enterprise, the capital structure should be such that
there is both contractions as well as relaxation in plans. Debentures and loans can be
refunded back as the time requires. (Bolton, 1996). According to him, equity capital cannot
be refunded at any point which provides rigidity to plans. Therefore, in order to make the
capital structure possible, the company should go for the issue of debentures and other loans,
Bolton (1996) maintains.
Choice of Investors: The company’s policy generally is to have different categories of
investors for securities. Therefore, a capital structure should give enough choice to all kinds
of investors to invest. Bold and adventurous investors generally go for equity shares and
loans and debentures are generally raised keeping in mind, conscious investors.
(Hovakimian, 2004).
Capital Market Condition: In the lifetime of an enterprise the market price of the shares
has got an important influence on the financial fortunes of the company. During the
depression period, the firm’s capital structure generally consists of debentures and loans
(Ryen, 1997). On the other hand, in periods of booms and inflation, the companies’ capital
structure should consist of share capital, generally equity shares. (Williams, 1995).
Period of Financing: When an enterprise wants to raise finance for a short period, it goes
for loans from banks and other financial institutions. (Shefrin, 2001). On the other hand, if it
34
wants to raise finance for a long period, it goes to the capital market for issue of shares and
debentures. (Shefrin, 2001). Impliedly, loans serve short period investments and shares and
debentures serve long period investments.
Cost of Financing: In a capital structure the company has to look to the factor of cost when
securities are raised. (Ross, 1977). It is observed that debentures at the time of profit-earning
prove to be a cheaper source of finance as compared to equity shares where equity
shareholders demand an extra share in profits.
Stability of Sales: An established business which has a growing market and has sales
turnover is in a position to meet fixed commitments. Interest on debentures has to be paid
irrespective of the level of profit. Therefore, when sales are high, the profits are likely to be
high and the company is in a better position to meet such fixed commitments like interest on
debentures, and dividends on preference shares. (Quan, 2002). If the company is having
unstable sales, then the company is not in a position to meet fixed obligations. So, equity
capital proves to be safe in such cases. (Butler, 2005).
Size of a Company: In a small-sized business enterprise, the capital structure generally
consists of loans from banks and retained profits. On the other hand, large-scale enterprises
having goodwill, stability and established profit trend can easily go for issuance of shares
and debentures as well as loans and borrowing from financial institutions. (Loof, 2003).
Thus, the size of a company determines, to a great extent, the profiles of its capital structure.
Importance of Capital Structure Decision
To Reduce the Risk of Parent Company: When capital structure is made before getting
money from the money lenders, many adjustments can be made to reduce the overall risk.
(Koller, 2006). For instance, suppose a capital structure is made up of three sources, one is
equity share, and the other is debenture and the last is preference shares, certainly, debt will
35
be paid at its maturity at any cost and its interest at fixed rate. So, getting minimum debt in
new business is necessary because the rate of return will be less than the rate of interest and
for getting more loans means taking high risk of return, more amount of interest even if
there is no profit. But if the business will be successful, that time, the amount of debt can be
increased.
To Do Adjustment According to Business Environment: An enterprise adjusts different
sources and amount according to business environment. Proper planning of capital structure
of future sources will be helpful to enlarge the area for getting money. ( Singh, 2000). In
finance, this action is referred to as maneuverability (Williamson, 2000). It means creating
mobility of sources of funds by including maximum alternatives in planned capital structure
(Tong, 2005). For instance, if the Central Bank of Nigeria, CBN, increases interest rate, it
means that the cost of getting loans will be high; at that time, then, other cheap sources of
funds can be chosen.
2.1.3. Capital Investment Decisions
Investments do not exist. They are created to attract investment of capital. In creating
investment opportunities, the following steps are taken.
Project Generation: Investment proposals in an organization can fall into one or more of
the following categories.
� Proposal to add to new products
� Proposals to expand capacity in existing product line
� Proposals designed to reduce cost in the output of existing product without jeo
pardizing the scale of operation.
36
Project Evaluation: Project evaluation involves two steps. These are:
� Estimation of benefits and costs, the benefits and costs must be measured in terms of
cash flows,
� Selection of an appropriate criterion to judge the desirability of the projects.
Project Selection: After the evaluation, the projects are then screened for final selection.
The selected projects are sent to the management for approval.
Project Execution: After the final selection of investment proposals, funds are then
appropriated for project execution. These steps are referred to as capital budgeting decision
processes (Quirin, 2003).
The most important steps in capital investment decisions using capital budgeting
method is working out if the benefits in investing large capital sums outweigh the cost of
these investments. The range of techniques that business enterprises use can be categorized
into two major ways, namely: the traditional methods and the discounting cash-flow
technique. The traditional methods embrace the average rate of return and the pay back
period method. The discounting cash-flow method uses the net present value (NPV),
profitability index otherwise known as benefit/cost ratio and the internal rate of return.
(Time web, 2010).
Traditional Techniques
The Payback Period:
Payback period expressed in time, informs the management of an enterprise how
many months or years it will take to recover the original cash cost of the investment project.
The payback period according to Pandey (1991), is the number of years required to repay
the investment cost of a project from its net proceeds. Similarly, according to Time web
37
(2010), payback period is the amount of time required for the cash inflows from a capital
investment project to equal the cash outflows Okafor, (1983), posited that when computing
the payback period, the expected annual profit of investment (normally after tax but before
depreciation) are aggregated until the amount of the initial capital outlay is recovered. The
payback period is an investment appraisal tool of analysis which is used to evaluate revenue
yielding projects owned by organizations. The usual way corporate organizations deal with
the payback period when taking decisions between two or more competing projects is to
accept the project that has the shortest payback period. Payback period is often used as an
initial screening method (Marnigart,1997).
Payback period is used to assess the viability of the commercial revenue-yielding
projects owned by an enterprise. It is used in selecting the projects and reveals how fast the
profits accrue from the projects to cover the initial capital outlay and at the same time
sustain the capital growth of the enterprise.
Merits of Payback Period: Several merits are associated with the use of payback period in
project evaluation. First, it is quickly understood because of its simplicity (Jones, 1969). It is
easy to calculate. Second, in a commercial environment of rapid technological change, new
plant and machinery may need to be replaced sooner than in the past, so a quick payback on
investment is essential (Time web 2010). Third, it costs less than the sophisticated
techniques which requires lots of analyst time (Elton, 1970). In the opinion of Brigham
(1990), besides simplicity, the risk of the project can be tackled by having a shorter payback
period as it may ensure guarantee against loss.
Demerits of Payback Period: However, some demerits have been found to exist in the use
of payback period in project evaluation. First, Fogler (1977), observed that the payback
period fails to take into account, the cash inflows earned after the payback period. and, it
38
does not measure the profitability of an investment project appropriately as it does not take
into account the entire cash inflows yielded by the project.
Use of the Payback Period in Project Appraisal
The explanation of the payback period above has shown that the management of
public enterprises in Enugu State can use the technique to work out the number of years it
may take them to recover their various capital outlays from their various investments. There
are two conditions which public enterprises may experience on cash inflows. One condition
is when the annual cash inflow is constant and the other is when there are unequal annual
cash inflows.
Constant Annual Cash Inflows
If the investment project generates constant annual cash inflows, the payback period
can be computed by dividing the cash outlays by the annual cash inflows (King, 2004).
Mathematically, payback period = Cash Outlay
Annual cash inflows
Consider an example, assume that a project requires an outlay of N500,000.00 and yields an
annual cash inflows of N150,000.00 for 8 years. Then the payback period of the project is:
Payback Period = Cash Outlay = 500,000 = 10
Annual Cash Inflow 150,000 3
= 31/3 years
= 3 years and 4 months.
Unequal Annual Cashflows: In the real world of business, it is very rare to obtain constant
cash inflows from investment projects. If the investment project generates unequal cash
39
inflows, the payback period can be found out by adding up the cash inflows until the total is
equal to the initial cash outlay. The number of years required to do so is the payback period.
Table I illustrates the calculation of payback period of the following project cash inflows
with an initial investment at the beginning of the year of N40,000.00
Table 2(1) Payback Period of Unequal Annual Cashflows
YEAR CAPITAL OUTLAY/ CASH
INFLOW
CUMULATIVE CASH INFLOW
Year 0 N40,00000 -
Year 1 N7,500.00 N7,500.00
Year 2 N7,500.00 N15,000.00
Year 3 N9,000.00 N24,000.00
Year 4 N10,000.00 N34,000.00
Year 5 N6,000.00 N40,000.00*
Year 6 N4,000.00 N44,000.00
* = Recovery Period Source: Timeweb (2010)
The payback period is 5 years because at that point, the amount invested is recovered.
Table 2(2) shows another example of a project’s cash flow with an initial investment outlay
of N110, 000.00. The payback period is within some years and some months.
Table 2(2) Payback Period of Unequal Annual Cash Flows.
The method for calculating the payback period is as follows.
Pbp = year before full recovery
+ (�������� ���� � ��� ��������� �� ��� �� �� �� ���� ����� ��� �� � )�12 (Madueme, 2014)
40
Table 2(2) Payback Period of Unequal Annual Cash Flows
YEAR CAPITAL OUTLAY/CASH INFLOW
CUMULATIVE CASH INFLOW
Year 0 N110,000.00 -
Year 1 N30,000.00 N30,00000
Year 2 N20,000.00 N50,000.00
Year 3 N40,000.00 N90,000.00*
Year 4 N40,000.00 N130,000.00*
• = The payback period is 3 years and 6 months
Source: Timeweb (2010)
Payback period = year before full recovery
+ �������� ����
� �� ������ ������ ��� �� � � 12
3 + �110000 − 9000040000 # � 12
= 3 $%&'( &)* 6 ,-).ℎ(
Explanation
The payback period is 3 years and 6 months. The sum of N20,000.00 is taken from the
N40,000.00 of the 4th year and added to N90,000.00, the cumulative cash inflow of the 3rd
year to get N110,000.00. Then the N20,000 is divided byN40,000 of the 4th year and
multiplied by 12 months to get 6 months.
Determination of the payback period is an important factor in investment evaluation because
it clearly shows the management of public enterprises how long the initial investment outlay
would be tied to a particular project before its recovery for use in other demanding
alternative investments (Dean, 2008). It guides the management of public enterprises in
deciding either to take a short-term loan or a long-term one depending on the opportunity
cost or the weight attached to the loan. The payback period can also be used as an accept or
reject criterion as well as for ranking investment projects (Porterfield, 1995). For an
41
investment project that does not have competitors, the payback period should be accepted if
it is less than, or equal to, the maximum period set up by management and rejected if the
payback period is greater than the stated maximum period (Bailey, 1959). When public
enterprises are appraising projects, alongside each other, the shortest payback period should
be accepted. The shorter the payback period, the better the investment (Gordon, 1956). As a
ranking method, the payback period technique gives highest ranking to the investment which
has shorter payback period and the lowest ranking to the project with the highest payback
period.
Average Rate of Return:
The average rate of return on investment, expressed as the average annual profit
normally after taxes and depreciation as a percentage of the original investment on the
project (Raymond, 1978). The average rate of return expresses the profits arising from a
project as a percentage of the initial capital cost (Time web 2010). Business enterprises use
it to verify whether the projects chosen were the best considering other competing
alternatives at a given time.
Merits of the Average Rate of Return: It is very simple and thus easy to understand. The
average rate of return has a link with some accounting measures that are commonly used
(Time web 2010). The percentage figure calculated under this method is more meaningful
and acceptable to the users because it satisfies them in terms of the rate of return on capital
(Pandey, 1991). The Average Rate of return is similar to the Return on Capital Employed in
its construction; this may make it easier for business executives to understand.
Demerits of Average Rate of Return: Pandey (1991) however, observed that the Average
rate of return on investment uses accounting profits, and not cashflows, in appraising the
42
projects. The concept of profits can be very subjective, varying with specific accounting
practices and the capitalization of project costs. As a result, the average rate of return
calculation for identical projects would likely result in different outcomes from one type of
business to the other.
Use of Average Rate of Return Criterion: The rate of return on investment is worked out
by dividing the average income after taxes and depreciation by the original investment on
the project, the rating being expressed in percentage (Myers, 1968). It is also expressed as a
percentage return on the average value of the investment during the life of the project.
Mathematically, it can be expressed as:
(TI –CO)
Average Rate of Return = ----------------- x 100 (%)
t x CO
Where,
TI = Total Income
CO = Capital Outlay
t = Number of years (Anyanwu:1991)
Example:
Using Anyanwu’s (1991) example to illustrate, we assume that a project to replace an item
of machinery by a public enterprise in Enugu State is being appraised. The machine will cost
N50,000.00 and the expected cashflows after taxes and depreciation through each of its 5
years of economic life are: N10,000.00; N20,000.00; N10,000.00; N25,000.00 and
N20,000.00.respectively. Calculate the average rate of return for this project.
43
Computation:
Here, TI = N (10,000 + 20,000 + 10,000 + 25,000 + 20,000) = N85,000.00
CO = N50,000.00
t = 5 years
Average Rate of Return = (85,000 -50,000) x 100 (%)
5 x 50,000
= 14 %
Public Enterprises in Enugu State, acting as entrepreneurs, can use the Average Rate
of Return as accept or reject decision rule. All those projects with their rates of return higher
than the minimum rate established by the management should be accepted and all those
projects with rates of return less than the minimum should be rejected. In addition, they
would rank a project as a number one if it has the highest rate of return while the lowest rank
would be assigned to the project with the lowest rate of return. Thus, project evaluators
should always advise public enterprises to embark on a project that has the highest rate of
return among other competing ones. All the average Rates of Return that are less than the
cost of capital should be rejected.
Discounting Cashflows Techniques
Discounting Cashflows techniques explicitly recognize the time value of money.
According to Pandey (1991: 395), “Cashflows arising at different times periods differ in
value and are comparable only when their equivalent present values are found out.” Value
depreciates with time and money is not an exception. The value of money depreciates over
time.
The implication of this is that given a choice between N1 today and N1 in a year’s
time, a rational man or organization would prefer N1 today to N1 in a year’s time. (Bones,
44
1964). The preference is due to the fact that N1 today could be invested to be worth more
than N1 in a year’s time. Furthermore, inflation could intervene and this would mean that
N1 would bring in less in a year’s time than it would, today. In addition, there is an element
of risk, however small attached to the receipt of N1 in a future date. For instance, debtor
may become bankrupt in a year’s time and therefore could not pay up. Another reason for
holding cash today is that sudden investment opportunity presenting itself and requiring
immediate cash will be lost if cash were not available.
Discounting cashflow technique is used to bring the future cash inflows to their
present value using the sacrifice made during the transaction of the business as the
discounting rate. The sacrifice made is known as the opportunity cost. Let us illustrate what
we are describing here. If one is to receive N1 in one year’s time, its value today using 10%
as the opportunity cost or the cost of capital is:
1 = N0.909
(1.10)
If he is to receive N4 in two years’ time, its value today using 10% as the cost of
capital is:
4 = N3.305
(1.10)2
The Net Present Value Criterion
The net present value method is a process of calculating the present value of cash flows of
an investment proposal using the cost of capital as the appropriate discounting rate and
finding out the net present value by subtracting the present cash outflows from the present
value of the cash inflows (Bierman, 1975). The net present value method could be used for
45
ranking of, and choosing among, competing projects provided that an appropriate rate of
return has been established and used.
In the words of Brandt (2003:74), “this method is best fit for decisions rule of accept or
reject”. Thus, using the net present value technique is to accept the investment project if its
present value is greater than or equal to one and to reject it if the net present value is less
than one (Myers, 1968). So, in using the net present value method, projects would be ranked
in order of net present value – that is first rank will be given to the investment project with
the highest positive net present value and so on but any negative net present value must be
rejected entirely. Bierman (1987) identified three major benefits that are associated with the
use of the net present value criterion for investment appraisal. The most significant
advantage, according to him, is that it takes into account the time value of money. Second, it
considers all cashflows over the entire life of the project in its calculations. Third, the
ranking of projects is independent of the discount rate chosen for the analysis. Finally, it is
consistent with the objective of maximizing the welfare of the owners of the enterprises. The
owner of public enterprises as their names appear is the public.
Use of Net Present Value Criterion: Present value refers to the value now of payments to
be received in the future. When a future sum is turned into its equivalent present value, we
say that the sum is discounted. This can be expressed in mathematical terms as follows:
Present value = ∑ Xt (1+i)i
Where t = number of years from one to n years
i = interest rate (percent) or discount rate
X = amount of money at any t year (Onah,2002)
t = 1
n
46
Furthermore, when money (capital outlay) is invested in a project and the expected
cashflows through each of its n years of economic life are given, then the net present value
(NPV) is given as:
NPV = ∑ Xt - 0 123(456)7
�
�84 (Onah 2002)
t=1(1+i)t
Where CO = Capital Outlay.
Illustration: Assume that a public enterprise is considering investing N75,000.00 in a
technology that will be used to preserve palm wine.
Table 2(3): Projected Profits for the Project
Year Cost Cash Inflow Net Cash
1. 10,000 20,000 N10,000.00
2. 15,000 40,000 N25,00000
3. 30,000 65,000 N35,000.00
4. 12,000 47,000 N35,000.00
5. 8,000 38,000 N30,000.00
Calculate the net present value using 10% as the discount rate 10% being the interest rate
n Xt - 0 123(456)7
�
�84
Net Present Value (NPV) = ∑ (1+i)t t=1
Here, t = 5; i = 10%;
I+ 10% = 1+0.10 = 1.10
n
47
The financial analysis is as follows at 10% discount rate.
Table 2(3) A Net Discounted present value of the profit.
Year Costs Cash Inflow Discount Factor at 10%
Net Cash Present Value (PV)
1. 10,000 20,000 0.9091 N10,000.00 9091.00
2. 15,000 40,000 0.8264 N25,00000 20660.00
3. 30,000 65,000 0.7513 N35,000.00 26295.50
4. 12,000 47,000 0.6830 N35,000.00 23905.00
5. 8,000 38,000 0.6209 N30,000.00 18628.00
135,000.00 98578.50
The result of the calculation of the net present value, NN98578.50 is positive and therefore,
the investment proposal has to be accepted
A positive net present value means that the project is worthwhile because the cost of tying
up the enterprise’s capital is compensated for by the cash inflows that result (Timeweb
2010). When more than one project is being appraised, the enterprise should choose the one
that produces the highest net present value.
The Profitability Index Criterion/ Benefit – Cost Ratio
The profitability index is also known as the benefit – cost (B/C) ratio. Maduemen
(2014) states that profitability index is the ratio of the present value of cash inflows at the
required rate of return, to the initial cashflow of the investment. As an accept or reject rule,
using the profitability index (PI) is to accept the project if its profitability index is greater
than one. Profitability index is a conceptually sound method of appraising investment
projects (Dean, 2008).
48
It gives due consideration to the time value of money. Since the present value of cash
inflows is divided by the initial cashflow, it is a relative measure of a project’s profitability.
(Rebichek, 1998). Profitability index is easy to calculate as its calculation follows the pattern
of calculating the net present value.
Use of Profitability Index in Investment Decisions: The definition of profitability index
(PI) indicates that:
PI = 9������ : ��� (;������)
9������ : ��� (����) (Madueme, 2014)
.
Madueme (2014) Illustrated: assume that a public enterprise is proposing to invest N75,000
in technology that will be used to preserve palm wine. The expected cash inflows are as
shown in table 4 below.
Table 2(4): Projected Profits for the Project
Year Cost Cash Inflow Net Cash
1. 10,000 20,000 N10,000.00
2. 15,000 40,000 N25,00000
3. 30,000 65,000 N35,000.00
4. 12,000 47,000 N35,000.00
5. 8,000 38,000 N30,000.00
49
Table 2(4) A calculation of Benefit – Cost Ratio at 10% Discount Rate Year Costs Discount
Factor at 10%
Present Value (PV)
Cash Inflow
Discount Factor at
10%
PV Cash Inflow
1. 10,000 0.9091 9091.00 20,000 0.9091 18182
2. 15,000 0.8264 123.96 40,000 0.8264 33056
3. 30,000 0.7513 22539 65,000 0.7513 48834
4. 12,000 0.6830 8196 47,000 0.6830 32101
5. 8,000 0.6209 49672 38,000 0.6209 23594,2
57189.20 1557672
Find the profitability index of this investment using 10% as the discount rate. 10% being the
interest rate.
Profitability Index (PI) or Benefit/Cost ratio. According to Madueme (2014) the procedure is
to divide present value of revenueby the present cost. = 9: (;������)
9: (����)
Benefit cost Ratio = 9: � �� <����� (;������)
9: ����
= 4==>?>.A=>4BC.A = 2.72
The profitability index is 2.72. Thus, investment in the technology should be embarked upon
by the public enterprise. The selection approach is that if a public enterprise is prospecting
for more than one investment, the profitability indexes should be arranged in order of
magnitude and the ranking of the investments done. The selection of project(s) should be
done according to these ranks.
Internal Rate of Return (IRR)
The internal rate of return is the annual percentage of return achieved by a project at which
the sum of the discounted cash inflows over the life of the project is equal to the sum of the
capital invested (Time web, 2010) This implies that the internal rate of return is the rate of
50
interest that reduces the net present value to zero. This criterion is called internal rate of
return because its value is a function of the capital outlay and the proceeds arising from the
investment and not on any rate determined outside the investment. The internal rate of return
approach asks if the IRR on the investment is greater than the borrowing rate (Okafor,
1983). If the IRR is r and the opportunity cost of capital is I, then accept the investment
project if r >I (Bones, 1964).
One of the values of the internal rate of return to a business enterprise is that the
decision- makers are able to see the level of interest that a project can withstand.
(Daellenbach, 1974). In a situation where a number of projects are competing for selection,
the one that is most resilient can be chosen (Time web, 2010).
Use of Internal Rate of Return Criterion: From the definition of internal rate of return
(IRR), we can see that it is obtained by using the formular:
∑ Xt - CO = 0
Where,
Xt = cashflows
t = number of years
r = internal rate of return
CO = capital outlay
Three cases of internal rate of return have been demonstrated by Timeweb (2010)
First, when the business lasts for only one year. This means when the investment is
entirely divested in one year period. Under this condition,
X1 = CO or X1 – CO = o
n
t = 1 (1+ r)t
51
(1+r)1 1+r Therefore,
r = X1 – CO Time web (2010) CO
Demonstration: If a project costs N3000 and its expected cash inflow in one year is N8000
and the project is entirely disinvested,
Then, r = 8000 - 3000
3000
= 5000
3000
= 1.666
= 167%
Public enterprises in Enugu State can embark on investment projects whose opportunity cost
or cost of capital is less than 167%.
Second, when the business lasts for only two years. That is it is disinvested in the second
year. Then we have
X1 + X2 - CO =0 Timeweb (2010) (1+r) (1+r)2 Timeweb (2010) demonstrates, if a project costs N4000 and its expected cashflows in two
years are N8000 and N6000 respectively and the business is entirely disinvested.
Let 1 = P 1+r Therefore, X1 + X2 - CO = 0 (1+r) (1+r)2 X1P + X2P2 _ CO = 0 Or, P2X2 + PX1 – CO = 0 6000P2 + 8000P – 4000 = 0
Evaluation brings the internal rate of return to be 159% (Time web (2010)
52
The management of public enterprises in Enugu State can embark on investment
projects whose opportunity costs or cost of capital is less than 159% If an investment project
is entirely disinvested in the first or second year period, its marginal productivity or rate of
return is unambiguously determined (Bailey, 1959).
Third, when the life of the investment project extends to a longer period or three or
more years. The determination of internal rate of return becomes ambiguous and the trial
and error approach is used to determine the internal rate of return (Bailey, 1959). The
method of linear interpolation is used to estimate the value of the internal rate of return
(Bailey, 1959).
Demonstration: A project costs N3000.00 and the expected cash inflows are as shown
below. Calculate the internal rate of return.
Table 2(5): Calculation of Internal Rate of Return When the Project Extends for Three
or More Years.
Year Cashflow (N)
1. 800
2. 800
3. 950
4. 950
5. 600
Source: Timeweb (2010)
Solution: Let us try 12%
800 + 800 + 950 + 950 + 600 - 3000
(1.12) (1.12)2 (1.12)3 (1.12)4 (1.12)5
= 714.28 +637.75 + 676.19 +60334 + 340.46 – 3000= -27.98
Now, let us try 11%:
= 800 + 800 + 950 + 950 + 600 - 3000
(1.11) 1.11)2 (1.11)3 (1.11)4 (1.11)5
53
= 720.72 + 649.30 +604.63 + 625.79 + 356.07 – 3000
= 46.51
This internal rate of return is between 11% and 12%.
Internal Rate of Return = 11% + (12-11)46.51%. (27.98 + 46.51 = 74.49)
74.49
= 11% + 0.62%
= 11.6%
If the opportunity cost of capital for this investment project is 12%, the investment should be
rejected because the internal rate of return is less than the opportunity cost of capital, i – that
is 11.6% < 12%. But if the opportunity cost of capital is 9%, then, the investment project has
to be accepted because the opportunity cost of capital is less than the internal rate.
of return- that is, 9% < 11.6%. A small internal rate of return cannot withstand a project with
high interest rate. Pandey (1991) noted that high growth companies earn very high internal
rates of return on their existing assets.
Estimating Cashflow and Discount Rate
In investment appraisal techniques, two vital components play great roles in project
selection. These components are cash inflows and the discount rate.
Cashflows Estimation: Accounting data form the basis for estimating cashflows (Brandt,
2003). It is the responsibility of the Financial Controllers of public enterprises to devote
adequate time, effort and money in getting correct estimates of cashflows. The financial
management unit can obtain the necessary information from those in accounting, production,
marketing, as well as the research and development departments and use the information so
obtained to prepare cashflow estimates (Hastings, 2005). The financial controllers of public
enterprises are expected to carry out a survey in order to obtain data that will be used to
estimate the cashflows. After collecting the cashflow estimates from various sources, the
54
financial management unit should reconcile the information collected so as to ascertain its
relevance and accuracy.
The finance managers must also put into cognizance the fact that investment
opportunities change rapidly and unexpectedly due to political, economic and social unrests.
However, it is difficult to predict change of events in an economy. Under this circumstance,
what the management has to do is to make adequate risk adjustment factors (Douglas, 1966).
The reason for the risk adjustment is that most investment outlays are sunk costs and
therefore cannot be retrieved should the investment projects encounter downward trends in
economic growth.
In the case of estimating cashflows on replaced equipment the method of the
estimation is to use the incremental approach (Pandey, 1991). This entails ensuring that the
cashflows of the new investment is higher than the cashflows of the old investment (Pandey,
1991).
Demonstration: Let us use an illustration to buttress what is being said here.
A public enterprise is considering replacing its old equipment which generates cashflows of
N4000, N7000 and N3000 for 3 years. Its book value is N6000.00 and the market value for
the 3 years is N2000. It is assumed that its market value will be zero after the 3 years.This
means that the old equipment will be sold by the end of 3 years. The new equipment with
capital outlay N8000 is expected to be generating N14,000, N18,000, and N12,000
respectively.
55
Table 6 below shows the incremental approach.
Table 2(6): Incremental Approach
Year 0 1 2 3
New Equipment capital outlay N8000 N14,000 N18,000. N12000
Old equipment Re-sale price N2000 N4000 N7000 N3000
Increment N6000 N10000 N11000 N9000
The increment is the difference between the new and the old cashflow. The book value,
N6000 of the old equipment is not useful here because it is a sunk cost. On the incremental
basis, the actual capital outlay for the new equipment is N6000. The reason is that although
the capital outlay in the new equipment is N8000, the old equipment was resold for
N2000.00, this N2000 is a cashflow to the enterprise. In addit6ion, if the enterprise
continues to use the old equipment it would generate N4000, N7000 and N3000 for the next
3 years. Therefore, the difference between the cashflow of the new equipment and the
cashflow of the old equipment reflects the incremental cash inflows.
Estimation of the Discount Rate: A business enterprise gets its capital from various
sources: the common equity, retained earnings and common shares, preference shares and
debt. Capital that is used to invest in a project has some costs attached to it. This cost is
known as the interest or the opportunity cost. The opportunity cost is the rate of return on
the next best alternative forgone investment opportunity of comparable risk (Pandey, 1991).
The cost of capital for those various sources of capital differs because of the varied
agreements between the enterprise and the investors. In the words of Dobrovolaky
(1958:28), “the cost of capital of each source of capital is known as components or specific
cost of capital”. These component costs are aggregated according to the weight of each
component capital to get the average cost of capital (Pandey, 1991). This average cost of
56
capital is known as the weighted average cost of capital (Jones, 1969). Pandey (1991) posits
that the component cost of capital should be used in evaluating investment projects. Thus,
the weighted average cost of capital is the discount rate.
Pandey (1991) presented the formula for calculating the weighted average cost of capital
(WACC) as:
WACC = K1W1 + K2W2 + K3W3 +…+KnWn
n
= ∑ KtWt
t=1
Where Kt is the proportion of the various capitals and
Wt is the weight or cost of the various capitals.
Demonstration: Consider the capital structure of a public enterprise in table 2(7) below.
Table 2(7): Capital Structure of a Public Enterprise
SOURCE OF FUNDS AMOUNT (N) COST (%)
Common Equity - -
Retained Earnings 75,000.00 10
Common Shares 60,000.00 7
Preference Shares 80,000.00 12
Debt 100,000.00 15
TOTAL 315,000.00
TABLE 2(8) below shows the calculation of the weighted average cost of capital for the
information in Table 2(7).
57
Table 2(8): Calculation of the Weighted Average Cost of Capital in table 2(7)
SOURCE OF
FUNDS
AMOUNT (N) PROPORTION
(Kt)
COSTS (Wt) KtWt
WACC
Common Equity
Retained
earnings
75,000 0.24 0.1 0.024
Common Shares 60,000 0.19 0.07 0.0133
Preference
shares
80,000 0.25 0.12 0.03
Debt 100,000 0.32 0.15 0.048
TOTAL 315,000 1 0.1153
Source: Pandey (1991)
Weighted average cost of capital (WACC)
= ∑KtWt= 0.24 x 0.1 + 0.19 x 0.07 + 0.25 x 0.12 + 0.32 x 0.15
= t =1
0.1153
Or 0.1153 x 100 (%)
= 11.53 %
Thus if a public enterprise is to embark on immediate investment in project using the
illustrated capital structure, then it should use 11.53% as its discount rate to determine the
viability of the project. However, Pandey (1991) remarks that the weighted average cost of
capital should be adjusted positively or negatively for the risk characteristics of the project.
Under this scenario, the adjusted weighted average cost of capital should appear like WACC
+ or – risk factor (Pandey, 1991).
This adjustment should be determined by the finance officer according to his experience and
judgment. In order to create value in our public financial resources, the budgetary allocation
or financial grants to our public enterprises should be regarded as loans and therefore, the
cost of capital should be attached to them as debt. We assume here that those actions will
n
58
prompt the financial management unit to treat them as invested loans and in effect, try as
much as possible to recover them with some profits.
Risk Management in Investment Atmosphere
When investment is made, the investor cannot know the extent of cashflow – inflows and
outflows. The investor faces two sides of the outcome: success or failure. The returns on
investment could be high, average or low. The variability of returns is referred to as the risk
of investment.
Risk is Inherent in all Investments: The risk associated with a project may be defined as
the variability that is likely to occur in the future returns from the projects (Pandey, 1991).
Public enterprises may develop guidelines for roughly integrating the investment project risk
differences. One approach is to categorise investment projects into broad risk groups and
then adopt different discount rates based on the decision maker’s experiences and judgment.
Thus, investment projects may be grouped as:
� Low risk investment projects
� Medium risk investment projects
� High risk investment projects. (Pandey, 1991)
In capital investment projects, low risk projects are associated with replacement of
equipment and modernization of investment projects. The management team that is
concerned with the capital expenditure or investment projects can estimate the benefits –
increase in revenue and reduction in costs of investment with relative accuracy. The
financial management unit can estimate the cash inflows and outflows because the
management has had the knowledge of these cashflows from the previous investment. Low
risk-adjusted discount rate should be used to discount the low-risk projects because the
investor can estimate the cashflows with some degree of accuracy. And because the investor
59
can estimate the cashflows with some degree of precision, the future behaviour of the
investment can be determined.
The investment that is under the umbrella of the medium risk project include investment for
expansion of the on-going or existing business level. The management is acquainted with
the nature of the business during the expansion period. The management using its
experience and judgment can have reasonable background knowledge of the variability of
cashflows (Dabrovolsky, 1958). Expansion of investment occurs due to the high demand of
the goods and services. Medium risk-adjusted rates should be used to discount the
cashflows. The reason for the use of this medium risk-adjusted discount rate is that it is not
all that easy to estimate cashflows.
Diversification into new projects constitutes high risk projects. In this condition, the
management has little or no idea of the new investments (Taylor, 2004). Since the
management has a faint idea of the business, it would find it difficult to estimate cashflows.
Cashflow could indicate high variability of returns. Thus, since diversification of
investments involve high risk, their cashflows are also discounted with high discount rates.
This implies using risk adjusted discount rate to take care of this variability. In all, the
process is to adjust the weighted average cost of capital to take care of the risk involved in
investing in those projects.
2.1.4. Working Capital Management
Working capital is a financial metric which represents operating liquidity available to
a business, organization or other entity including governmental entity (Free Encyclopedia,
2010). There are two definitions surrounding working capital. One is focused on gross
concept and the other is focused on net concept (Pandey, 1991). The gross working capital
60
also known as working capital refers to the enterprise’s investment in current assets. Current
assets are the assets which can easily be converted to cash, short-term securities, debtors,
bills receivable and stock – that is inventory. On the other hand, the term net working capital
refers to the difference between current assets and current liabilities (Pandey, 1991). Current
liabilities are all those claims of outsiders which are expected to mature for payment within
an accounting year and include creditors, bills payable, and outstanding expenses
(Ramamoorthy, 2004).
Decisions relating to working capital and short-term financing are referred to as
working capital management (Free Encyclopaedia, 2005). These involve managing the
relationship between an enterprise’s short-term assets and its short-term liabilities. The aim
of working capital management is to ensure that the enterprise is able to continue its
operations and that it has sufficient cashflows to satisfy both maturing short-term debt and
up-coming operational expenses. This definition implies that working capital management
entails short-term decisions generally relating to the next one year period. Short term
decisions relating to the one year period are reversible (The Free Encyclopaedia, 2005).
These decisions are therefore based on cashflows and/or profitability. Hence, Olajide (2010:
.8) observed that:
One measure of cashflows is provided by the cash Conversion cycle – the net number of days from the Outlay for raw materials to receiving payment from the customer. As a management tool, this metric makes explicit the inter-relatedness of decisions relating to inventories, accounts receivables and payable and cash. Because this number of days effectively corresponds with the time that the firm’s cash is tied up in operations and unavailable for other activities, management generally aims at low net count. In this context, he continued the most useful measure of profitability is return on capital. The result is shown as a percentage determined by dividing relevant income for the 12 months by the capital employed. Return on equity shows
61
this result for the firm’s shareholders. Firm value is enhanced when, and if, the return on capital, which results from working capital management, exceeds the cost of capital, which results from capital investment decisions as stated above. Return on capital measures are therefore useful as a management tool in that they link short-term policy with long-term decision making
Olajide (2010) further posited that the credit policy of the firm is another factor that
affects the firm’s working capital management. It includes buying of raw materials and
selling of finished goods either in cash or on credit. This affects the cash conversion cycle,
Olajide (2010) stated that, in consonance with and guided by the above criteria, the
management of an enterprise will use a combination of policies and techniques in the
management of working capital. These policies aimed at managing the current assets,
generally cash and cash equivalents, inventories, and debtors and short-term financing such
that cashflows and returns are acceptable (Nnamoko, 2006).
Cash Management: The management of an enterprise should identify the cash
balance which allows for the business to meet day-to-day expenses, but reduces cash-
holding costs, or tying cash down. In detail, Pandey (1991) points that the consideration of
investment in current assets should avoid two dangerous points: excessive and inadequate
investments in current assets. According to him, the investment in current assets should be
just adequate and not more and not less to the needs of the business enterprise. Pandey
(1991) maintained that certain investments in current assets should be avoided because it
impairs enterprise profitability, as idle investment generates nothing for the enterprise. On
the other hand, inadequate amount of working capital can threaten the solvency of the
enterprise if it fails to meet its current obligations. It is necessary to point out that the
working capital requirements of the enterprise could be fluctuating due to business activities
or government policy just as the Nigerian government unexpectedly withdrew her subsidy
62
on oil on 1st January, 2012. Pandey (1991) rightly observed that this sudden change of
business activity may cause excess or shortage of working capital frequently. The
management should be too prompt to initiate an action and correct the imbalances.
The basic objectives of cash management are in two folds:
� To meet the cash disbursement needs, and
� To minimize funds committed to cash balances. (Olajide, 2005).
However, these two objectives are contradictory and the duty of cash management is
to reconcile them. In other words, it is the duty of the finance manager to strike a balance
between holding excess cash and not holding sufficient cash. The major tool for determining
optimal cash level is the cash budgeting system or technique. It is important that the forecast
for cash are made with realistic assumptions (Olajide, 2010). It is important to observe that
the more frequent the cash forecast, the less the deviation of actual from the forecast. In
determining the cash levels to be held, Olajide (2010) pointed out that the finance manager
or the investment manager should therefore recognize an established model known as J. M.
Keynes motives for holding cash. These motives are as outlined below:
� Transaction Motive: This refers to the holding of cash to meet the operational or
day-to-day requirements of a company, for example, purchases of stocks, payment of
salaries, and meeting of other operational expenses that may crop up from time to
time.
� Precautionary Motive: In this case, additional cash should be held to meet
unexpected cash needs at short notice. This may be the result of sharp increase in
cost of raw materials, unexpected slow-down in the collection of accounts receivable
and cancellation of order by a major customer.
63
� Speculative Motive: This refers to the desire of a firm to take advantage of
opportunities which present themselves at expected moments. The speculative
motive helps to take advantage of: an opportunity to purchase raw materials at
reduced price with the expectation that their prices will rise in the future, an
opportunity to purchase securities when their prices are low but with the expectations
that their prices will rise in the future.
Where it has been determined that there is surplus cash, it must be invested using the
following guidelines (Walker, 1964): the surplus cash should be put in short term investment
opportunities available and within an acceptable minimum required rate of return.
Furthermore, the conversion of the investment to cash must be easily attainable. In short, the
guideline provides that the short-term investment must be readily realizable with minimum
cost and minimum cost of capital.
Cash Collection Strategies: Pandey (1991: 850) identified three approaches which,
if properly applied, can accelerate cash collections in an organization. The approaches are:
reduction of order processing float; decentralization and lock-box system.
Reduction of Order Processing Float: The first hurdle in accelerating the cash
collection could be the enterprise itself. It may take the firm a long time to process the
invoice of sold goods. The days taken to get the invoice to the buyer or customer is referred
to as order processing float. Cash collection can be accelerated by reducing the gap or the
lag between the time a customer pays the bill and the time the cheque is collected and funds
made available for the enterprise to use.
Decentralization of Collections: A decentralized collection procedure is a system of
operating through a number of centers, instead of a single collection centre, located at the
enterprise’s headquarters. Under this system, the enterprise will have a large number of bank
64
accounts operated in the areas where the enterprise has its branches. The collection centres
will be required to collect cheques from customers and deposit in their local bank accounts.
The collection will transfer funds above some pre-determined minimum to the headquarters
bank accounts each day.
Lock–Box System: In a lock-box system, the enterprise establishes a number of
collection centres, considering customer locations and volume of remittances. At each
centre, the enterprise hires a post office box and instructs its customers to mail their
remittances or materials to the box. The enterprises’ local bank is given the authority to pick
up the remittances directly from the local box. The bank picks up the mail several times per
day and deposits the cheque to the enterprise’s account. The bank prepares the detailed
records of the cheques or materials picked up.
Inventory Management: The management of an enterprise identifies the level of
inventory which allows for uninterrupted production but reduces the investment in raw
materials, minimizes reordering costs and consequently increases cashflow (Childs, 1961).
Besides this, the lead time s in production should be covered to reduce work- in- process. In
a similar vein, the finished goods should be kept as low as possible to avoid over-production
(King, 2004). Over-production may not only lead to duplicate supply but to quadruplicate
supply. In effect, the management of stock involves striking a balance between the costs and
benefits of working stocks. The basic issues involved in stock are: the size and timing of
stock replenishment; the action to take where supply orders are met; establishing a model
which enables the financial managers to reduce the optimal quantity to order (Buffa, 2005).
The model should have the objective of determining the quantity that should be ordered any
time the management is ordering, such that the costs associated using stocks will be reduced
to the barest minimum (Chukwuemeka, 2006). The costs associated with stocks are as
65
follows: purchase cost; ordering cost; holding/carrying cost; and stock-out cost. In
developing a model for the size of order to be made, and the inventory control. Hastings
(2005) recommends Economic Order Quantity (EOQ), defined as:
EOQ = ip
cd2
where c = procurement cost of each order
d = demand in units
p = cost price per item
I = stock holding
The use of EOQ was demonstrated under inventory control.
Debtor’s Management: The management of an enterprise should identify the
appropriate credit policy. This means that identifying credit terms will attract customers
such that any impact on cashflows and the cash conversion cycle will be offset by increased
revenue and hence, the return on capital (Orgler, 2005).
Metta (1974), rightly posited that as in all other components of working capital, the
key factor in debtors’ management is the decision as to the optimal level to maintain. This,
according to him, implies striking a balance between the advantages of increasing sales,
profits by giving credit and the administrative cost and the finance costs of giving credit
including the risk of bad debts and legal cost taking action against debtors.
In setting a credit policy for a company, Free Encyclopaedia, (2005), asserts that the
following points should be addressed: who do you sell to on credit?, terms of credit; the
credit period, the credit limit depending on the rating of the customers, penalty for late
payment and cash discount for early payment. The Free Encyclopaedia posits that debt
collection method should include: correspondence or letters of reminder, using debt
66
collection agencies, taking legal actions where necessary. Further issues to be addressed
when setting a credit policy is financing of book debts. This includes all actions that may be
taken by the company to get money faster; such actions is expanded to embrace invoice
documentation, factor financing (factoring) and the use of bills of exchange (Olajide, 2010).
Short-term Financing: The management should identify the appropriate source of
financing given the cash conversion cycle. The inventory is ideally financed by credit
granted by the supplier. However, it may be necessary to utilize a bank loan or overdraft or
to “convert debt to cash’ through factoring. In South-Eastern Nigeria, isusu can be used as a
source of short-term financing. Management can source funds from an isusu group and use
such funds for investment. Hedge funds can also be used as a source of short-term financing
of investments.
Measuring the Efficiency of Working Capital Management
Working capital management also involves analyzing certain ratios among others the
following ratios and indicators can be utilized:
Current Ratio = Current Assets (Pandey 1991: 115)
Current liabilities
Current assets include cash and those assets which can be converted into cash within
a year such as marketable securities, debtors and inventories Prepaid expenses are also
included in Current Assets as they represent the payments that will not be made by the firm
in the near future. All the obligations maturing within a year are included in current
liabilities (Pandey, 1991: 115). By implication, current liabilities include creditors, bills
payable, accrual expenses, short-term bank loans, income tax liability and long-term debt
maturing in the current year. Current ratio is a measure of the firm’s short-term solvency the
67
index shows the availability of current assets in Naira for every one Naira of current
liability. Anyanwu (1991) posits that the current ratio of 2:1 or more is commonly accepted
as satisfactory.
For instance, if the current assets of a firm is N1,400,000.00 and its current
liabilities is N700,000, then
Current Ratio = 1,400,000.00
700,000.00
= 2 :1.
In this case, the firm will be able to meet its obligations because its current assets are
twice the current liabilities.
Another one we present here is the turnover cycle or operating cycle or working
capital cycle. This is defined as the length of time between paying for raw materials and the
recovery date from your own customers that is, it is the length of time between expenditure
on stocks and the inflow of cash from sales (Free Encyclopedia, 2005). The longer the cycle
or period, the more funds a company will require for its daily operations (Free
Encyclopaedia, 2005). Efficient management of working capital will ensure that this
turnover cycle is not too long.
2.1.5. Inventory Management
Inventory is one of the more visible and tangible aspects of investment in both
private and public enterprises. Various interest groups have various interpretations for
inventory. For instance, accountants often discuss inventory in terms of goods for sale;
other organizations like manufacturers, service providers and not-for-profit organizations
have their own inventory, which they do not intend to sell. Manufacturers, distributors and
wholesalers have their inventories to cluster in warehouses. Retailers’ inventory may exist in
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a warehouse or in a shop or in a store accessible to customers. Inventories not intended for
sale to customers or to clients may be held in any premises an organization uses (Coulter,
1995).
Generally, inventory refers to the stock of anything necessary to do business
(Hedrick, 2010). These stocks represent a large portion of the business investment and must
be well managed in order to maximize profit and their utilities. In fact, many business outfits
cannot absorb the shocks resulting from the types of losses arising from poor inventory
management. Well management of inventories will ensure their reliability, efficiency and
cost reduction in their procurement.
Inventory management is primarily about specifying the shape, and the percentage of
stocked goods (Free Encyclopaedia, 2005). Inventory management is required at different
locations within a facility or within many locations of its supply network to proceed the
regular and planned course of production and stock of materials. The scope of inventory
management concerns the fine lines between the replenishment lead time, carrying costs of
inventory, asset management inventory, forecasting inventory, inventory valuation,
inventory visibility, future inventory price forecasting, physical inventory, available physical
space for inventory, quality management replenishment, returns and defective goods and
demand forecasting (http://www.Phitch.com). Balancing these competing requirements lead
to optimal inventory level which is an ongoing process as the business needs shift and react
to the wider environment. Inventory management involves a retailer seeking to acquire and
maintain a proper merchandise assortment while ordering, transporting, handling, and
related costs are kept in check(http://www.inventorymatters.co.uk). It also involves systems
and processes that identify inventory requirements, set targets, provide replenishment
techniques, report actual and projected inventory status and handles all functions relating to
69
the tracking and management of material(http://citeseers.ist.psu.edu.). This would imply the
monitoring of material moved into and out of the stock room locations and the reconciling of
the inventory balances. Inventory balances may include ABC analysis, lot tracking, cycle
counting support among others(http://www.inventorymatters.co.uk).
Typology: The various types in which inventories are prepared in business enterprise
are: buffer stock, cycle stock, de-coupling, anticipation and pipeline stock.
Buffer is the stock kept for safety purposes. Cycle stock is the stock used in batch
processes, it is the available inventory; however, it excludes buffer stock. De-coupling is a
buffer stock held between the machines in a single process which serves as a buffer for the
next one allowing smooth-flow of work instead of waiting for the previous or next machine
in the same process. Anticipation stock is the building up of extra stock for periods of
increased demand. For example, yam for planting season. Pipeline stock involves goods still
in transit or in the process of distribution – have left the factory but have not arrived at the
customer yet. (Geoff, 2008).
Forms of Inventory
The various forms in which inventories are kept in an enterprise are: raw materials,
work-in-process, finished goods and goods for resale (Johnson, 1987). Raw materials are
those units and components that are scheduled for use in making a product. Work-in-process
inventories are those units and components that have begun their transformation to finished
goods. Finished goods inventories are those units of goods that are ready for sale to
consumers. Goods for resale inventories are those returned goods that are saleable (Johnson,
1987).
The inventory materials used in the production of goods for sale to the customer
were identified. But companies maintain other aspects of inventories that are not meant to be
70
sold. Pandey (1991) referred to this category of inventory as supplies and they are expanded
to embrace office equipment, soap, brooms, mops, among others. These materials do not
directly enter production but are necessary for the production process. Thus, this category of
inventory must be accorded due recognition.
Reasons for Keeping Inventories
The three basic reasons that explain why inventory is kept are time, uncertainty and
economies of scale. (http.//www.planware.org/workingcapital.htm). The time lags present in
the supply chain from supplier to user at every stage, requires that an enterprise maintains
certain amounts of inventory to use in this “lead time”. However, in practice, inventory is to
be maintained for consumption during, “variations in lead time”. Lead time itself can be
addressed by ordering that many days in advance. Inventories are maintained as buffers to
meet uncertainties in demand, supply and movement of goods. For instance, the unexpected
withdrawal of fuel subsidy in Nigeria on 1st January, 2012, drastically affected the
movement of goods in Nigeria. The ideal condition of one unit at a time, at a place where a
user needs it, when he needs it, principle tends to incur lots of costs in terms of logistics. So
bulk buying, movement and storing bring in economies of scale, thus, inventory.
Valuation of Stocks
There are six ways that are normally used for evaluation of stock/materials. These
ways, according to Anyanwu (1991) are first-in-first-out (FIFO); last-in-first-out LIFO);
simple average method (SAM); weighted average method (WAM); standard price method
(SPM); current replacement price (CRP); of stock valuation.
FIFO: In this case, materials purchased and brought into the store at the early stage are
assumed to be issued first. It involves the use of the actual price. In times of rising prices,
charges to production are low and this has the effect of over-stating the profit.
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LIFO: In this method, materials or goods purchased last are assumed to have been issued
first. It also involves the actual price. Charges to production are closely related to current
price level. Consequently, an accurate statement of price is obtainable in the period of rising
prices. Fifo and Lifo can be applied to staff rationalization in an organization. That is the
first to come in can be transferred first or the last to come in can be transferred first provided
that there is a reason behind the choice of the principle adopted (Anyanwu 1991)
SAM: By this method, the total of the prices paid for the materials is divided by the number
of prices to get an average figure on the basis of which the materials are charged out or sold.
For instance, the table below illustrates SAM:
Table 2(9) Calculation of Simple Average Method.
QUANTITY UNIT PRICE TOTAL
100 @ N2.00each N200.00
200 @ N3.00 each N600.00
150 @N2.50 each N375.00
200 @ N1.50 each N300.00
TOTAL= 650 9/4= N2.25 N1475
Source: Anyanwu (1991)
From the above illustration, total goods of 650 cost N2.25 each on the average.
WAM: In this method both quantity and price are considered. Prices are calculated
immediately after a new purchase has been received. The merit of this method is that price
fluctuations tend to be smoothened out (leveled out). The main problem is that the new
average has to be calculated each time fresh supply is made From the illustration under
WAM: We can see that the weighted average = 1475/650 = N2.27. In this case, a total of
650 items cost N2.27 each.
SPM: In this case, the price that has been charged for each material is determined by
the management putting into consideration all the economic factors relevant to their own
72
circumstances. Any difference between the actual price and the standard price is charged to
price variation account and written off by the end of the year for the profit and loss account
if it is a loss (Olajide, 2010).
CRP: This method uses the ruling prices at the date of issuing the material. This means that
the materials are issued at the cost of replacing them at the date of issue (Anyanwu, 1991).
Inventory Control Systems
The main inventory control systems that exist are; the just-in-time, the re-order level
system, the periodic review system and the ABC analysis.
The Just-In-Time (JIT): Nowadays many large manufacturers operate on a just-in-time
(JIT) basis whereby all the components to be assembled on a particular day arrive at the
factory early that morning – not earlier, not later
(http://www.planware.org/workingcapital.htm). This, according to the website helps to
minimize manufacturing costs as JIT stocks take up little space, minimize stock-holding and
virtually eliminate the risks of obsolete or damaged stock. This is because JIT
manufacturers hold stock for a very short time and thus, they are able to conserve substantial
cash. The key issue of a business is to identify the fast and slow stock-movers with the
objectives of establishing optimum stock levels for each category and thereby minimize the
cash tied up in stocks.
The Re-Order Level: The re-order level is the level of inventory units in which
additional inventory order is to be made.
Re-order level = maximum usage x Maximum lead Time ( Pandey, 1991).
For example, if the maximum usage is 30 units and the maximum delivery period
lead rime is 60 days,
Re-Order level = 30 x 60 units
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= 1800 units.
Minimum Stock Level: The minimum level is the level at which stock should not be allowed
to fall below. It is also called the sufficient stock (Olajide, 2005)
Minimum Level = Re-Order Level – (Average Usage x Average lead time). For instance, let
the average usage be 15 units and the average delivery period be 45 days. If the re-order
level is 1800 units,
Minimum Stock Level = 1800 – (15 x 45)
= 1800 – 675
= 1125 units.
The stock is not supposed to fall below 1125 units.
Maximum Stock Level: The maximum stock level is the point at which stock must not
be allowed to be over.
Maximum Stock Level = Economic Order Quantity (EOQ) + Re-order –
(Minimum usage x Minimum lead time)
EOQ = ip
cd2
where,
c = procurement cost of each order
d = demand in units
p = cost price per item
i = stock holding
Illustration:
Suppose procurement cost of each order = N600.00
Demand in units = 7300 units.
Cost price per item = N100.00
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Stock holding = 20 % of cost price per item
Minimum usage = 10 units
Minimum Re-Order period = 30 days
Re-order level = 1800
Then
EOQ = 10002.
73006002
x
xx
= 662 units.
Maximum Stock Level :
= EOQ + Re-order level – (Min. Usage x Min. re-order Quantity)
= (662 + 1800) – (10 x 30 )
= 2162 units.
The level of inventory is not expected to exceed 2162 units under this condition.
Periodic Review Systems: Olajide (2010) proposed that stock levels for all items should be
reviewed at fixed intervals, usually every week or every month. According to him, re-order
quantity is not predetermined but is based on the following: the current stock level,
estimated demand until the next review period; and lead time (Olajide, 2010).
The ABC Analysis: The main crux of this analysis is that the enterprise should focus
maximum attention on those items that have the highest value. Star (1962) posits that ABC
analysis concentrates on important items and is also known as control by importance and
exception. The enterprise, therefore, categorize inventories to identify which items should
receive the most input of the enterprise in controlling. The enterprise should be selective in
its approach to control investments in various types of inventories. This selective approach
to inventory control is referred to as ABC analysis. It tends to measure the significance of
each item of inventories in terms of its value (Pandey, 1991). Thus, the high-valued items
are classified as “A items” and would be under the tightest control. “B items” fall in-
between A and C items and would require reasonable attention of control. The “C items”
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represent relatively least value and would be under simple control (Pandey, 1991). This is
also referred to as inventory proportionality analysis.
Certain steps have been identified for the execution of the ABC analysis. These
include: classification of the items of the inventories, determining the expected use in units
and the price per unit for each item; establishing the local value of each item by multiplying
the expected units by its unit price; ranking the items in accordance with the total value ,
giving first rank to the item with the highest total value and so on; calculating the ratios or
percentage of number of units of each item to total units of all items and the ratio of the total
value of each item to the total value of all items and combining items on the basis of their
relative values to form three segregations – A, B, and C.
Credit Inventory: Credit refers to the use of stock or inventory as collateral to raise
finance. Inventory credit is a potentially important way of overcoming financing constraints
(http://www.inventorymatters.co.uk). Inventory credit on the stored agricultural produce is
widely used in developed and developing countries (http://www.inventorymatters.co.uk). A
pre-condition for such credit is that banks must be confident that the stored product will be
available if they need to call on the collateral; this implies the existence of a reliable network
of certified warehouse. Banks or individuals also face problems in valuing the inventory.
The possibility of sudden falls in commodity prices means that they are usually reluctant to
lend more than about 60% of the value of the inventory at the time of the loan.
Distressed Inventory: Distressed inventory or expired stock is the inventory whose
potential to be sold at a normal cost has passed or will soon pass
(http://www.specialinvestors.com/terms/1072html.) In certain enterprises, it will also mean
that the stock is or will soon be impossible to sell. Examples of distressed inventory include
products that have reached their expiry dates or have reached a date in advance of expiry at
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which the planned market will no longer purchase them. For example, three months left to
expire, clothing that is defective or out of fashion, music that is no longer popular, an old
newspaper or magazines. It also includes computer or consumer electronic equipment that is
obsolete or discontinued and whose manufacturer is unable to support it.
(http://www.specialinvestors.com). Most enterprises write off the unsaleable inventory and
auction the ones whose expiry date is at hand (http://www.specialinvestors.com).
2.1.6. Receivables Management
The purpose of any commercial enterprise is the earning of profi, credit in itself is
utilized to increase sale, but sales must return a profit. The primary objective of management
of receivables should not be limited to expansion of sales but should involve maximization
of overall returns on investment (Wood, 1953). So receivables management should not be
confined to mere collection of receivables within the shortest possible period but is required
to focus due attention to the benefit-cost trade-off relating to numerous receivables
management. Management of trade credit is commonly known as management of
receivables (Wood, 1953).
In order to add profitability, soundness and effectiveness to receivables management,
an enterprise must make it a point of duty to follow certain well-established and duly-
recognized principles of credit management. The first of these principles relate to the
allocation of authority pertaining to credit and collection of some specific management
functions. The second principle puts stress on the selection of proper credit terms. The third
principle emphasizes a thorough credit investigation before a decision on granting a credit is
taken. And the last principle touches upon the establishment of sound collection policies and
procedures (Mishra, n.d.). In detail, therefore, Mishra (n.d.) identified the principles of
receivables management as follows:
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Principles of Credit Management
Allocation of Authority:
The efficiency of a credit management team, unit or department in the formulation
and execution of credit and collection policies largely depends on the location of the credit
department in the organizational structure of the enterprise. The aspect of authority
allocation can be viewed under two concepts (Curtis, 1959). As for the first concept, it is
placed under the direct responsibility of the chief finance officer for it is being a function
primarily financed by nature. Further, credit and collection policies lay dire ct influence on
the solvency of the organization. For these reasons the credit and collection function should
be placed under the direct supervision of the individuals who are responsible for the firm’s
financial position (Chambers, 1967). There are others who suggest that business enterprises
should strictly enforce upon their sales departments, the principles that sales are isolate until
the value thereof is realized (Curtis, 1959).Those favouring this aspect plead to place the
authority of allocation under the direct charge of the marketing executive or the sales
department. According to Chambers (1967:273), “The reasonability to administer credit and
collection policies may be assigned either to a financial executive or to marketing executive
or to both of them jointly depending upon the organizational structure and the objectives of
the firm”. This assertion by Chamber (1967) means that the finance officer or the marketing
officer can administer credit policies.
Selection of Proper Credit Terms: The receivables management of an enterprise is
required to determine the terms and conditions on the basis of which trade credit can be
sanctioned by the customer. These terms are of vital importance for an enterprise. The
nature of the credit policy of an enterprise is dependent on the basis of components of the
credit policy. The components include credit period, cash discount and cash discount period.
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In practice the credit policy of enterprises vary within the range of lenient and stringent
(Benishay, 1965). A firm that tends to grant long period credits and its debtors include even
those customers whose financial position is doubtful. Such a firm is said to be following
long-term lenient credit policy. Contrary to this, firms providing credit sales for a relatively
short period of time that are on highly selective basis only to those customers who are
financially strong and have proven their credit worthiness is said to be following stringent
credit policy (Benishay, 1965).
Credit Investigation: If a firm desires to maintain effective and efficient receivables
management it must undertake a thorough investigation before deciding to grant credit to a
customer. The investigation is required to be carried out with respect to the credit worthiness
and financial soundness of the debtors, so as to prevent the receivables from falling into the
category of bad debts later on at the time of collection. Credit investigation is not only
carried on beforehand but also in the case of firms practicing liberal credit policy. Such
investigations may be required to be conducted when a debtor fails to make payments of
receivables due on him even after the expiry of credit sale so as to save doubtful debts from
becoming bad debts.
Sound Collection Policies and Procedures: Receivables management is linked with
a good degree of risk. As fewer debtors are slow payers and some are non-payers. How-so-
ever efficient and effective a receivables management may be, the element of risk cannot be
avoided altogether but can be minimized to a great extent (Seidan, n.d.). It is for this reason
that the essence of sound collection policies and procedures arises. A sound collection
policy aims at accelerating collection from slow payers and reducing bad debts losses as a
good collection policy ensures prompt and regular collection by adopting collection
procedures in a clear-cut sequence.
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Objectives of Credit Management
The objective of receivables management is to promote sales and profit. The primary
aim of receivables management is in the area of minimizing the value of the firm while
maintaining a reasonable balance between risk (in the form of liquidity) and profitability.
The main purpose of maintaining receivables is not sales maximization nor is it for
maximization of risk involved by way of bad debts. Had the main objective been the growth
of sales, the enterprise would have opened credit sales for all sorts of customers contrary to
this, if the aim had been the maximization of risk of bad debts, the enterprise would not have
made any credit sale at all. That means, an enterprise should indulge in sales expansion by
way of receivables only until the extent to which the risk remains within an acceptably
manageable limit (Agrawal, n.d.)
All in all, the basic target of management of receivables is to enhance the overall
return on the optimum level of investment made by the firm in receivables (Walker, 1964).
The optimum investment is determined by comparing the benefits to be derived from a
particular level of investment made by the firm in receivables (Walker, 1964). The
optimum investment is determined by comparing the benefits to be derived from a particular
level of investment with the cost of maintaining the level. The costs involve not only the
funds tied up in receivables, but also losses from accounts that do not pay. The latter arises
from extending credit too leniently (Seiden, n.d.). Seiden (n.d.) presented a brief inference of
objectives of management of receivables as follows:
� To attain not only maximum profit but also optimum volume of sales.
� To exercise control over the cost of credit and maintain it on a minimum possible
level.
� To keep investments at an optimum level.
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� To plan and maintain a short average collection period.
Granting of credit and its proper and effective management is not possible without
involvement of any cost. These costs are credit/ administrative expenses, bad debt losses,
opportunity costs, production and sales advertisement costs. These costs cannot be possibly
eliminated altogether but should essentially be regulated and controlled (Joy, 1978).
Elimination of such costs simply mean reducing the costs to zero; that is, no credit grant is
to the debtors. In that case, the firm would no doubt, escape from incurring these costs yet,
the other face of the coin would reflect that the profits forgone on account of expected rise in
sales volume made on credit amounts much more than the costs eliminated (Agrawal, n.d.).
Thus, an enterprise would fail to materialize the objective of increasing overall return on
investment. The goal of receivables management is to strike a golden mean among risk,
liquidity and profitability. It turns out to be effective marketing tool. It helps in capturing
sales volume by winning new customers besides retaining the old ones.
Aspects of Credit Policy
The discharge of the credit function in a company embraces a number of activities for which
the policies have to be clearly laid down. Such a step will ensure consistency in credit
decisions and actions. A credit policy thus establishes guidelines that govern, grant or reject
credit to a customer, what should be the level of credit granted to a customer (Porterfield,
1965).
A company falls prey of many factors pertaining to its credit policy. In addition to
specific industrial attributes, like the trend of industry pattern of demand, pace of technology
changes, factors like financial strength of a company, marketing organization, growth of its
product also influence the credit policy of an enterprise. Certain considerations demand
greater attention while formulating the credit policy like a product of lower price should be
81
sold to the customer bearing greater credit risk. Credit of smaller amounts result in greater
turnover of credit collection. New customers should be least favoured for large credit sales.
The profit margin of a company has direct relationship with the degree of risk. They are said
to be inter-woven. Since every increase in the profit margin would be counterbalanced by an
increase in the element of risk. Gross (n.d.) observed that two very important considerations
involved in incurring additional credit risk are: the market for a company’s product and its
capacity to satisfy that market. If the demand for the seller’s product is greater than its
capacity to produce, then it would be more selective in granting credit to its customers.
Conversely, if the supply of the product exceeds the demand, the seller would be more likely
to lower credit standards with resulting greater risk (Gross, n.d.). Such a condition would
appear in case of a company having excess capacity coupled with high profitability and
increased sales volume.
The credit policy of every company is to a large extent influenced by two conflicting
objectives irrespective of the nature and type of company. They are liquidity and
profitability. Liquidity can be directly linked to book debts. The liquidity position of an
enterprise can be easily improved upon without affecting profitability by reducing the
duration of the period for which the credit is granted and further by collecting the realized
value of receivables as soon as they fall due (Weston,1988) To improve profitability, one
can resort to lenient credit policy as a booster of sales but the implications are:
� Chances of extending credit to those with weak credit rating.
� Unduly long credit terms.
� Tendency to expand credit to suit consumer’s needs; and
� Lack of attention to overdue accounts (Gross, n.d.).
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Thus, a lenient credit policy is somehow harmful to the enterprise as it falls into the hands of
those who may not be able to fulfill the credit agreement.
Decision Variables of Credit Policy
Three important decision variables of credit policy have been identified by Joy (1978) as
follows:
� Credit terms.
� Credit standards, and
� Collection Policy.
Credit Terms: Credit terms refer to the stipulations recognized by the enterprise for
making credit sale of the good to its buyers (Seiden, n.d). In other words, credit terms
literally mean the terms of payments of receivables. An enterprise is required to consider
various aspects of credit customers, approval of credit periods, acceptance of sales
discounts, provisions regarding the instruments of security for credit to be accepted are a
few considerations which need due care and attention. Like the selection of credit customers
can be made on the basis of enterprise capacity to absorb the bad debt losses during a given
period of time However, an enterprise may opt for determining the credit terms in
accordance with the established practices in the light of its needs. The amount of funds tied
up in the receivables is directly related to the limits of credit granted to customers. These
limits should never be ascertained on the basis of the subjects own requirements, they should
be based upon the debt paying power of customers and his ledger record of the orders and
payments. There are two important components of credit terms which are detailed below:
(Seiden, n.d.).
� Credit period, and
� Cash discount terms.
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Credit Period: According to Seiden (n.d.), “Credit period is the duration of time for which
trade credit is extended”. During this time, the overdue amount must be paid by the
customer. The credit period lays its multi-faced effect on many aspects: the volume of
investment in receivables, its indirect influence can be seen on the net worth of the
company. A long period credit term may boost sales but it also increases investment in
receivables and lowers the quality of trade credit. While determining a credit period, a
company is bound to take into consideration, like buyer’s rate of stock turnover,
competitors’ approach, the nature of commodity, margin of profit and availability of funds
(Seiden, n.d.)
The period of credit differs from industry to industry. In practice, the enterprises of
some industries grant varied credit period to different individuals as most of such firms
decide upon the period of credit to be allowed to a customer on the basis of his financial
position in addition to the nature of commodity, quality involved in transaction, the
difference in the economic status of customers that may considerably influence the credit
period (Cook, 1963).
The general way of expressing credit period of a firm is to coin it in terms of due
date that is, if a firm’s credit terms are “Net 30”, it means that the customer is expected to
repay his credit obligation within 30 days (Mao, 1969). Generally, a free credit period
granted, to pay for the goods purchased on accounts tend to be tailored in relation to the
period required for the business and in turn, to resale the goods and to collect payments for
them.
An enterprise may tighten its credit if it confronts fault cases too often and fears
occurrence of bad debt losses. On the other hand, it may lengthen the credit period for
enhancing operating profit through sales expansion. Anyhow, the net operating profit would
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increase if only the cost of extending credit period will be less than the incremental
operating profit. But the increase in sales alone with extended credit period would increase
the investments in receivables too because of the following two reasons (Beranek, 1968):
� Incremental sales result into Incremental receivables.
� The average collection period will get extended as the customers will be granted
more time to repay credit obligations.
Determining the options credit period, therefore, involves locating the period where
marginal profit and increased sales are exactly off-set by the cost of carrying the higher
amount of accounts receivables.
Cash Discount Terms: The cash discount is granted by the enterprise to its debtors
in order to induce them to make the payment earlier than the expiration of the credit allowed
to them. Granting discount means reduction in prices entitled to the debtors so as to
encourage them for early payment before the time stipulated to pay back- that is, the credit
period. According to Beckman, quoted in Curtis (1959) discount is a premium on payment
of debts before the due date and not a compensation for the so-called prompt payment. Grant
of cash discount beneficial to the debtor is profitable to the creditor as well. A customer of
the enterprise - that is debtor – would be released from his obligation to pay soon, that is, at
the discounted prices. On the other hand, it increases the turnover rate of working capital
and enables the creditor of the enterprise to operate a greater volume of working capital. It
also prevents debtors from using trade credit as a source of working capital.
Cash discount is expressed as percentage of sales. A cash discount term is
accompanied: (a) by the rate of cash discount, (b) the cash discount period, and (c) the net
credit period. For instance, a credit term may be given as “1/10 Net 30” that means a debtor
is granted (1%) percent discount if he settles his accounts with the creditor before the tenth
85
day starting from a day after the date of the invoice. But in case the debtor does not opt for
discount, he is bound to terminate his obligation within the credit period of thirty days
(Gross, n.d.).
Analysis of Credit Discount Costs
This analysis holds its own distinct utility for buyers and sellers. The main purpose
of conducting this analysis is to have a fair idea about the amount of financial cost that will
be borne by:
(i) The seller, while granting such discount if the customer pays within the discount period
allowed to him
(ii) The customer, in case he fails to make good the advantage of discount available to him.
Gross (n.d.) has presented at length some selected credit terms and their equivalent effective
annual interest rates suggesting the costs expected to be forgone by neglecting to pay within
the stipulated period. The Table 2(10).below illustrates those terms and the annual interest
rates.
Table 2(10): Relationship of Credit Terms and Effective Per Annum Interest Rates
Credit Terms Effective Per Annum Interest Rates
1/2% 10 Days Net 30 days 9%
1% 10 Days Net 30 Days 18%
2% 10 Days Net 30 Days 36%
2% 10 Days Net 60 days 14%
2% 30 Days Net 60 Days 24%
2% 30 Days Net 120 days 8%
3% 10 Days Net 30 Days 54%
5% 10 Days Net 120 Days 16%
6% 10 Days Net 60 Days 43%
8% 10 Days Net 120 days 26%
Source: (Gross, n.d: 83).
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By way of illustration, if credit terms are 8/10 Net 120, then its effective annual interest rate
will be:
360 x 8 = 26% app
(120-10)
Change in cash discount can either have positive or negative implication and at times both.
Any increase in cash discount would directly increase the volume of credit sale. As the cash
discount reduces the price of commodity for sale, so the demand for the product ultimately
increase leading to more sales. On the other hand, cash discount lures the debtors for prompt
payment so that they can relish the discount facility available to them. This, in turn, reduces
the average collection period and bad debt expenses thereby bringing about a decline in the
level of investment in receivables. Ultimately, the profits would increase. Increase in the
discount rate can negatively affect the profit margin per unit of sale due to reduction in
prices.
Agarwal (n.d.) pointed out that we market our products through established dealers. If
sometimes, payment is not received within the credit period, it is just not possible to deny
discount as it would jeopardize business relations. Yet, the management of business
enterprises should always take note of the point that cash discount as a percentage of invoice
prices, must not be high as to have an uneconomic bearing on the financial position of the
concern. It should be seen in this connection that terms of sales include net credit period so
that cash discount may continue to retain its significance and might be prevented from being
treated by the buyers just like quantity discount. To make cash discount an effective tool of
credit control, a business enterprise should also see that it is allowed to only those customers
who make payments at due date. And finally, the credit terms of an enterprise on the receipt
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of securities while granting credit to its customers. Credit sales may be got secured by being
furnished with instruments such as trade acceptance, promissory notes or bank guarantees.
Credit Standards: Credit standards refer to the minimum criteria adopted by an enterprise
for the purpose of short-listing its customers for extension of credit during a period of time.
Credit rating, credit reference, average payments periods are quantitative basis for
establishing and enforcing credit standards. The nature of credit standard adopted by an
enterprise can be directly linked to changes in sales and receivables. In the opinion of Gross
(n.d.) “there is the cost of additional investment in receivables, resulting from increased
sales and a slower average collection period”.
A liberal credit standard always tends to push up the sales by luring customers into dealings
(Schiff, 1964). The firm, as a consequence, would have to expand receivables investment
along with sustaining costs of administering credit and bad debt losses. As a more liberal
extension of credit may cause certain customers to be less conscientious in paying their bills
on time. Contrary to these strict credit standards would mean extending credit to financially
sound customers only. This saves the firm from bad debt losses and the firm has to spend
lesser by a way of administrative credit cost. But this reduces investments in receivables
besides decreasing sales. In this way, profit sacrificed by the firm on account of losing sales
amounts more than the cost saved by the enterprise.
Prudently, an enterprise should opt for lowering its credit standard only up to that level
where profitability arising through expansion in sales exceeds the various costs associated
with it. That way, optimum credit standards can be determined and maintained by inducing
trade off between incremental returns and incremental costs.
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Customers’ Quality
The quality of firm’s customers largely depends upon credit standards. The quality of
customers can be discussed under two main aspects; average collection period and default
rate Pandey, quoted in Gross (n.d).
(i) Average Collection Period: It is the time taken by customers bearing credit obligation in
materializing payment. It is represented in terms of the number of days, for which the credit
sales remains outstanding. A longer collection period always enlarges the investment in
receivables.
(ii)Default Rate: This can be expressed in terms of debt-losses to the proportion of
uncontrolled receivables. Default rate signifies the default risk that is profitability of
customer’s failure to pay back their credit obligation.
Pandey in Gross(n.d) has cited three Cs of credit terms as character, capacity and
condition that estimate the likelihood of default and its effect on the firms’ management
credit standards. Two more Cs have been added to the three Cs of I.M. Pandey, namely;
capital and collateral. All the five Cs of credit are discussed below in brief. (Gross,n.d).
Character: Character means reputation of debtor for honest and fair dealings. It refers to the
free will or desire of a debtor of a firm to pay the amount of receivables within the stipulated
time, that is, credit period. In practice, the moral of customer is considered important in
valuation of credit. The character of customer losses its importance if the receivable is
secured by way of appropriate and adequate security.
Capacity: Capacity refers to the experience of the customers and their demonstrated ability
to operate successfully. It is the capacity particularly financial ability of a customer to
borrow from other sources in order to discharge his obligations to honour contract of the
enterprise.
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Capital: Capital refers to the financial standing of a customer. Capital acts as a guarantee of
the customer’s capacity to pay.
Collaterals: Collaterals are the assets that a customer readily offers to the creditor (that is
enterprise granting credit) as a security, which should be possessed by the enterprise in the
event of non-payment by the customer. An enterprise should be particular with regards to
the real worth of assets offered to it as collateral security.
Condition: Condition refers to the prevailing economic and other conditions, which can
place their favourable or unfavourable impact on the ability of customer to pay. An
enterprise must ensure that its customers have completely and accurately furnished with the
above stated information. As a matter of precaution an enterprise should carry out credit
investigation on its own level. This involves two basic steps (Ryen, 1997).
The first step involves obtaining credit information from internal and external
sources. Internal sources include filling up various documents (pertaining to the financial
details of the credit applicants) and records (that fulfill formalities related with extension of
credit) of a concern. The external sources of information are financial statements, bank
references, sales representatives’ report, past experiences of the concern among others.
The second step involves analysis of credit information obtained in respect of the
applicant for deciding the grant of credit as well as its quantum. An enterprise is free to
adopt any procedure that suits its needs and fulfills the desired requirements, as there is no
established procedure for analysis of information. But, it must be born in mind that the
analysis procedure shall be competent enough to suit both the qualitative and quantitative
aspects of the applicant. Qualitative aspect refers to customer’s character, goodwill and
credit worthiness. While the quantitative aspect is based on the factual information available
from the applicants financial statements, his past records and the like factors. As a matter of
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fact the ultimate decision of his credit extension and the volume of credit depend upon the
subjective interpretation of his credit standing (Ryen, 1997).
Collection Policy: Collection policy refers to the procedures adopted by an enterprise
(creditor) to collect the amount from debtors when such amount becomes due after the
expiry of credit period. Mishra (n.d.) states that a collection policy should always emphasize
promptness, regulating and systemization in collection efforts. It will have a psychological
effect upon the customers, in that; it will make them realize the obligation of the seller
towards the obligation granted. The requirements of the collection policy arise on account of
the defaulters; that is, the customers not making the payments of receivables in time, as a
few turn out to be slow payers and some others, non-payers. A collection policy shall be
formulated with a whole and sole aim of accelerating collection from bad debt losses by
ensuring prompt and regular collections. Regular collections, on one hand, indicate
collection efficiency through control of bad debts and collection costs as well as by inducing
velocity to working capital turnover. On the other hand, it keeps debtors alert in respect of
prompt payment of their dues. A credit policy is needed to be framed in the context of
various considerations like short-term operations, determination of the level of authority,
control procedures, and so on. The credit policy of an enterprise shall be reviewed and
evaluated periodically and if necessary, amendments shall be made to reflect the changing
nature of business. It should be designed in such a way that it co-ordinates activities of
concerned departments to achieve the overall objective of the business enterprise (Singh,
2000). Finally, poor implementation of good credit policy will not produce optimal results.
Collection of Accounts Receivables
Despite enterprises’ best precautionary efforts in escaping the bad and doubtful debts, there
is always in existence, a certain number of unpaid accounts on the due date. Three well-
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known causes of failure of such payments on the part of debtors (i.e., firm’s customer) have
been cited by Joy (1978):
� It may happen at times that the due date of payment slips from debtors’ mind and
he delays in making good the payments at the right time.
� It may incidentally occur at the time of grant of credit that a firm fails to access
and interpret the character, the capacity, the capital, the collateral and the
conditions.
� There may arise a considerable change in the financial position of a debtor after
the credit has been granted to him by the enterprise.
All the above-stated reasons compel an enterprise to formulate collection programmes
to obtain recovery of receivables from delinquent account. Such programmes may
consist of the following steps: (Joy, 1978).
� Monitoring the state of receivables
� Dispatch of letters to customers whose due dates are near.
� Telegraphic and telephone advice to customers about the due date.
� Threat of legal action to overdue accounts, and
� Legal actions against overdue accounts.
Collection Efforts
A well-established collection policy always attempts at enlisting clear-cut guidelines in
order of a sequence in precise terms for collection of overdue debts from customers. Orgler
(2005) suggests that, the sequence adopted must be capable of bringing effectiveness and
efficiency in collection policy. For instance, if the credit period granted to a customer lapses,
but he does not pay, the enterprise should begin with a polite letter of reminder reflecting
demand for payment. This may be followed by telephone calls or even a personal visit by
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the enterprise’s representative. After that, the firm may go for legal action if the amount of
receivables will remain unpaid. It should be noted that as an account becomes more and
more overdue, the collection effort becomes more personal and strict. But before initiating
any legal action, the financial position of the debtor must be considered. A legal action
against a customer who bears a weak financial condition would be of no good to the
enterprise. On the contrary, it will cause customers’ bankruptcy reducing the chances of
even a marginal amount of payment (Orgler, 2005).Thus, an enterprise should face such a
situation with patience and try to settle the account by accepting a reduced payment.
Degree of Collection Efforts
The efforts of collection policy can be better explained by categorizing the collection
efforts of a company as strict, liberal and lenient. (Mao, 2005). Strict collection policy is
characterized by debtor’s payment on, or before, the due date. As a result, many times
debtor benefits himself with cash discount. Whereas a lenient policy is featured by
defaulters, in payments of Receivables, forfeiture of cash discounts. Such customers are
often Vied future suppliers, charged with interest for the period of default and may even
undergo legal action pertaining to the payment of overdue amount (Hastings, 2009).
Hastings (2009) states that a rigorous collection policy shortens the average
collection period, pulls down sales and bad-debt percentage along with increasing collection
expenses. A relaxed collection programme would push up sales and bad-debts percentage,
lengthen the average of collection period and reduce collection expenses but enhances credit
administrative cost (Joshua, 2009).
An enterprise must make use of financial default and risk analysis; if it is willing to
follow liberal credit policy. Similarly, a firm can help being cautious while adopting strict
collection policy; for, it may offend the customers if they are forced to switch over to the
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competitors. Between the two extremes, of rigorous and soft collection policies, there also
exists flexible collection policy, which involves reminding the customers through
correspondence before the due date. Optimum collection policy may be achieved by
comparing costs and benefits, which will be consistent with the goal of attaining maximum
value for the enterprise.
Collection Follow-up System
An element of regularity is always desired in collection efforts, which primarily
depends on two prerequisites: the development of suitable system of collection and the
establishment of a congenial collection follow-up system. A congenial collection follow-up
system is a system of collection that makes the management to feel comfortable and relaxed
with regard to collection of receivables from debtors.
As far as the development and adoption of suitable collection period is concerned, it
varies from industry to industry or at times from enterprise to enterprise. Therefore, a
congenial collection follow-up system can be established through various practices. Some of
them are mentioned below:(Chandra, n.d.).
Accounts Receivable Report: This device is regarded as highly useful in timely
collection of receivables from debtors. It makes a successful attempt at keeping a keen eye
over almost all outstanding accounts of the enterprise. Hence, enabling an enterprise to
initiate appropriate and timely measure against defaulters as it affects the guidelines framed
by the collection policy of a company.
Leger Plan or Card Tickler System: In order to establish a sound collection
follow-up system, ledger plan of the collection follow-up system is based on the creditor’s
ledger record. The card tickler system involves maintenance of cards in the name of each
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delinquent filed date wise in a proper sequence. The card specifies information regarding the
amount, terms, due date, collection actions taken so far.
Computer and Credit Management: Of late, the use of computers has also come in
vogue for the purpose of credit management. The computer helps a great deal in availing
essential up-to-date information. For a quick access to various sorts of information, all
pieces of information previously placed on receivable ledger can be placed on punched cards
or tapes. Computer can also provide report on summary of all billings, payments, discounts
taken, amount still owed. In addition to this, complete report on delinquent accounts can be
obtained along with timely and accurate information regarding the five Cs of the customer
namely character, capacity, condition, capital and collateral. Further special reports can be
prepared for a particular span of period supplemented with categorization and comparison of
customer as well as adopted credit policies.
Credit Control
Credit control is a complex process, which costs both time and administrative costs. The
functions of credit control incorporate the following elements (Seiden, n.d.):
� Checking customer’s credit worthiness
� Prompt invoicing and follow-up
� Credit insurance
� Financial statements, and
� Use of electronic data processing equipment
Checking Customers’ Credit Worthiness: This step relates to applicants’ ability to pay for
the goods or services opted for by him. The decision pertaining to credit grant and its
volume largely depends upon this assessment Seiden (n.d.) stated that the assessment can be
done on the basis of financial soundness, general behaviour, past records, business habits
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and traits. Trade references, banker’s records available with the geriatric (medical care and
treatment) are few of certain elements that provide relevant information for conducting this
assessment (Seiden, n.d.).
Prompt Invoicing and Follow-up: This is an executive action involving prompt issue of
invoice and equally closes follow-up action. A continuous personal attention is required for
reviewing amounts of bills receivables. Methods are selected among the various possible
alternatives available to ensure that the time period is minimum between realization of
payments and converting it into bank’s credit account.
Credit Insurance: This point pertains to credit exports. It is export credit guarantee
department, which formulates appropriate rules and issues credit insurance policies for
exports on payments of a nominal premium (minimum cost of insurance). These facilities
are of high importance for credit control exports.
Financial Statements: A financial statement is an important document that presents
desirable sources of information to the seller regarding the financial position of customer for
credit control. For the companies carrying out seasonal business, interim statements instead
of financial statements are preferred. For acquiring the authenticated information, audited
financial statements should be favoured rather than un-audited figures with possibilities of
fraud.
Use of Electronic Data Processing Equipment: In the modern world, the importance of
computers cannot be possibly denied. Electronic data processing equipment holds its own
individual importance in providing timely and accurate information as regards the status of
accounts (Curtis,n.d.). The computer can provide a vast array of detailed information,
previously impractical to obtain that may be useful not only to the credit manager but also to
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other members of staff. In addition to processing data, the computer can be programmed to
make certain routine credit decisions.
Control of Receivables
Control of receivables largely depends on the system of credit control practiced by a
business enterprise. It becomes a part of organizational obligation to obtain full and relevant
information complete in all respects before deciding on the right customer for the right
amount of credit grant. Whenever an order is placed by an applicant, his financial position
and credit worthiness become essential. Only after ensuring the degree of safety should an
order be accepted and delivered (Curtis, n.d.).
An enterprise is expected to prepare sales invoice and credit notes as early as
possible; side by side (Curtis, n.d) It should also ensure that they are dispatched at specific
regular intervals for effective control of receivables. It is kept as a separate ledger for the
accounts of bad and doubtful debtors. Such segregation not only helps in easy assessment of
the position of bad and doubtful debtors in relation to the total debtor’s position. A
considerable amount of reduction in debtors can be achieved by offering cash discount to the
customers.
Even in the case of export sales, segregation of credit sales into separate ledger adds
effectiveness to the control of receivables. Sometimes, large contracts, payable by
installment, involve credit for several years. The price fixed in these cases should be
sufficiently high not only to cover export credit insurance, but also to cover a satisfactory
rate of interest on the diminishing balances of debt expected to the one outstanding during
the credit period.
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2.1.7. Control in Public Financial Institutions
Control Tools
It is very much understandable that effective and efficient performance cannot be achieved
in an organization unless resources are controlled. Branto (1960) in his discussion on
management control and accountability sees the control function in most enterprises as
based on the analysis of current performance in the light of predetermined standard; the
object of the analysis being to guage the extent to which achievement matches expectations
and to find out if and where corrective actions is necessary. Hence, control of revenue and
expenditure is best achieved through budgetary control. Budgetary control, according to
Taylor (2004) is a tool working side by side with the accounting system; it is primarily
forward-looking and aims to provide all ranks of management with an instrument for
recording plans and measuring performance in relation to these plans. The Institute of Costs
and Works Accountants ( in Modern Accountant, ASUTECH, 1991) defines budgetary
system as consisting of the establishment of budgets, relating the responsibilities of the
executives to the requirements of a policy and the continuous comparison of actual with
budgeted results either to secure by individual action, the objective of that policy or to
provide a basis for its revision. Ademolekum (1982) summarized three objectives which
characterize the budget as a technique or tool of management, used for both planning and
controlling, a device for monitoring procedures, and reviewing and evaluating the
performance and an overall method of improving operations. Budget improves internal co-
ordination; the budgetary system provides an integrated picture of the enterprises’ operations
as a whole. Financial control policies embrace the organization and context of various kinds
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of financial control (Onah and Edame, 2008). These include a budget for individual products
and for every significant activity of the enterprise.
Budgeting system in a public enterprise will be ineffective unless the means are provided for
controlling the various personnel, material and financial activities in the enterprise.
Budgetary control involves two main stages, namely:
- Budgetary preparation, and
- Budgetary execution.
The first stage in the installation of budgetary control system is the establishment of budget
centres or cost centres. This is because according to Barthy (1974: 117), “effective control
requires that due consideration must be given to the fact that costs are best controlled at the
point at which they are incurred”. Thus, for Bathy, departments and divisions in an
organization should constitute budget centres so as to reduce costs. But Nwosu (1975) stated
that one of the major features of government enterprises in Nigeria is the almost total
absence of cost-consciousness in the people working at various levels in such enterprises.
He suggested that in any well-managed organization, all heads of departments and their
subordinates should be trained to work hard to reduce their departmental costs. The essence
of profit planning through budgetary control is to enhance high returns on invested naira.
The training and retraining of employees on cost reduction in public enterprises should
constitute part of profit planning.
Instruments for Enforcing Control
There are some instruments that are involved when enforcing financial controls in public
institutions in Nigeria. For instance, the main instruments for exercising and enforcing
financial controls in Enugu state are the Constitution of the Federal Republic of Nigeria,
1999, Appropriation laws, financial regulations circulars and the generally accepted
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accounting standards and principles. The operation of the funds was governed by the
Constitution and in detail by the Audit account Law of 1956 and the control and
management of public finance Ordinance of 1958. The audit account of 1956, sections 13
(1), and (2) mandated the Accountant –General of the Federation to produce certain
accounts and statements for audit purposes at the end of every financial year.
After the attainment of the republican status in 1963, the Acts of Parliament became the
instruments of financial control. The 1999 Constitution which is a product of the 1979
constitutional edifice , at section 93(4) provides that the Auditor-General shall have power
to conduct periodic checks of all government statutory corporations, commissions,
authorities, agencies, including all persons and bodies established by an Act of the National
Assembly or State Assembly as the case may be. In view of this provision , the same 1999
constitution, section 93 (2) provides that the Auditor-General or any person authorized by
him in that behalf shall have access to all the books, records, returns, and other documents
relating to those accounts.
In addition to the constitutional provisions relating to financial controls, the 1988 civil
service reforms (1988:8) provides that the Chief Executives and Accounting Officers of
public organizations shall have periodic checks in order to ensure full adherence to the
Finance (Control and Management ) Act of 1958 and its amendments. To this end:
� All instructions relating to expenditure of public funds by the accounting officer
shall be in writing.
� All Accounting officers are made to understand that they are responsible to account
for the public accounts Committees for all monies voted for each department and
that they are also pecuniarily liable.
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� All ministers and chief Executives and Accounting officers shall render annual
reports of their ministries in order to ensure accountability and enforce performance
ethics.
� The Auditor-General of the Federation now has the power to sanction any officer
and to alert the president of any audit alarm of significant importance and any
serious prepayment audit query for which the accounting of the ministry is liable or
responsible.
These innovations impose on the chief Executives of public enterprises in Enugu State
the onus of observing and fully complying with checks and disbursement of public funds
and other assets of the enterprises. These measures can be realized by instituting audit
inspection and accounting controls in the enterprises. Audit inspection may be carried out by
the internal or external auditor to the enterprises. Howard (1982:2) defines auditing as the
independent examination of, and expression of opinion, on the financial statements of an
enterprise b y an appointed auditor and in compliance with any relevant statutory obligation.
An audit is therefore, first of all the investigation of a statement of figures which involves
the examination of certain evidence which the object of the investigation is to enable the
auditor to make a report on the statement.
The 1999 Constitution, section 93 (2) requires the Auditor-General to submit his report
on the Accounts of the government to the National Assembly and that the House is expected
to appoint a Public Accounts Committee. According to Onah and Edame(2008:477), “the
public accounts committee usually concentrate on the Auditor-General’s Reports which are
published in the Appropriation accounts of Ministries and departments as rendered by the
Auditor-Gerneral”. The Auditor-General’s advice is always made available to the
Committee. The Committee uses the content of the advice to draw up its programmes and
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also uses it to select materials for examination. The Public Accounts Committee at its
meetings, examines the audit reports in detail and takes oral and written evidence as
necessary from the Accounting officers concerned, from a representative of Ministry of
Finance and where appropriate, from other witnesses (Onah and Edame, 2008).At the end of
the meeting, the Committee produces its Report, records its conclusions and makes critical
comments and recommendations where appropriate.
The exhaustive consideration of the Public Accounts Committee report is expected
from the ministry of Finance in consultation with other departments, parastatals concerned
and responses are usually set out in a ,”Memorandum of Public Accounts”. This
memorandum indicates the action taken to give effect to those of the Public Accounts
Committees’ recommendations which are accepted, and provides a written reply to any
excuses which may not be accepted (Onah and Edame, 2008). Thus, the effectiveness of the
work of the Auditor-General depends to a large extent on the acceptance of the report of the
Auditor-General by the Public Accounts Committee.
Every public enterprise has a controlling ministry. The supervising ministries, the
Board of Directors and the Management play complementary roles in the achievement of
enterprises’ objectives. Ideally the cabinet office generates the policies and with the help of
the enabling Acts establishes public enterprises through the supervising ministries. The
board of Directors directs, controls and supervises the affairs of the organization (Ekwealor
2007). The Board is required by statute to delegate to the chief executive as much of its
powers that will enable him manage and run the enterprise (Ekwealor 2007). Thus, the
management executes the policy objectives of the enterprises and runs the daily activities of
the organization. However this delegation does not abdicate the responsibility of the Board
of Directors.
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Control Mechanisms
There are other measures that promote financial controls in public agencies. These
measures include: accounting controls, and administrative controls which are means to
ensure that records of returns are properly kept. These involve internal checks, analytical
reviews and division of responsibilities among staff in order to ensure adherence to
management policies, safeguard assets and secure as far as possible the completeness and
accuracy of the enterprises’ resources.
Both accounting and administrative controls are embodied in the concept of internal control
which Chime (2003: 7) defined as;
“the whole system of control , financial and otherwise established by management in order to carry on the business of an organization in orderly manner, safeguard its assets and ensure as far as possible, the accuracy and reliability of the records.
He isolated accounting control to embrace internal checks, internal audit, internal planning,
and budgetary controls, among others. Thus, accounting control consists of a system of
internal checks and counter-checks and balances installed and maintained to prevent or at
least reduce errors and fraudulent manipulations or manoeuvres. In accounting controls,
routine checks like random checks of Accounts (finance and stores) by senior officers in
accounts aimed at ensuring that frauds are exposed before they generate problems to the
organization. For Chime (2003), there must be clear and consistent policy. He advocates that
procedures on depreciation, stores requisition, custody and use of assets, handling of cash,
recording of transactions, how often to summarize records and produce annual periodic
accounts and statements should be specified. Furthermore, Chime (2003) posited that
accounting control consists of an internal monitoring, review and audit unit charged with
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other functions: internal checks, ensuring compliance with internal accounting policies and
planning and budgetary control.
The other one, administrative control, consists of an organizational structure
depicting the hierarchy of the organization (Chime, 2003). The organizational structure
provides a clear separation between operational, financial, and accounting duties. This
implies that administrative control lays down discipline and code of business ethics.
Rotation of duties, transfers and vacations are aspects of maintaining business ethics. This is
because according to Chime (2003), there should be transfers and compulsory annual
vacations both to enable an independent check of his work and to relieve the worker of
fatigue. Manpower development programmes as part of administrative control also enhance
higher level of productivity Chime (2003) as one is forced to believe that the higher the
responsible post one occupies, the more disciplined one is supposed to be. In all eliminations
of waste and extravagance, the encouragement of sound practice in estimating, controlling,
and financial administration in public enterprises will produce goods and services that will
match value for money used in their production.
2.1.8. Investment Management Practices in Commercial Enterprises
Commercial enterprises are duty bound to create proper investment atmosphere that
will generate high return on invested capital. Proper investment atmosphere is created only
if efficient systems of investment management practices comprising capital budgeting
decision practices, control practices and motivation practices are employed in the operations
of their business. Prominent among these investment management practices is capital
budgeting decision. Hence, Pandey (1989) conducted a study to investigate the capital
budgeting decision adopted during the evaluation of investment proposals by high-growing
Indian companies.
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Pandey (1989), found that 13 out of the 14 companies studied use the payback
criterion in their investment selection. The study also revealed that 9 out of the 14
companies use internal rate of return when screening their investment projects. The study
found that 6 companies adopt the net present value method when screening their investment
proposals. Pandey (1989) also found that 4 out of the 14 companies studied adopt the
average rate of return criterion. From the above findings by Pandey (1989), it can be inferred
that in India, investment appraisal techniques are payback period, internal rate of return and
net present value. In India, the payback period and the internal rate of return ranked first and
second respectively in use when screening investment proposals. In India, not only do
business enterprises use investment appraisal techniques during the screening of their
investment proposals, payback period and internal rate of return are more popular and hence,
most frequently used. However the study further clarified that 11 companies out of 14
responded that investments in projects like replacement of old equipment, office equipment
or furniture, replacement of assets, of immediate requirements, welfare and statutorily
required projects were not subjected to formal evaluation.
In his survey of capital budgeting methods used by American companies during the
screening stage of investment project proposal, Sunden (1978) found that 10 out of 12
companies studied adopt the internal rate of return and net present value methods. This
implies that in America, companies depend on the adoption of net present value and internal
rate of return techniques.
Rockley (1993), in his discussion on investment for profitability using 15 British
companies, stated that all the companies covered use the payback period criterion during the
selection of investment proposals. The payback period method is convenient to use and its
communication is easy to understand by the users. Investment capital is a scarce commodity
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and thus knowing when it is going to be recovered after investment is a concern to the
investors. This implies that investors would like to know the number of years their capital
would be tied up in the investment.
A company’s survival and profitability hinge on effective management of capital
flows (Pandey, 1991). One of the functions of investment management practices is to
estimate cash flows. Investors use this cashflows to estimate the profitability of investments
in a company. The adoption of capital budgeting decision practices, namely: payback period,
net present value profitability index, average rate of return and internal rate of return as
investment appraisal techniques guided these companies in America, Britain and India to
identify the most viable investments. In effect, investment in viable projects generated high
financial returns for their enterprises. These financial returns were used to modernize and
expand their enterprises which enabled them to diversify their scope of operations.
Enterprises that diversify their scope of operations are going concern organizations. This
implies that the enterprises are growing. Public enterprises in Enugu State, Nigeria can also
adopt these capital budgeting decision practices during the evaluation of their investment for
their survival and growth.
Pandey (1984) studied the corporate managers’ attitude towards the use of
borrowings in India. The study revealed that the practicing managers generally preferred to
borrow instead of using other sources of funds because of low cost of debt due to the interest
tax deductibility and the complicated procedures for raising the equity capital. In the light of
these findings, Pandey (1985) conducted another study examining the industrial patterns,
trends and volatilities of leverage and the impact of size, profitability and growth on
leverage. For this purpose, data of 743 companies in 18 industrial groups for the period
1973-1974 to 1980-981 were analyzed. It was found that about 72 % to 80.5 % of the assets
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of sample companies were financed by external debt. These sample companies obtained
external debt probably because their internal financing could not sustain their growth as
Pecking order theory (Myer, 1984) propagated that companies go for external financing
when their internal financing is no longer feasible. The study showed that companies
employed trade credit as much as bank borrowings. However, Severin (2006), using 19
quoted companies in Sweden, studied capital structure decisions to ascertain whether theory
explains practice He found that 50% of the respondents said that they preferred to finance
new projects with cash. The study found that larger projects are financed with debt. Serverin
(2006) further found that only in cases when the leverage is too high do companies turn to
equity financing. These results speak strongly in favour of the financing hierarchy of the
Pecking Order model. This means that financing is done internally and through debt if
internal financing is not possible and equity financing is adopted as the last resort – that is if
the other sources fail. In his discussion on inventory management, Kennon (2005) observed
that the use of Just-in-Time (JIT) introduced by Kanban in 1987 has been inspired by
Japanese JIT parts inventory management made famous by Toyota Motors in the 1980s.
According to him, Toyota Motors used Just-In-Time approach to manage her stock and this
solved the problem of duplicate orders.
In his study of receivables management in India, Pandey (2009) using 4 steel
companies, found that the average of sales indices (177.74) and receivables indices (121 27)
indicates that the sales grow faster than receivables. According to him, this is an indication
that credit terms are less liberal. Impliedly in granting credit to customers in India, the
quality of customers is highly considered. This means that steel companies in India attempt
to identify the customer’s quality (character, capital, condition, collateral and capacity)
before granting credit to him.
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In his study to find out the control of capital expenditure in British companies using
15 companies, Petty (1975) found that the power to commit a company to a specific capital
expenditure and to examine investment proposals is confined to a few top corporate
officials. However, the study found that the duties of examination and evaluation of a
proposal is spread throughout the corporate management staff as responded to by 8 out of
the 15 companies studied. In effect, senior managements of the companies tightly control
capital expenditure. According to the findings, in British companies, budgetary controls are
also implemented strictly. Projected cashflow are matched with actual cashflow to find out
the deficit or surplus. In the study to examine the capital budgeting decision practices in
Indian companies, Pandey (1989) found that Indian companies practice control of
expenditure through the use of regular project reports. Pandey (1989) specifically found that
6 companies required quarterly reporting; four companies, monthly reporting; one company
required half yearly reports and other companies required continuous reporting. He further
disclosed that in India, companies’ evaluation of reports involve information on expenditure
to date, stage of physical completion and approval and raised total cost. Findings by Pandey
(1989) also indicated that Indian companies embark on re-appraisal of investment proposal
as a source of control. Re-appraisal, according to the finding, is directed towards comparison
between the actual and the projected capital costs; savings and the rate of return. Nine
companies admitted that a re-appraisal would lead to the following kinds of actions: revision
of the aims and size of the project, redesigning and rescheduling of project; and financial
revision of the project to provide for cost escalation. The study found that it is the duty of
the chief executive of the companies to re-appraise the investment proposal.
The adoption of appropriate control practices by Indian, American and British
companies helped the companies to safeguard the financial returns (profits) realized from
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investment in viable projects and also from benefits associated with not granting credits to
customers whose quality was doubtful. These secured financial returns were employed to
diversify or grow the business activities of the enterprises.
In his survey to find out the control of capital expenditure in 15 American
companies, Sunden (1978) found that project initiation was a bottom-up process in these
companies with about 82% of investment proposals coming from divisional management
and plant personnel. The implication of Sunden’s findings is that 18% of investment
proposals come from top management. In an effort to investigate who generates investment
ideas in British companies King (1988) found that out of the 14 companies surveyed, more
than 50% of the investment ideas were generated at the plant level. He found that 8 of the
companies depended on the board upto 20% of the investment ideas. Furthermore, he found
that 2 companies depended on research centres for about 10% to 20% of the investment
ideas. The implication of these findings is that the investment idea generation is primarily a
bottom-up process in these companies studied Companies use a variety of motivation
methods to encourage investment generation. For instance, in his study to examine the
capital budgeting decision practices in Indian companies Pandey (1989) found that out of the
14 companies studied, 10 depended on management sponsored studies for project
idealization, 7 companies adopted formal suggestion scheme and 6 companies adopted
consulting advice approach. He noted that most of the surveyed companies adopted a
combination of methods. Impliedly, these companies use training and retraining of
employees as a way of motivating them for greater commitment and participation in
investment generation. He posited that other efforts employed by the companies for
searching investment ideas were review of researches done in the country or abroad,
conducting market surveys, and sending executive officers to international trade fair for
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identifying new product or new technology. These are various ways of motivating
employees for greater commitment to the course of their organization.
The employment of these appropriate motivation practices in business set up by
these American, Indian, and British companies encouraged their employees to be initiating
investment. It was these investments that were appraised and most viable projects selected
for investment or diversification. Any commercial enterprise that has reached the stage of
diversifying its scope of operations is said to be growing.
2.1.9 Synthesis of the Literature
We reviewed the features of a commercial enterprise which exposed us to various
categories of sources from which an enterprise can raise its capital mix. We also saw capital
structure decisions which exposed us to the hierarchy of financing and capital investment
decisions which presented various project appraisal techniques. The other ones, working
capital management and inventory management depicted an appropriate liquidity ratio 2:1 of
current assets to current liabilities that can keep an enterprise going on day to day basis and
the just in-time inventory respectively. The other review, the receivables management
exposed us to the quality of the customer which must be satisfied before granting him credit
facility. Control in public financial institutions presented control tools, instruments for
enforcing control and control mechanisms. Investment management practices in commercial
enterprises show the applicability of various investment practices in investment institutions.
Thus, this review is paramount to this study because it has exposed us to the modern
investment management practices and their applications for the expansion and growth of
investment concerns. The empirical review has shown investment management practices in
different commercial enterprises in developed countries for the sustainability and growth of
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their quoted companies. The incorporation of these practices in public enterprises in Enugu
State will enhance their sustainability and growth.
2.1.10 Gap in the Literature
In the literature review of this study, we saw that separate studies by Pandey (1989),
Sunden (1978) and Rockley (1993) on capital budgeting decision practices were focused on
private sector companies only. Similarly, in separate studies by Pandey (2009) on receivable
management directed his studies towards private sector companies only. In the same vein,
Petty (1975) in his studies on control practices also focused his studies on private sector
companies. Kennon’s J1T (2005) study directed his study towards private sector companies.
King’s (1988) study on motivation practices was directed towards private sector
companies. Pandey (1989) just like King (1988) studied motivation practices in private
sector companies. The issue is that none of these studies bothered to carry on their studies in
public sector companies. Since all these studies by different researchers were focused on
private sector companies, it becomes necessary to carry out this study on investment
management practices in public sector companies with particular reference to public
enterprises in Enugu State, Nigeria.
2.2 Theoretical Framework
In providing a theoretical framework for this study, we capture the Weingartner’s
capital rationing theory for the management of public enterprises in Enugu State
(Weingartner, 1977). Capital rationing attempts to allocate funds to investment projects
according to a guiding rule as determined by the enterprises’ financial resources standing.
Naturally, no enterprise grows to infinity because resources are scarce. Every enterprise,
irrespective of its size has limited resources to execute its business activities, hence the need
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for rationing. Capital rationing is an investment decision to limit the expenditure decision to
spend on an investment according to the level of financial resources available for the project.
Thus, according to Weignartner’s (1977) capital rationing theory “there should be
restrictions on channel of outflow of funds by placing a cap on the number of projects”. Gap
here means that the number of projects must be within the budgets. Budgets that are meant
for other projects should not be touched. Capital rationing occurs when an enterprise’s
management places a maximum amount it can make on new project over a given period of
time (Shobaikb; 2010). Capital rationing is a strategy employed by companies to make
investments based on the current relevant circumstances of the company. The objective of
capital rationing is to select the group of projects within the organization budget that
provides the highest rank according to the investment appraisal techniques adopted. Every
enterprise will choose to employ strategies that support the productive use of disposable
funds built within a capital budget. At the same time, it is important to understand what
benefits can reasonably be expected from owing the asset in question.
Capital rationing is all about setting criteria that any investment opportunity must
meet before the enterprise will seriously entertain the investment. Many enterprises choose
the strategies as their guiding process for any investment. Using the basic principles of the
techniques adopted, an enterprise can develop a list of standards that must be addressed
before any capital investment is made. If the standards are set in a manner that accurately
reflects the current condition of the enterprise, then there is a good chance that the right
types of investments will be made. (Capital budgeting Decision, 2010).
There are some important factors to consider as part of a productive capital rationing.
These factors are: financial condition of the enterprises, the long and short term goal of the
investment and proper attention to daily operations (Pandey, 1991). One of the benefits
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associated with capital rationing is that the approach helps to ensure that funds for basic
operations are not diverted to take advantage of the so-called “can’t fail” opportunity which
helps to maintain the stability of the enterprises (Shoaibk, 2010). Capital rationing is
justified by external and internal factors (Pandey, 1991).
External Capital Rationing: External capital rationing occurs when the lending institution
cannot lend the amount needed by the borrower or the enterprise. An enterprise may borrow
funds because of internal financial shortages occasioned by substandard operating
performance, unfavourable credit conditions or when it introduces a new untested product
that requires aggressive advertisement.
Internal Capital Rationing : Internal Capital rationing occurs when an enterprise imposes
its own rationing on capital because the enterprise may not have adequate middle –
management personnel to cover expansion. Internal capital rationing is adopted as a means
of financial control. In an organizational set up, the divisional manager may overstate their
investment requirements. One way of forcing them to carefully evaluate their investment
opportunities and set priorities is to put upper limit to their capital expenditure.
2.2.1 Application of the Framework to the Study
In applying the Weingartner’s capital rationing theory in public enterprises in Enugu
State, the enterprises have to build strong managements. With strong managements well-
established in public enterprises, they have to prepare grounds for effective and efficient
management of their limited resources to enhance their productivity. The management of
public enterprises starts the application of the capital rationing theory by gathering
information on the investments and their future prospects. The information gathered is used
to appraise the risk of the investment project and hence the required returns on the
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investment; and to estimate the future cashflows and profit potential . Furthermore, one or
more appraisal technique is used. This technique combines the elements of risk, return and
profit or cashflow in order to evaluate the worthwhileness of the investment (Manigart,
1997).
After gathering the required information, and after the selection of the appraisal
technique to be adopted, the investment appraiser now appraises the investment projects one
after the other. The next stage becomes ranking the values obtained according to the
principles guiding the appraisal technique adopted. What follows this is the choice of the
investment projects in the order of the ranking till the funds budgeted is put into the
investment chosen. This implies that the management should not put extra costs by going
beyond the budgeted funds.
It should be noted that when applying capital rationing, higher hurdle rates should be
used for projects that are riskier than the existing enterprise, and lower hurdle rates should
be used for lower risk projects (Capital Budgeting Decisions, 2010). This is obtainable only
if the technique adopted is one of the discounting techniques of Net Present Value (NPV),
profitability index (PI) or Internal Rate of Return (IRR).
2.3 Hypotheses
1. Application of appropriate capital budgeting decision practices in public enterprises
in Enugu State has no significant influence on investment in profitable projects for
their growth.
2. Institution of appropriate control practices in public enterprises in Enugu State has
no significant influence on financial and material returns in the enterprises.
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3. Adoption of appropriate motivation practices in public enterprises in Enugu State has
no significant influence on employees’ participation in investment generation and
revenue collection strategies.
2.4 Operationalization of Key Concepts
In this section, we operationalize the following key concepts in this work: capital,
investment, management practices, growth; high, moderate and poor growth
enterprises and public enterprises.
Capital: The term capital in financial management means total funds invested in the
business (Pandey, 1991:1098).
Investment: Investment in this context means the ploughing of naira into projects in
anticipation of yielding future benefits.
Management practices: Management practices in this context are all those inputs and
actions that are made by public enterprises in Enugu State to direct where, how and when
capital is to be invested in productive projects in order to enhance their growth. Management
practices in this context are circumscribed in: capital budgeting decision practices, control
practices and motivation practices for encouraging employees for greater commitment and
participation in investment idealization and collection strategies
Growth: Growth in this context means expansion of investment capacity of an enterprise
beyond its traditional investment areas. This implies that Growth involves diversifying into
new product or introducing new auxiliary enterprises without jeopardizing the existing
product line (traditional investment areas) Growth here is measured by the number of
auxiliary enterprises created within an organization. Furthermore, we classified growth of
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public enterprises in Enugu State into three categories of growth. The classification is as
follows:
High growth enterprises: These are enterprises which have three or more auxiliary
enterprises in their scope of operations.
Moderate growth enterprises: These are enterprises which have one or two auxiliary
enterprises in their investment portfolio
Poor growth enterprises: These are enterprises which have no auxiliary enterprises to
support their present level of operations.
Public Enterprises: Public enterprises are institutions or organizations which are owned by
the state or in which the state holds a majority interest, whose activities are of a business in
nature and which provide services or produce goods and have their own distinct
management (Efange, 1987). Public enterprises which are profit oriented are established to
compete with the private companies and are registered under the company Act of 1968
(Ekwealor 2007). Such enterprises are required to register with the Registrar of companies a
Memorandum and Articles of Association which contains the objective clause, capital
outlay, rules governing the operations of the company including the roles, rights and
priviledges of shareholders, appointment of Board of Directors, functions and powers of the
Board of Directors and Chief Executive, Annual General meetings and submission of
Annual returns and accounts. Public enterprises in this category operate under the same
company laws that regulate the operations of the private sector business enterprises. They
are either jointly or fully owned by the government. They are categorized as either state
owned or state joint companies (Ekwealor 2007). Public enterprises in Enugu State under
this study are state owned companies that were created to generate profits for the up liftment
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of the generality of the people. In oder to perform favourably, these public enterprises must
adopt the features that characterize high performing private companies.
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CHAPTER THREE
STUDY AREA AND RESEARCH PROCEDURE
3.1 The Study Area
Background Information on Enugu State, Nigeria
Historical Development: Enugu State was created on August 27, 1991 with city of
Enugu as its capital. The state derives its name from the capital city which was established
in 1912 as a small coal mining town, but later grew to become the capital of the former
Eastern Region of Nigeria (Ministry of Information, 1992). In 1967, when the Gowon
administration created twelve states in Nigeria, Enugu remained the capital of the East
central state of Nigeria, one of the three states carved out of the former Eastern Region.
Nine years later, two states. Anambra and Imo were carved out of the East central
State and Enugu continued to serve as the capital of Anambra State. The administrative
hinter land of the city became much smaller in 1991 when Anambra state was further split to
form Enugu State and the new Anambra State (Ministry of Information 1992).
In 1996, the Abakaliki area, one of the three political and administrative divisions of
Enugu State was carved out and added to a part of Abia State to make up Ebonyi State,
which was created in that year along with five others. Today, Enugu State covers a much
reduced territory compared to its size in 1991 when it was initially created.
The town of Enugu, where coal is found in commercial quantity is euphemistically
referred to as the “coal city. The immediate fortunes in terms of development in education
and commerce of the state appears to be tied among other things with the rehabilitation of
the coal industry and cities of the state take delight in being associated with the pseudonym
of the coal city State’. Indeed, the shooting of Nigerian coal miners in Enugu in the year
1949, by military officers of the British colonial administration, contributed very much as a
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catalyst in changing the political history of Nigeria towards the granting of independence in
1960 (Ministry of information, 1998) Enugu State has a population of 3.3 million people
according to the 2006 census result (Yishau, 2007). Enugu State is the home and seat of the
Igbo of South eastern Nigeria.
Geography:
Enugu State is one of the states in the Eastern part of Nigeria. The state shares
borders with Abia State and Imo State to the south, Ebonyi to the east, Benue State to the
North East Kogi to the North West and Anambra State to the West.
Enugu State has good soil-land and climatic conditions all year round, sitting at
about 223 metres above sea level, and the soil is well rained during its rainy season. The
mean temperature in Enugu State in the hottest month of February is about 87.160F or
30.64-0C, while the lowest temperatures occur in the month of November, reaching 60.540F
or 15.860C. The lowest rainfall of about 0.16 cubic centimeters is normal in February, while
the highest is about 35.7 cubic centimeters in July (Ministry of information, 1998).
Administrative Areas: There are seventeen local government areas in Enugu State. These
include: Aninri, Awgu, Enugu East, Enugu North, Enugu South, Ezeagu, Igbo Eitit, Igbo-
Eze North, Igbo-Eze South, Isi Uzo, Nkanu East, Nkanu West, Nsukka, Oji River, Udenu,
Udi, and Uzo-Uwaniu. The principal cities in Enugu State are Enugu, Agbani, Awgu, Udi,
Oji and Nsukka. However, Enugu-Ezike and Obollo-Afor are fastly moving towards urban
city status.
Administrative Structure: The executive governor is at the helm of affairs in the state. He
is assisted by the Deputy Governor. Other officers of the State Executive council are the
119
secretary to the State Government, the Head of Service and the Commissioners. The
Governor is also assisted by a number of special advisers and special assistants.
The state legislature the lawmaking body is headed by the speaker. He is assisted by the
clerk of the House in the general administration of the Assembly. The seventeen local
government areas are each headed by an Executive chairman. The chairman is assisted by a
Deputy chairman and several supervisory councilors. Each local government has a
legislative arm composed of councilors who represent the various wards.
Traditional Administrative Structure: Some communities are governed by a system of
gerontocracy in which a council of elders forms the government (Ministry of Information,
1992). One of the members usually the oldest is designated the community Head or chief or
Traditional Ruler. He works with a cabinet of executive and ordinary members who
represent their respective village wards. Other communities select their chiefs or traditional
rulers in accordance with their written constitution. In all cases, each community has a town
union known as community Development Association or General Assembly headed by a
President. The President works with a team of assisting executive members chosen through
a popular election. Town unions spearhead development activities and ensure that the
government’s new programmes are implemented. At the head of the traditional political
system is the “Okpala” or “Onyishi” as the case may be. The Onyishi/Okpala holds the
symbol of political and religious authority called “Arua”. In some parts of the state,
however, the aggregate system of government is used and in many others, traditional
government is by their titled societies (Nze na Ozo). Generally these forms of government
make use of masquerade societies to execute decisions. The present administration in Enugu
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State recognizes the roles of town unions and we may refer to it as fourth tier system of
government in the State.
Economic Activities: Economically, the State is predominantly rural and agrarian with a
substantial proportion (68.3%) of its working population engaged in farming, trading 18.8%
and services 12.9% of the working population respectively (William, (2008). In the urban
areas, trading is the dominant occupation, followed by services. A small proportion of the
population is also engaged in manufacturing and fabrication activities.
Education: Every community in Enugu State has at least a Primary or Elementary school
and at least one secondary school, funded and run by the state government. The state also
owns a University, College of Technology, college of Education and a College of
Agriculture.
Health: Enugu State owns and maintains seven District Hospitals at Enugu Urban, Udi,
Agbani, Awgu, Ikem, Enugu-Ezike and Nsukka. Every community has at least one health
centre. These health centres are maintained and run by the local gvernemnt where they are
established.
Agriculture: Agriculture predominantly subsistence, ranks first in the people’s economic
activities. It is divided into two types. Agriculture on the plateau is based on the extensive
cultivation of the conventional staple of yam, cassava, maize, sweet potato, grain legumes
pawpaw, banana, plantain and vegetables. Income from the farm is supplemented by
earnings from the sale of products from local economic tree crops like oil palm, cashew,
kolanut, coconut, mangoes, breadfruit (Ukwa), castor beans, oil beans, Ogbonno, peperish
kola among ethers. Terrace farming is important on the hill slopes of Nsukka, Lejja, Udi and
Aku floodplain agriculture is practiced in parts of Niger Anambra plains especially at Adani
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and Omor. It is based comparatively on large scale cultivation of rice and yam, and also fish
farming (Ministry of information 1998) Cow rearing is also found in Opi.
Religion: Two major religious groups exist in Enugu State. These groups are the traditional
religion (Anyanwu, Chi, Nna) and Christianity. A high level of religious tolerance exists in
the state.
Hospitality: The people of Enugu State are very hospitable. They receive and accommodate
people from various backgrounds. This could explain the reason why the white men used
Enugu as the capital of Eastern Region and the Nigeria’s foremost nationalist late Dr.
Nnamdi Azikiwe moved North wards to establish Nigeria’s pioneer University at Nsukka.
We decided to use Enugu state as our study area because we believe that public enterprises
in Enugu State are passing through the same growth challenges as other public enterprises in
Nigeria. Thus the results obtained can be used to generalize the characteristics of other
public enterprises in Nigeria.
3.2 Research Procedure
3.2.1 Design of the Study
The study adopted a survey design. Survey research design is the plan of study which
enables us to use reliable techniques to collect data from a well-defined population (Eze,
2005). Survey design was adopted because the research was directed towards identifying the
investment management practices that are adopted in public enterprises in Enugu State to
further their efficient performance. Survey research design is always concerned with what
exists in a population, the factors that influence them and their inter-relationship (Eze,
2005). Survey design was employed because this study involved populations that were
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extensive in spread and large in size. We thought it more reasonable to draw segments
(samples) of the population for investigation as it would be very difficult for us to reach all
the people who formed the population. Moreover, not all the people who constituted the
population could respond to the survey items. Secondary and primary data were used in this
study.
3.2.2 Population, Sample Size and Sampling Procedure
The population for this study consisted of the workers of public enterprises in Enugu
State that have been drawn for this study. These were Enugu State marketing company,
Enugu State Transport company, Ikenga Hotels, Nsukka and Nike Lake Resort Hotels. The
population of workers in these enterprises was 305. Nigeria Construction and Furniture
Company refused to participate in the study.
Purposive sampling procedure was used to get 5 respondents from each enterprise
Purposive sampling procedure was chosen because only the few people who occupy certain
positions would respond to our questionnaire items. An indication of the entire population
and sample used is given below in table 3(I).
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Table 3(1): Population and Sample Size
Name of Enterprise Number of
Employees
Number of
Sample
Number
Returned
Officers Used
Enugu State Marketing
Company Ltd
(ESMC) Enugu
32
5
5
Corporate Affairs Manager,
Accountant,
Administrative Manager,
Marketing Manager,
Procurement Manager
Enugu State Transport
Company Ltd
(ENTRACO)
95
5
5
Administrative Manager,
Personnel Officer
Accountant,
Auditor (Internal),
Transport Supervisor.
Ikenga Hotels Ltd
(IKH) Nsukka
25 5 5 Manager,
Stores Officer,
Sales Manager,
Purchasing Officer,
Finance Officer,
Nike Lake Resort
Hotels Ltd.
(NLR) Enugu
153
5
5
Human Resource Manager,
Accountant,
Stores Officer,
Purchasing Officer,
Sales Manager,
4 305 20 20
Source: Field Work (2012)
3.2.3 Sources and Method of Data Collection
We obtained information from secondary data provided by books, journal articles,
internet materials, official documents and unpublished materials. Secondary data are
important because we build our future on the good foundation of the old. The second
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information was obtained from the primary data. Results from primary data constituted our
findings.
We used Questionnaire on investment management practices - cum direct oral
interview for data collection. The questionnaire was titled, Investment Management
Practices of Public Enterprises in Enugu State “(IMPPEES)”. The questionnaire was made
up of four parts. The first part, section A, sought information on the background of the
public enterprises that were studied. It had 6 items. The second part, section B, was billed to
gather information on the capital budgeting practices in public enterprises in Enugu State. It
had 10 items. The third part, section C, dwelt on information on the control practices
adopted in public enterprises in Enugu State. It consisted of 12 items. The fourth part,
section D, sought information on motivation practices for investment-generation methods
and collection strategies. It had 15 items. The data collection instrument was a structured
questionnaire in that we provided the options. We decided to choose this approach because
according to Free Papers (2003), “finance is an open pursuit. It further continued that
money can be raised and managed in a bewildering variety of ways, making the crafting of a
finance thesis a rather more open-ended pursuit (Free Papers, 2003). It concluded by stating
that however it develops, a finance thesis must focus tightly on the more creative aspect of
money management. Therefore, in order to create ideas on modern aspect of money
managements in public enterprises in Enugu State we decided to draw a structured
questionnaire raised from our reviewed literature.
3.2.4 Validation and Reliability of Instruments
The data collection instrument was subjected to expert vetting in the Department of
Public Administration and Local Government, University of Nigeria, Nsukka. The experts
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were given the initial draft of the instrument. They checked the structuring and the adequacy
of the instruments as well as their reliability and validity for the research.
Furthermore, we administered pre-test administration twice. First test, we gave the
questionnaire to the first three companies chosen on the basis of balloting. The first three
companies that were selected formed the sample size for the pre-tests. During the second
administration of the test, we altered the numbering of the items and re-administered the
questionnaire to the same three companies. We reconciled the questionnaire item numbers
and ascertained whether they provided the same answers as in the first questionnaire items.
The answers that were consistent were given two marks each and any answer that was
inconsistent in any way was given one mark each. In effect, the maximum score for all items
was 6 and the minimum score was 3. This means that an item could get 3, 4, 5, or 6.
It is worthy of note here that after the administration of the two pre-tests, the
reliability of the instrument was obtained by using the Pearson’s Product moment
Correlation coefficient, reliability /stability of the half length (odd-numbered and even-
numbered items) (Downie and Heath, 1974). As shown in appendix 1A, a correction of the
error inherent in the half length was effected by using the Spearman- Brown prophecy
formular:
� 2r1/2
1 + r1/2
The result obtained was 0.98 which depicted a good degree of reliability of the instrument
used. The respondents were to a large extent consistent in the provision of responses. The
data that were used for calculating the Pearson’s product moment correlation coefficient and
the Spearman-Brown prophecy formula for effecting the correction of the error inherent in
the half/length can be found in Appendix 1B.
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3.2.5 Administration of the Instrument
We employed the direct delivery technique in the administration of the questionnaire. This
implies that the questionnaire was administered personally to the respondents. We also went
back to retrieve the questionnaire from the respondents personally. 20 copies of the
questionnaire were distributed to the respondents to capture the needed data. They were
distributed to the human resource managers, heads of marketing, and chief financial officers,
purchasing officers of the affected companies. The collection of the questionnaires was
effected on later days as follows: ENTRACO took 5 days, IKH took 14 days, ESMC took 4
days and NLR took 3 days.
3.2.6 Method of Data Presentation and Analysis
This chapter dealt with the application of statistical tool for the analysis of data and making
inferences. In preliminary analysis the data were presented in tables. This helped us to come
out with some inferences based on the observation from the tables. This was followed by
the analysis of hypotheses. The different hypotheses that were formulated to guide this study
were analysed at this stage. This exercise revealed certain underlying facts of the research
problem which helped us to recommend strategies for the operation of public enterprises in
Enugu State in particular and other business concerns in general. This chapter has a major
subsection like Data presentation, Analysis and Findings.
The questionnaire was developed on a five (5) point rating of Likert type of Strongly Agree
(SA), Agree (A), Undecided (UD), Disagree (D) and Strongly Disagree (SD).
(Panneerslvam 2012, 161), the scale was rated as follows:
SA –5points A – 4points UD – 3points
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D – 2points SD –1point
Mean score statistics was used for analysing research questions. The data collected
were analysed in the following ways. Responses relating to each research question were
tallied and weighted. The total weight frequencies were used to determine the mean scores
(X) for each item. Any mean score of 3.50 or above was adopted as agreement while those
below 3.50 or equal to 3.00 represented undecided and those below 3.00 represented
disagreement. Single classification Analysis of Variance (ANOVA) was used to analyse the
data. Furthermore, extent was classified as low (1.00 to 3.49), average (3.50 to 3.99) and
high (4.00 to 5.00).
Respondents used Likert scale to score questionnaire items according to the extent to
which the items are employed in public enterprises in Enugu State. Every item in the
questionnaire was scored 1, 2, 3, 4 or 5 in accordance with the Likert scale. No item was
scored less than 1 or more than 5. The item scores of every respondent were summed up.
This was how the data for 5 respondents in Enugu State Transport Company (ENTRACO), 5
in Ikenga Hotels (IKH), 5 in Enugu State Marketing Company (ESMC) and 5 in Nike Lake
Resort Hotels (NLR) were generated and used to perform single classification Analysis of
variance.
128
CHAPTER FOUR
DATA PRESENTATION, ANALYSIS AND FINDINGS
In this chapter, we present data emanating from this study. We also make a brief
analysis of the findings and finally present summary of major findings of this study. The
results of this study are presented in tables, graph bar charts and pie charts. Each table is
followed by a brief description of its content
4.1 Data presentation
Table 4 (1)
Profile of the Studied Public Enterprises in Enugu State.
Name of Enterprise Year of
Establishment
Business Activities Level of
Technology
Enugu state Marketing
company ltd (ESMC)
1984 Sale of Fish, Oil palm
and Rice
Moderate
Enugu state Transport
company ltd (ENTRACO)
1991 Transportation Low
Ikenga Hotels ltd (IKH) 1987 Bar Restaurant and
lodging
Low
Nike lake Resort Hotels ltd
Enugu (NLR)
1988 In-bar, Bush-bar,
Restaurant and
lodging
Moderate
Source: Field work 12/4/2013
Table 4(1) above portrays that public enterprises in Enugu State carry on different
business activities. The table shows the year of their respective establishment, the types of
specific business activities of each company and their various levels of technology adopted
in the course of carrying out their functions. Of the 4 enterprises in our study, 50% employ
low technology and 50% employ moderate technology.
129
We found from oral interview (Aneke ENTRACO, 14th April 2013) that Enugu state
Marketing company (ESMC) is under the control of Ministry of commerce and Industry and
Enugu state Transport company. (ENTRACO) is under the supervision of Ministry
Transport. Both Ikenga Hotels (IKH) and Nike Lake Resort Hotels (NLR) are under the
control of Ministry of Culture and Tourism. Boards of Directors are also instituted for each
of these companies studied. Even though, these enterprises have their respective Boards of
Directors, this study found that they are authorized to generate investment ideas that can
promote their expansion and growth.
Table 4(2)
Sources of Finance for Public Enterprises in Enugu State.
Names of Pubic Commercial Enterprises in Enugu State
Sources of capital mix Internal External
Debt Equity
ESMC Government subvention Borrowing ____
ENTRACO Government grant Borrowing ____
IKH Government subvention and Asset
Vendor supply Borrowing
____
NLR Government subvention and
Asset
Borrowing ____
Source: Field work (17/4/2013)
The data in table 4(2) were obtained from the oral interview (17/4/2013) we had with
chief executives of the companies studied. It can be discerned from table 4(2) that all the
companies use both internal and external financing and within external financing, they use
debt only. This finding also shows that in addition to the internal financing and debt
instrument, IKH also makes use of vendor supply as a source of raising capital. In this
130
scenario money is paid back to the supplier after selling the goods. This facility does not
attract cost of capital.
We found from questionnaire responses as shown in table 4(3) which displays the
size-that is the volume of sales of each company, the capital intensity-that is the net fixed
assets and the volume of spending-that is the capital expenditure of each company. It can be
seen from table 4(3) that two companies namely – ENTRACO and IKH are on the verge of
collapsing having annual income of 30 million and 2 million naira respectively in the year
2011. The graphs of annual sales in ENTRACO, IKH, ESMC and NLR(2006-2011) are
shown in figures 4(1)A, 4(1)B, 4(1)C, and 4(1)D respectively.
Table 4(3) Revenue Stands of Public Enterprises in Enugu State, 2006-2011
4(3)A Revenue stand of ENTRACO
Year Annual sales N
M = Million
Net fixed asset N Annual Expenditure
2006 53m 35m 35m
2007 48m 28m 32m
2008 35m 12m 18.3m
2009 30m 12m 17.2m
2010 30m 11.2m 16m
2011 30m 11.6m 16m
Total 226,000,000 134,000,000
Source: Estimates unit, Finance Department,
Table 4(3)A shows that annual sales in ENTRACO was N53 million in 2006 and fell to N30
million in 2011.
131
Fig 4(1)A Graph of Annual Sales of ENTRACO
The graph shows the fall in annual sales of ENTRACO, 2006-2011
Table 4(3)B Revenue stand of IKH
Year Annual sales N Net fixed asset N Annual Expenditure
2006 4m 830m 3m
2007 3.5m 790m 3m
2008 2.5m 692m 2.2m
2009 2.3m 694m 2m
2010 2m 692m 1.5m
2011 2m 630m 450,000
Total 16,300,000 12,150,000
Source: Finance Department
0
10
20
30
40
50
60
2005 2006 2007 2008 2009 2010 2011 2012
An
nu
al In
co
me
ENTRACO
132
Table 4(3) B it can be seen that annual sales in IKH was 4 million in 2006 and declined to 2
million in 2011.
Fig 4(1)B Graph of annual sales of IKH
The graph shows the decline of annual sales of IKH, 2006-2011.
Table. 4(3)C Revenue stand of ESMC
Year Annual sales N Net fixed asset N Annual Expenditure
2006 105M 15.7 60M
2007 132M 15M 75M
2008 140M 14.8 61M
2009 145M 14M 55M
2010 154M 13.7 40
2011 152M 13.5M 20M
Total 740,000,000 311,000,000
Source: Account unit Finance Department
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
2005 2006 2007 2008 2009 2010 2011 2012
An
nu
al In
co
me
133
TABLE 4(3)C shows that annual sales of ESMC was N105 million in 2006 and rose to
N152 million in 2011.
Fig 4(1)C Graph of annual sales of ESMC, 2006-2011
The graph 4(1)C shows that annual sales of ESMC rose from 105m in 2006 to 152m in 2011
Table Fig 4(3)D Revenue of stand of NLR
Year Annual sales N Net fixed asset N Annual Expenditure
2006 274M 985M 70M
2007 276M 980M 80M
2008 295M 932M 74M
2009 300M 926M 80M
2010 345M 825M 820M
2011 420M 840M 320M
Total 1,910,000,000 706,000,000
Source: Estimates unit, Finance Department
0
20
40
60
80
100
120
140
160
180
2005 2006 2007 2008 2009 2010 2011 2012
134
It can also be seen from table 4(3)D that annual sales of NLR was N274 million in 2006 and
rose to N420 million in 2011.
Fig. 4(1)D Graph of annual sales of NLR, 2006-2011
Fig. 4(1)D shows the rise of annual sales of NLR, 2006-2011
Table 4(3)E Internal rates of Returns of the Existing Investments of Public
Enterprises in Enugu State.
Name of Enterprise Internal Rate of Return (IRR)
ENTRACO 19.8%
IKH 10.2%
ESMC 33.9%
NLR 34.2%
Table 4(3)E above shows that internal rate of return on investment in ENTRACO is 19.8%
while that of IKH is 10.2%, ESMC is 33.9% and NLR is 34.2%. The calculation of internal
rate of return is shown in Appendix 3. Calculation by method of linear interpolation.
0
50
100
150
200
250
300
350
400
450
2005 2006 2007 2008 2009 2010 2011 2012
An
nu
al In
co
me
135
Fig 4(1)E Bar Chart showing the Internal Rate of Returns of ENTRACO, IKH, ESMC,
and NLR, 2006-2011
Table 4(4)
Auxiliary Enterprises in Public Enterprises in Enugu State.
Name of
Enterprise
Auxiliary
Enterprises
Number of Auxiliary
Enterprises
Number of Existing
Business Activities
Growth
Potential
Growth
Category
ESMC In-bar 1 3 33 Moderate
ENTRACO Nil 0 1 0 Poor
IKH Nil 0 3 0 Poor
NLR Foot wears, Eye glasses, Stationeries
3
4
75
High
Source: Field work 17/4/2013
0
5
10
15
20
25
30
35
40
ENTRACO IKH ESMC NLR
IKH - Ikenga Hotels Ltd.
ESMC - Enugu State
Marketing Company Ltd.
NLR - Nike Lake Resort Hotels
Ltd.
Enugu State Transport
Company Ltd.
Inte
rnal
rat
e o
f re
turn
136
Growth potential is the number of auxiliary enterprises expressed as a percentage of number
of existing enterprises.
It can be noticed from table 4(4) that ESMC has 1 auxiliary enterprise with growth potential
of 33 and ENTRACO has no auxiliary enterprise with growth potential of 0. Furthermore
IKH has no auxiliary enterprise with growth potential of 0 and NLR has 3 auxiliary
enterprises with growth potential of 75. We categorized ENTRACO and IKH as poor
growth enterprises. Similarly, we have categorized ESMC as moderate growth enterprise
and finally we grouped NLR as high growth enterprise.
Table 4(5)
Categories of Growth
Growth
Category
Number of
Enterprises
Degree
Poor (ENTRACO and
IKH)
2 1800
Moderate (ESMC) 1 900
High (NLR) 1 900
Total 4 3600
137
Table 4(5) shows that 2 enterprises belong to poor growth category, 1 enterprise belongs to
moderate growth category and 1 enterprise belongs to high growth category. The data are
also represented in pie chart figure 4(2). The semi circle represents the number of enterprises
in poor growth enterprises. And one quadrant 900 each representing number of enterprises in
moderate and high growth enterprise respectively. The other semi-circle or 1800 represents
poor growth enterprises.
Research question one
To what extent have capital budgeting decision practices been instituted in Public
enterprises in Enugu State to enhance investment.
The data for answering the above research question are presented in table 4(6) below.
KEY
Poor Growth Group
Moderate Growth Group
High Growth Group
Fig. 4(2)
Pie Chart
138
Table 4(6): Mean Scores of Respondents in Public Enterprises in Enugu State with
regard to the extent to which Capital Budgeting Decision Practices have been
Employed in the Enterprises.
Questionnaire items Respondents ENTRACO
Respondents IKH
Respondents ESMC
Respondents NLR
x INT x INT x INT x INT
(1) Pay back period technique is used to
appraise projects before investment is made
1.75
SD
1.60
SD
5.00
SA
5.00
SA
(2) Net present value technique is used to
appraise projects before investment is made;
1.04
SD
1.00
SD
2.50
UD
5.00
SA
(3) Profitability index/cost–benefit ratio
technique is adopted when appraising projects
for investment.
1.26
SD
1.23
SD
3.25
UD
3.40
UD
(4) Internal rate of return technique is used to
appraise projects before investment decision in
made
1.87
SD
1.65
SD
1.65
D
2.80
UD
(5) Average rate of return is used to appraise
projects before investment decision is made.
1.10
D
2.21
D
5.00
SA
5.00
SA
(6) Weighted average cost of capital is used as
the discount rate.
2.00
D
2.11
D
2.60
UD
3.25
UD
(7) Capital rationing approach is adopted when
embarking on investment projects.
1.40
UD
3.36
UD
4.50
SA
5.00
SA
(8) Current ratio of 2:1(current assets: current
liabilities) is used as indication of cash liquidity
1.42
SD
1.35
SD
3.80
A
4.65
SA
(9) First in first out is used as a criterion for
issuing out stock
4.21
A
4.35
A
4.90
SA
4.95
SA
(10) Last in first out is used as a criterion for
issuing out stock
1.33
SD
1.96
SD
2.65
D
2.67
UD
Cluster X 1.95 Low 2.09 Low 3.59 Average 4.17 High
x = mean INT = Interpretation
139
It can be seen from table 4(6) that the mean scores of respondents in ENTRACO
range from 1.04 to 4.21. The negative mean scores depict that it does not apply those
appraisal techniques in the evaluation of her investment proposals. The positives score
4.21indicates that ENTRACO adopts the principles of first in, in first out when issuing out
stock.
The above table 4(6) shows the mean scores of the respondents in IKH ranging from
1.00 to 3.50, the mean scores of respondents in ESMC ranging from 1.65 to 5.00. The
positive scores are indications of the respondents in ESMC and NLR agreement or
acceptance that they do adopt the very appraisal techniques in their enterprises to promote
wise investment. The other negative scores are indications that they do not employ those
appraisal techniques in the analysis of their investment proposal. The negative mean scores
imply that ENTRACO and IKH do not adopt appraisal techniques during the screening of
their investment projects. The other negative mean scores 1.40 and 3.36 point to show that
they do not employ capital rationing. This is an indication that their investments are
haphazardly done and that there is no guiding criterion which they adopt when embarking
on investments. The above table 4(6) shows that the cluster mean scores of the respondents
in ENTRACO is 1.95 while in IKH is 2.09, in ESMC is 3.59 and in NLR IS 4.17. Public
enterprises that adopt investment appraisal techniques during the screening of investment
projects have higher growth potential as found earlier on that ENTRACO, IKH, ESMC and
NLR have growth potentials of 0,0, 33 and 75 respectively.
Research Question Two
To what extent have proper control mechanisms been instituted in public enterprises
in Enugu State to promote financial and materials returns. The data providing answers to the
above research question are shown in table 4(7).
140
Table 4(7) Mean score of respondents in Public Enterprises in Enugu State with
Regard to the Extent to which Control Practices have been Adopted in the Enterprises.
Questionnaire items Respondents ENTRACO
Respondents IKH
Respondent ESMC
Respondents NLR
x INT x INT x INT x IN
(11)We embark on reappraisal of investment proposal as a means of control
1.98
SD
1.25
SD
3.72
A
4.75
SA
(12)We practice control through the
use of regular project reports
3.88
A
3.65
A
4.15
A
4.14
A
(13)We consider applicant’s character
before granting credit to him
4.10
A
3.11
UD
3.84
A
4.35
A
(14)We consider applicant’s capital background before granting credit to him
2.90
UD
4.70
A
2.96
UD
2.98
UD
(15) We consider applicants condition
before granting credit to him.
3.90
A
2.90
UD
3.22
UD
4.48
A
(16) We consider applicants collateral
before granting credit to him.
2.78
UD
4.55
A
2.73
UD
3.44
UD
(17) We consider applicant’s capacity
before granting credit to him.
3.11
UD
3.45
UD
3.65
A
3.55
A
(18) Rotation of duties amongst employees is adopted as a means of control.
5.00
SA
4.12
A
4.85
A
4.95
SA
(19) Just-in-time technique is used as a
source of inventory control.
4.95
SA
4.95
SA
4.66
SA
4.56
SA
(20) Re-order level model is adopted
as a means of inventory control.
2.90
UD
2.80
D
5.00
SA
5.00
SA
(21) We auction inventory whose
expiry date is at hand.
4.51
A
4.90
SA
5.00
SA
5.00
SA
(22) Our employees are trained to
enhance their responsibility.
2.30
D
1.74
SD
4.33
A
5.00
SA
Cluster X 3.53 Averag
e
3.51 Ave
rage
4.00 Hig
h
4.35 High
141
The above table 4(7) shows that negative mean scores of respondents in ENTRACO
range from 1.98 to 2.30. This implies that ENTRACO does not employ those control
techniques. The positive mean scores range from 3.88 to 5.00. This means that the company
employs control through regular project reports, considucting of applicants character,
consideration of applicants’ condition just-in-time (J1T) and auction of inventory whose
expiring date is at hand as sources of control.
Also viewing table 4(7), we can observe that items 12, 14, 16, 18, 19, and 21 are
rated 3.65, 4.70, 4.55, 4.12, 4.95 and 4.90 respectively, by the respondents in IKH. Items 11,
20, 22, are however rated low by these respondents. These items have mean scores of 1.25,
2.40, and 1.74 respectively. The other items 12,14,15,16 and 17 have mean scores of 3.11,
3.00, 2.90, 2.55 and 3.45 respectively. From the analysis it can be seen that IKH does adopt
regular project reports, consideration of applicants capital and collateral, rotation of duties as
means of controls. They also do adopt just – in time and auction of expiring inventory as
ways of inventory control.
Mean scores of respondents in ESMC are 3.72, 4.15, 3.84, 2.96, 3.22, 2.73, 3.65,
4.85, 4.66, 5.00, 5.00 and 4.33. The positive scores are indications of the respondents
agreement that the factors so stated are to a great extent adopted as control practices in
ESMC. For instance in ESMC reappraisal of investment proposal is adopted as a means of
control. Also in the same ESMC regular project reports are adopted as instruments of
control. Mean scores for respondents in NLR are 4.75, 4.14, 4.35, 2.98, 4.48, 3.44, 3.55,
4.85, 4.88, 4.56, 5.00 and 5.00. The positive scores are indications of the respondents’
agreement that the factors so stated are to a great extent adopted as control practices in NLR.
For instance in NLR reappraisal of investment proposal is adapted as a means of control.
Also in the same NLR training and retraining of employees is adopted as an instrument of
142
control. ESMC adopts most of these control instruments and NLR adopts majority of these
control instruments. The cluster mean score of respondents in ENTRACO is 3.53 while in
IKH is 3.51, in ESMC is 4.00 and in NLR is 4.35 Unwise investment is adversely affecting
the annual sales of ENTRACO and IKH. For instance we have shown in this study table 4(3)
– 4(3)A, 4(3)B, 4(3)C, and 4(3)D that annual sales for NLR table 4(3)A rose from N274
million in the year 2006 to N420 million in the year 2011. IKH shows a reverse trend. Its
annual sales totaled N4 million in the year 2006 and declined to N2 million in the year 2011
table 4(3)B. In ESMC table 4(3)C, annual sales amounted to N105 million in the year 2006
and rose to N156 million in the year 2011. In ENTRACO table 4(3)D, its annual sales
summed up to N53 million in the year 2006 and fell to N30 million in the year 2011.
Research Question Three
To what extent have employees of public enterprises in Enugu state been motivated
to enhance their commitment and participation in investment generation and revenue
collection strategies. The data depicting answers to the above research question are
presented in table 4(8).
Table 4(8) Mean Score of Respondents in Public Enterprises in Enugu State with
Regard to the Extent to which Employees are Motivated to Enhance Investment
Generation and Revenue Collection Strategies
Questionnaire items Respondents
ENTRACO
Respondents
IKH
Respondents
ESMC
Respondents
NLR
x INT x INT x INT x INT
(23) In order to motivate our employees, project initiation comes from divisional management and plant level.
2.11
D
2.40
D
3.78
A
4.52
SA
(24) We encourage our employees to go to
research centers for project initiation.
2.22
D
1.75
D
2.25
D
3.72
A
143
(25) Management sponsors employees for
studies in project initiation
1.20
SD
1.25
SD
2.73
D
2.50
D
(26) Workers are encouraged by giving room
for suggestion scheme for project initiation.
4.12
A
3.65
A
4.78
SA
4.50
SA
(27) Employees are given the provision to review researches done on project initiation in the country or abroad.
2.41
D
2.35
D
2.47
D
3.75
A
(28) Workers are encouraged to conduct market
surveys on project initiation.
5.0
SA
4.75
SA
4.88
SA
4.50
SA
(29) Executive officers are sent to international trade fair to identify new product or new technology.
1.46
SD
2.36
D
4.15
A
4.66
SA
(30) We embark on modernization of existing
projects as a means of enhancing revenue
generation.
1.90
SD
1.87
SD
3.87
A
4.80
SA
(31) We embark on the expansion of existing
business level in order to raise revenue
3.12
UD
3.21
UD
4.50
SA
4.50
SA
(32) We embark on establishing auxiliary
enterprises as a way of promoting revenue
generation.
1.00
SD
1.00
SD
4.77
SA
5.00
SA
(33) One of the strategies for revenue collection
is the reduction of time to process invoice of
sold goods.
4.40
A
4.21
A
4.50
SA
4.52
SA
(34) We write letter of reminder to our
defaulting debtor to pay his debt.
3.58
A
3.61
A
2.50
D
2.60
D
(35) We make telephone calls to remind our
debtor to pay his debt.
1.30
SD
1.34
SD
3.85
A
3.70
A
(36) We pay personal visit to the home of our
debtor to collect our money.
1.24
SD
1.23
SD
4.50
SA
4.60
SA
(37) We collect money from our debtor through
legal action.
1.05
SD
1.00
SD
1.00
SD
1.50
SD
Cluster x 2.41 Low 2.40 Low 3.64 Aver
age
4.00 High
144
It can be observed in table 4(8) that the negative scores of respondents in ENTRACO
range from 1.05 to 2.41. This means that the company does not make use of those
motivation techniques having those negative mean scores. On the other hand, the positive
scores range from 3.58 to 5.00. Impliedly, the company employs those motivation
techniques having those positive mean scores to raise the morale of its employees.
The mean scores in table 4(8) for respondents in IKH are 2.40, 1.75, 1.25, 3.65, 2.35,
4.75, 2.36, 1.87, 3.21, 1.00, 4.31, 3.61, 1.34, 1.23 and 1.00 and 3.78, 2.25, 2.73, 4.78, 2.47,
4.88, 4.15, 3.87, 4.50, 4.77, 4.50, 2.50, 3.85, 4.50 and 1.00 for respondents in ESMC
respectively. Similarly, the mean scores for respondents in NLR are 4.52, 3.72, 2.59, 4.50,
3.75, 4.50, 4.66, 4.80, 4.50, 5.00, 4.52, 2.60, 3.70, 4.60 and 1.50. The positive mean scores
are indications that the respondents in each group agree that the factors so stated to a very
great extent are adopted as instruments for motivating employees for greater commitment
and participation in the operations of their enterprises. The negative mean scores are
indications that the factors so stated are not adopted as instruments for motivating
employees for their commitment and participation in the operations of their organizations.
ENTRACO and IKH have the least motivating mechanisms: conducting market surveys,
reduction of time for issuance of invoice of sold goods and suggestion scheme. On the other
hand ESMC and NLR have almost equal motivating strategies. For instance both send their
executives to international trade fairs, modernize existing projects and consequently embark
on the establishment of auxiliary enterprises. The cluster mean score of respondents in
ENTRACO is 2.41 while in IKH is 2.40, in ESMC is 3.64 in NLR is 4.00.
Hypothesis I
Application of appropriate capital budgeting decision practices in public enterprises in
Enugu State has no significant influence on investment in profitable projects for their
growth.
145
Table 4(9) Scores of Respondents in Public Enterprises in Enugu State
NLR ESMC IKH ENTRACO
46 38 25 25
45 46 30 30
48 46 38 31
50 42 25 23
48 35 31 27
Table 4(9) shows the scores obtained from public enterprises in Enugu State. Table
4(10) below shows the analysis of variance.
Table 4(10) Single Classification Analysis of Variance (ANOVA)
Source of Variance
Degree of Freedom(df)
Sum of Squares
Mean squares
F ratio cal.
F table
Between
squares
3
1273,75
424.5833
Within
squares
16
202.8
12.675
33.5
3.01
Total 19 1476.55
The necessary calculation to the above table is in appendix 2(A). As the calculated F
ratio 33.5 is greater than the table value of F 3.01 which was obtained with df 3,16 at 5%
level, the null hypothesis which states that application of appropriate capital budgeting
decision practices in public enterprises in Enugu State has no significant influence on
investment in profitable projects for their growth is rejected.
146
Inference: This means that the application of proper capital budgeting decision practices in
public enterprises in Enugu State influences the selection of profitable investments for the
enterprises.
Hypothesis II
Institution of appropriate control practices in public enterprises in Enugu State has no
significant influence on financial and material returns in the enterprises.
Table 4(11) Scores of Respondents in Public Enterprises in Enugu State
NLR ESMC IKH ENTRACO
46 48 20 37
36 41 30 38
56 43 28 43
42 30 38 27
47 49 40 29
Table 4(11) above shows the scores obtained from public enterprises in Enugu State. Table
4(12) below shows the ANOVA
Table 4(12) ANOVA
Source of Variance
Degree of Freedom(df)
Sum of Squares
Mean squares
F ratio cal.
F table
Between
squares
3
794.95
264.9833
Within
squares
16
3158.6
197.4125
1.34
3.01
Total 19 3983.55
147
The data in the table 4(12) were extracted from the calculation done in appendix
2(B). The enterprises and scores are shown in table 4(11). As the calculated F ratio 1.34 is
less than the table value of F 3.01 which was obtained with df 3,16 at 5% level, the null
hypothesis which states that the institution of appropriate control practices in public
enterprises in Enugu State has no significant influence on financial and material returns in
the enterprises is valid.
Inference: This means that the institution of proper control practices in public enterprises in
Enugu State is not the problem of poor returns of annual sales of the enterprises concerned.
This means that the problem is from unwise investment in unviable projects.
Hypothesis III
Adoption of appropriate motivation practices in public enterprises in Enugu State has no
significant influence on the participation of employees in the generation of investments and
revenue collection strategies.
Table 4(13) Scores of Respondents in Public Enterprises in Enugu State
NLR ESMC IKH ENTRACO
44 43 27 23
50 26 30 18
45 38 25 15
42 37 32 21
48 45 21 17
Table (13) above shows the scores obtained from Public Enterprises in Enugu State. Table
(14) below shows the ANOVA.
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Table (14) ANOVA
Source of Variance
Degree of Freedom(df)
Sum of Squares
Mean squares
F ratio cal
F table
Between
squares
3
2054.15
684.727
Within
squares
16
544.8
34.05
20.11
3.01
Total 19 2598.95
The necessary calculation to the above table is in appendix 2(c). It can be clearly
discerned from the table that the calculated F ratio 20.11 is greater than the table value of F
3.01 which was obtained with df 3.16 at 5% level of significance. Therefore the hypothesis
which states that the adoption of appropriate motivation practices in public enterprises in
Enugu State has no significant influence on the participation of employees in the generation
of investments and revenue collection strategies is rejected.
Inference: This implies that the adoption of appropriate motivation practices in public
enterprises in Enugu State enhances the participation of employees in the generation of
investments and revenue collection strategies.
4.2 Analysis
Preliminary findings indicate that 50% of public enterprises in Enugu State apply
moderate technology in their operations. These findings also point out that 50% of the said
enterprises employ low technology. The implication of these findings is that none of these
companies employ high technology to facilitate their business activities. Even those that
employ moderate technology, use only grass controlling machines. Our interaction with
these companies (Nwakwe, 22/4/2013 and Alumona, 24/3/2013) show that these enterprises
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using moderate technology employ manual approach to tackle most of their business
activities. When we visited the premises of these companies using low technology (Aneke
ENTRACO, 22/4/2013 and Akubue, 22/4/2013) we found that their organizational climate is
poor. Environmental degradation is observable in these enterprises. Information
dissemination in these companies is asymmetrical. This poor organizational climate in these
companies is a product of lack of technological facilities to promote their business activities.
For instance, these companies do not have basic operational tools like grass controlling
machines and inter-communication to ease their linkage with their employees. If this trend is
allowed to continue, a time will come when these enterprises will not be able to maintain its
present level of operations because employees who get an alternative employment will
leave. Every effort should be made to restructure these public enterprises in Enugu state,
Nigeria so that they can experience growth.
Our findings from the oral interview we had with the chief executives of the
companies studied (Alumona, 24/4/2013 and Akubue, 22/4/2013) show that all the
enterprises studied do in fact have Boards of Directors. Even though these enterprises have
their respective Boards of Directors and that these boards permit the managements of these
companies to idealize investment projects that can be propelled to promote the growth of
their enterprises, this study found that these Boards are not functional in their respective
establishments. A deep analysis of our oral interview shows that members of these boards
have little or no knowledge of the companies they were appointed to preside over. The
implication of this scenario is that members of the Board attend meetings only to collect
unearned income as they do not have any technical contribution to make. The rightsizing of
public enter prises in Nigeria should start from the appointment of Boards of Directors who
are supposed to be initiating investment ideas necessary for the growth of their enterprises.
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This study shows that100% of the enterprises studied use internal financing and debt
as sources of raising their capital-mix. The use of government grant as a source of
investment financing mix to run public enterprises in Enugu State means that the enterprises
adopt internal financing since the government owns them. The use of borrowings is an
indication that external bodies have not interfered in the ownership of these companies. This
is in consonance with the financing hierarchy of pecking order model as propagated by
Myers (1984). Introducing equity financing as a means of raising capital mix for public
enterprises makes the owners who are the public to be alienated from the ownership and
control of these enterprises, their appropriate tax regimes were employed to establish. And
because of this implication Myers (1984) in his pecking order model advanced that project
financing should in the first instance be from internal financing, and if this is not feasible,
debt should be used and equity should be adopted if other options fail. Our respondents
pointed out that they raise debt when their cash position is not sufficient to do business.
Looking at the enterprises annual sales, it can be seen that just half of the companies
(ESMC and NLR) have strong capital base. The other two companies (IKH and
ENTRACO), have weak annual sales base. This poor capital base may worsen their
situation. This is because it is the sign of the first stage of financial distress. Financial
distress is when cash inflows of an enterprise are not sufficient to fulfill its obligations. (Loo
f: 2004). Strong cash inflows have competitive advantage due to the fact that customers
prefer to do business with financially stable companies. Enugu state government should do
something to put these companies in better footing.
Analysing investment management practices in public enterprises in Enugu State in
relation to their growth, this research found that the extent to which capital budgeting
decisions practices are adopted in public enterprises in Enugu State table 4(6) was low in
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ENTRACO �̅ = 1.95), low in IKH (�̅ = 2.09), average in EMC (�̅ = 3.59) and high in NLR
(�̅ = 4.17). It was also found that the extent to whom proper control practices are employed
in public enterprise in Enugu State (table 4(7)) was average in ENTRACO (�̅ = 3.51),
average in IKH (�̅ = 3.51), high in ESMC (�̅ = 4.00) and high in NLR (�̅ = 4.35). We also
found that the extent to which proper motivation practices are employed in public
enterprises in Enugu state (table 4(7)) was low in ENTRACO (�̅ = 2.41), low in IKH (�̅ =
2.40), average in ESMC (�̅ = 3.64) and high in NLR (�̅ = 4.00). Result also indicated that all
those enterprises that have low mean rating with regard to the extent to which they employ
appropriate investment management practices are not growing while those enterprises that
have average or high mean ratings are growing. For instance, in (tables 4(4) and 4(3)E) it
can be discerned that ENTRACO has low mean rating and it has O auxiliary enterprise or O
diversified project, its growth potential is O and it has low internal rate of return of 19.81%
table 4(3)E. These depict that ENTRACO is a low growth enterprise. Similarly, IKH has
low mean rating and it has O auxiliary enterprise or O diversified project it growth potential
is O and it has low internal rate of return of 10.2%, table 4(3)E. These also indicate that IKH
is a low growth enterprise. On the other hand, ESMC has average mean rating and it has 1
auxiliary enterprise or 1 diversified project, its growth potential is 33 and it has internal rate
of return of 33.9%, table 4(3)E. These show that ESMC is a moderate growth enterprise.
NLR has high mean rating and it has 3 auxiliary enterprises; its growth potential is 75 and
has high internal rate of return of 34.2%. These depict that NLR is a high growth enterprise.
These enterprises are categorized as poor growth (ENTRACO and IKH), moderate growth
(ESMC) and high growth (NLR), respectively.
In particular, when it comes to the capital budgeting decision practices adopted, table
4(6) shows that all the respondents in poor growth enterprises (ENTRACO and IKH) agree
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that capital budgeting decision practices: payback period, average rate of return, net present
value, profitability index and internal rate of return are not adopted in their investment
management portfolio. This action means that ENTRACO and IKH do not appraise their
investments before they embark on investments. It also means that they do not even appraise
their existing projects to determine whether the internal rate of return is high or low. The
implication of this is that ENTRACO and IKH do not ration their capital and that their
investments are hap hardly done.
The same table also indicates that all the enterprises adopt the principle of first in
first out when they are issuing out stock. On a closer interview we had with the respondents
in poor growth enterprises Aneke (22/4/2010) and Alumona (24/4/2013) to ascertain why
investment appraisal techniques are not applied as criteria for capital rationing, we were
made to understand that they had not enough manpower to carry out project evaluation
techniques. None use of investment appraisal techniques in poor growth enterprises is
inimical to their growth. The internal rate of return of: ENTRACO is low (19.2%) and IKH
is also low (10.2%) (table 4(3)E). These rates are also indicative that they are not growing.
The application of investment appraisal techniques in poor growth enterprises will enhance
their wise investment in productive projects. The fact that poor growth enterprises do not use
investment appraisal techniques is something that strongly disfavours the findings of Sunden
(1978), Pandey (1989) and Rockley (1993) who stated that American, Indian and British
companies adopt investment appraisal techniques during the selection of investment
proposals. Table 4(6) also shows that all the respondents in moderate (ESMC) and high
growth (NLR) enterprises agree that they adopt payback period and, average rate of return,
during the selection of investment project. The same table 4(6) also indicates that
respondents is ESMC and NLR agree that: they ration their capital based on the results
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obtained from investment appraisal techniques adopted during the allocation of capital to
investment projects; they apply current ratio of 2:1 as an indication of cash liquidity and first
in, first out for issuing out stock. The same table shows that only high growth enterprise
adopts net present value. Even though ESMC and NLR do not adopt all the investment
appraisal techniques, the ones they adopt are helping them to invest in viable projects. This
is manifested in their high return on investment, for instance, the internal rate of return of
investment in ESMC is 33.9% and the internal rate of return of investment in NLR is 34.2%.
These internal rates of returns of these public enterprises in Enugu state are indicatives that
they are growing. Even companies in America, India and Britain adopt different investment
appraisal techniques when they want to embark on investment selection as; findings of
Sunden (1978), Pandey (1989) and Rockley (1993) showed that American, Indian and
British companies adopt different investment appraisal techniques. For instance, in Indian
companies, payback period and internal rate of return ranked first and second respectively.
But in American companies, internal rate of return and net present value topped the
appraisal list and in the British companies only payback period criterion is widely adopted.
The fact that ENTRACO and IKH do not ration their capital in accordance with appropriate
investment appraisal techniques during funds allocation to projects disfavours the theoretical
framework for this study, Weingartner’s (1977) capital rationing theory. The implication of
this is that ENTRACO and IKH make haphazard investment. This means making investment
without reference to any result obtained from investment appraisal techniques. Similarly, the
inability of ENTRACO and IKH to adopt current asset liability ratio of 2:1 disfavours
Anyanwu’s (1991) propagation that the current asset: liability ratio of 2:1 is satisfactory as
an indication of cash liquidity. The implication of this, is that they will not know the time
they will go illiquid and unable to solve their immediate cash requirements. Thus, where
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capital budgeting decision practices problems lay is in poor growth enterprises. This is in
view of the fact that they are not adopting investment appraisal techniques and they are not
growing, signaling that the non-use of these techniques is the cause of their poor growth.
In case of control practice adopted in public enterprises in Enugu State, table 4(7)
shows that respondents in ENTRACO and IKH (poor growth enterprises) agree that regular
project reports, rotation of duties amongst employees, just-in-time technique auction of
expiring inventory are adopted as sources of control. The adoption of regular project reports
and rotation of duties by poor growth enterprises is in consonance with the Pandeys (1989)
findings that Indian companies required continuous reporting and rotation of duties amongst
employees as sources of control. It also agrees with Kennon’s (2005) observation that
Japanese companies adopt just-in-time and auction of the inventory whose expiring date is at
hand. The same table 4(7) shows that all the respondents in ESMC and NLR agree that
reappraisal of investment proposal, regular project reports consideration of character of
applicants, capacity background of applicant, rotation of duties amongst employees, just-in-
time reorder – level model, auction of expiring inventory and training of employees are all
adopted as sources of control. However respondents in NLR went further to agree that the
conditions of employees are considered before granting credit to them. Even though
Moderate Growth (ESMC) and High growth (NLR) enterprises do not use all the control
variables as indicated in our empirical review, they still maintain substantial control
practices as indicated by Pandey (1989), and Pandey (2009). Pandey (1989) pointed out that
Indian companies adopt reappraisal and regular reporting as sources of control. Also,
Pandey (2009) found that steel companies in India attempt to identify the customers quality
(character, capital, condition, collateral and capacity) before granting credit to him. Thus, it
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becomes necessary for public enterprises in Enugu State to institute adequate control
practices to enhance financial and material returns.
Analysing the motivation practices, respondents in ENTRACO and IKH agree that
suggestion scheme, conducting market surveys, reduction of time to process invoice of sold
goods, writing letter of reminder to defaulting debtor are the motivation practices adopted in
public enterprises in Enugu State to enhance the encouragement of employees for greater
commitment and participation to the course of their enterprises (table 4(8)). This finding
agrees with Pandey’s (1989) finding that companies in India adopt formal suggestion
scheme and conducting market surveys as ways of employees’ motivation. This finding also
agrees with Pandey’s (1991) observation that reduction of time to process invoice of sold
goods and writing letter of reminder to defaulting debtors can also motivate employees in an
enterprise. This is because these actions could promote revenue generation of their
enterprise. The inability of ENTRACO and IKH to embrace other motivation practices like
project initiation coming from divisional management and plant level and training of
employees could be pathological to the growth of their enterprises as employees would not
be ready to put in their best in their enterprises.
When it comes to ESMC and NLR, respondents in these companies agree that
investment generation emanating from divisional management and plant level, providing
avenue for suggestion scheme, conducting market surveys, attending international trade fair,
modernization of existing projects, expansion of existing of business level, establishing
auxiliary enterprises, reduction of time to process invoice of sold goods, making telephone
calls to remind debtors to pay their debts and paying personal visit are adopted by both
enterprises as motivation practices (table 4(8)). They are motivation practices because these
actions could promote the revenue base of these enterprises. This finding agrees with
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Sunden’s (1978) finding that project initiation was bottom up in American companies. This
finding also agrees with king’s (1988) finding that project initiation was generated at plant
level in British companies and that investment generation is a bottom-up. However,
respondents in NLR alone agree that employee get project initiation from research centres
and review researches done on project initiation in the country or abroad. This finding
concurs with Pandey’s (1989) finding that Indian companies visit research centres for
project initiation and review and adopt researches done in the country or abroad. The
inability of all public enterprises in Enugu State to sponsor employees for studies in project
initiation could be due to lack of fund, but training employees is part of investment for
greater performance. For all public enterprises in Enugu State not to use legal action to
recover their money from debtor could be that legal action involves more expenditure than
the bad debt. Therefore, it would be unwise to use bigger amount to recover small amount of
money. In all, project generation is poor especially in ENTRACO and IKH enterprises due
to the fact that the motivational practices for employee encouragement are few and hence
inadequate.
The result of hypothesis 1 (table 4(10)) reveals that the application of appropriate
capital budgeting decision practices in public enterprises in Enugu State has significant
influence on the investment in productive projects for the growth of the enterprises. This
implies that capital budgeting decisions promote investments in profitable projects in public
enterprises in Enugu State.
The result of hypothesis II (table) 4(12) shows that the institution of proper control
practices in public enterprises in Enugu State is not the problem of poor financial returns of
annual sales of the enterprises concerned but the problem is making investments in unviable
projects.
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Result of hypothesis III (Table 4(14)) reveals that the adoption of appropriate
motivation practices in public enterprises in Enugu State has significant influence on the
participation of employees in the initiation of projects and revenue collection strategies. This
means that motivation of employees encourage them to be committed to project initiation
and revenue collection strategies in public enterprises in Enugu State.
This finding means that managements of NLR and ESMC adopt almost the same
motivation practices to enhance the encouragement of employees for investment generation
in their respective enterprises (table 4(8)). On the other hand, managements of NLR adopt
different and wider motivation techniques than managements of ENTRACO and IKH.
Similarly; managements of ESMC adopt more scope of motivation practices than
managements of ENTRACO and IKH. This could explain the reason why auxiliary
enterprises are found more in NLR and ESMC. This implies that employees of NLR and
ESMC initiate investment ideas and employees of ENTRACO and IKH do not.
4.3 Findings
The followings are the results of this research.
1. From this analysis, we deduce that the extent to which capital budgeting decision
practices were employed in public enterprises in Enugu State was low in
ENTRACO, (x = 1.95), low in IKH (x = 2.09), average in ESMC (x = 3.59) and
high in NIR (x = 4.17). Result of this study showed that ENTRACO and IKH did
not adopt investment appraisal techniques for the evaluation of their project
proposal. ESMC adopted payback period and average rate of return during the
evaluation of its investment and NLR adopts payback period, average rate of return
and net present value during the evaluation of its investment proposals. The growth
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potential of ENTRACO was 0 and for IKH it was also 0, for ESMC it was 33 and for
NLR it was 75. The internal rate of return (IRR) of investment is ENTRACO was
19.8%. The IRR of investment in IKH was 10.2%. The IRR of investment in ESMC
was 33.9% and that of NLR was 34.2%.
2. This result showed that the extent to which control practices were employed in
public enterprises in Enugu State was average in ENTRACO (�G= 3.51), average in
IKH (�G = 4.00) high in ESMC (�G = 4.00) and high in NLR (�G = 4.35). Findings of
this study indicated that ENTRACO and IKH adopted the followings as control
practices to enhance financial and material returns: regular project reports, rotation
of duties, just-in-time (JIT) for inventory control, and auctioning of expiring
inventory. Findings also showed that ESMC adopts: reappraisal of investment
proposal, regular project reports, and consideration of: character, capacity of
applicants before granting credit to him as control practices. ESMC also adopted:
rotation of duties, just-in-time (JII) for inventory control, recorder level model,
auction of expiring inventory, and training of employees as control mechanisms. Our
findings also show that NLR embraces reappraisal of investment proposal, regular
project reports as practices of control NLR also considered: character, condition and
capacity before granting credit to an applicant. Capital and collateral of applicants
are not considered before granting credit facility to them. It was also found that
rotation of duties, just-in-time (JIT), re-order level model, auction of expiring
inventory, and training of employees to enhance their responsibility were adopted as
control practices by NLR. We can infer here that all public enterprises in Enugu
State have almost equal control variables. However, they are not adequate enough to
promote financial and material returns to all the enterprises.
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3. The extent to which motivation practices were employed in public enterprises in
Enugu state was low in ENTRACO (x = 2.41), low in IKH (x = 2.40) average in
ESMC (x = 3.64) and high in NLR (x = 4.00). Our findings showed that
ENTRACO and IKH adopted the followings as motivation practices to raise the
employee morale in the performance of his duties. These motivation practices
included: giving employees opportunity for open suggestion scheme, conduction of
market surveys, reduction of time to process invoice of sold goods, and writing letter
of reminder to their defaulting debtors. When it comes to ESMC, this company
adopted: allowing project initiation to come from divisional management and plant
level, providing for open suggestion scheme, conducting market surveys, sending
their executive officers to attend international trade fair, modernization of existing
projects, expansion of existing business level, establishing auxiliary enterprises,
reduction of time spent on invoice processing, making telephone calls to remind
debtors to pay their debt, and making personal visit to the home of debtor to recover
their money as motivation mechanisms. Our analysis of the questionnaire showed
that NLR and ESMC have the same motivation mechanisms except that in addition,
NLR; visits research centres for project initiation and review researches done on
project initiation in the country or abroad. Drawing inference on this finding, we say
that motivation mechanisms in ENTRACO and IKH were inadequate, thus they have
poor investment generation, making every one of them to have 0 auxiliary enterprise.
In ESMC, motivation mechanisms are less than the ones adopted by NLR. Project
initiations by employees exist in NLR and ESMC, ESMC has 1 auxiliary enterprise
and NLR has 3 auxiliary enterprises.
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4. The result of hypothesis1 (Table 4(10)) showed that F calculated (33.5) > F α = 0.05
and df = (3.16) (3.01). Hence the null hypothesis is rejected. This means that
application of appropriate capital budgeting decision practices in public enterprises
in Enugu State has significant influence on the selection of profitable investments.
5. The result of hypothesis II table (4(12) showed that F calculated (1.34) < fα = 0.05
and df = (3.16) (3.01). Hence the null hypothesis (Ho) is accepted. The adoption of
proper control practices in public enterprises in Enugu State has no significant
influence on their financial returns. This implies that institution of appropriate
control practices in public enterprises in Enugu State is not the problem of poor
returns of annual sales of the enterprises concerned but this problem is investing in
unprofitable projects. This is because proper controls are put in place in all the
enterprises studied.
6. The result of hypothesis III (Table 4 (14) indicated that F calculated (20.11) > fα
=0.05 and df = (3.16) (3.01).
Therefore the null hypothesis (Ho) is not valid. This means that the adoption of
appropriate motivation practices in public enterprises in Enugu State has significant
influence on the participation of employees in the generation of investment and revenue
collection strategies.
Findings of this study have some important management implications especially
today that there is pressing need to intensify efforts towards improving the management of
public enterprises. This study reveals that all public enterprises in Enugu State do not adopt
certain investment appraisal techniques like: profitability index, internal rate of return and
weighted average cost of capital as discount rate during the evaluation of investment project.
Under this condition, managements of public enterprises will find it difficult to ascertain the
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unit profit of goods sold; they will also find it difficult to a ascertain whether return on
investment is equal, less or greater than the rate of interest or not. The adoption of one
components cost of capital disfavours investment as the risk involved in other components
are disregarded when they are not aggregated as part of discount rate.
These findings also reveal that managements of some public enterprises in Enugu
State do not consider the capital stand and collateral of customers before approving credit
facility for them. This action may lead to encountering doubtful debt which could lead to
bad debt as there will be no place to lay hand should the recovery of the money proves to be
difficult.
In addition, these findings also show that all public enterprises in Enugu State do not:
Sponsor employees for studies in project initiation and that ESMC and NLR do not write
letter of reminder to their defaulting debtor. All public enterprises in Enugu State do not
adopt legal actions in an attempt to recover bad debts. Project initiation course improves the
decision making skill of the personnel concerned. In effect the absence of project initiation
training in public enterprises in Enugu state limits the employees’ investment generation.
Writing letter of reminder solves the problem of information asymmetry. Letter of reminder
closes the information gap between the creditor and the debtor. However costly legal action
maybe, it can be applied as the last resort to recover bad debts. Alternatively, instead of
incurring more costs arising from legal action, an enterprise can renegotiate with the debtor
for a reduced payment and for a spread payment.
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CHAPTER FIVE
DISCUSSION
The discussions are presented under the following subthemes:
- Capital Budgeting Decision Practices in public enterprises in Enugu state
- Control Practices in public enterprises in Enugu State
- Motivation Practices in public enterprises in Enugu State
5.1 Capital Budgeting Decision Practices in Public Enterprises in
Enugu State
The emergence of public enterprises in Nigeria is not a new development. It existed prior to
the advent of colonial administration. Our traditional societies established public enterprises
to cater for their common and individual needs which private individuals could not establish.
These included rain harvesting ponds, sporting centres, roads and security outfits. However,
the incursion of colonial administration in Nigeria led to the expansion and modernization of
public enterprises. These public enterprises grew and flourished until when wrong sizing
came into their management. For instance, engineers were assigned to manage museum
centres and historians were made general managers of steel companies. Public enterprises
were run by wrong personnel. At that time, the adoption of capital budgeting decision
practices (investment appraisal techniques), appropriate control practices and appropriate
motivation practices in the management of public enterprises were not worthwhile. But with
the recent turn around maintenance and management policy of the federal government, the
integration of appropriate investment management practices in public enterprises in Enugu
State becomes paramount.
When we were setting out for this study, we considered it necessary to acquire basic
information relevant to the background of public enterprises in Enugu State. Our first
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striking finding was the poor physical condition of 50% of these enterprises
(Alumona,12/4/2013).
Findings of this study showed that the offices of 50% of these enterprises studied were made
of cabins or what are popularly known as “containers”. This research discovered that 50% of
these enterprises studied adopted low technology and the other 50% adopted moderate
technology. Analysis of our questionnaire showed that none of these enterprises studied
adopted high technology to catalyze its operations. The inability of these companies
adapting low technology to modernize their scope of activities generateed a lot of negative
implications for them. They lost out more sales volume as customers were discouraged to
patronize them. Moreover, these companies operated below labour capacity as employees
were not prepared to initiate ideas on investment areas due to poor motivation.
Government did well by instituting Boards of Directors to supervise the workings of her
public enterprises. Some of these Boards of Directors did of course pursue the objectives of
their establishments to logical conclusions, but some others did not. Government should
give all Boards of Directors of her establishments the same orientation so that the goals of
the government can be delivered.
Result of this study showed that financing hierarchy of pecking order model holds in
public enterprises in Enugu State. It was found that managers of public enterprises in Enugu
State considered internal financing to be cheaper and easier to use than external financing
and debt to be cheaper and easier to use as financing than equity. Cost difference in this
context is the degree of information asymmetry in the financing source (Sever in: 2006).
Certainly managers of public enterprises in Enugu State do well by not subjecting their
enterprises to equity financing because equity financing generates information asymmetry
which makes the shareholders to over value these enterprises. The implication of over
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valuing enterprise is high dividend demand. Even though vendor supply is in form of debt,
its major difference between the actual debt is that it does not attract interest. Therefore
public enterprises in Enugu State enjoying this benefit should not abuse it by paying back
the realized money from the sold goods to the supplier.
This study showed that 50% of public enterprises in Enugu State had weak annual
sales returns. Yes, they can embark on aggressive marketing using various instruments to
attract customers for enhanced patronage. Press releases, banners indicating special features
of products and adopting loyalty card scheme (Desager 2008) can be used to show case the
business activities of these enterprises. It is very disappointing that in this modern time, a
company can have 0 growth potential. Aggressive business management achieved by the
incorporation of proper investment management practices can reverse this trend.
In our empirical review we discovered that the findings of Sunden (1978), Pandey
(1989) and Rockley (1993), revealed that all growing companies in America, India and
Britain applied one or more investment appraisal techniques during the evaluation of their
investment projects. In this study as portrayed in table 4(6), ENTRACO and IKH did not
apply any of the investment appraisal techniques during the screening of investment project.
This action contradicts the investment practices of high growing American, Indian and
British companies. This development certainly inhibits the growth of enterprises in this
group. Public enterprises in this group did not however ration their capital as we indicated in
the capital rationing theory that public enterprises in Enugu State should ration their capital
in consonance with results obtained from investment appriasl techniques chosen. Their
investment capitals are rationed without reference to any criterion. This could be attributed
to the existence of the government owned financial system which always raises funds to
finance her profitable projects. This action possibly rendered the employees of public
165
enterprises less interested to embark on project evaluation. In addition, this may be due to
lack of technical manpower to handle the analytical computations involved in project
appraisal. Public enterprises in Enugu State should not attract government funds to waste
them. If favourable investment opportunities are to be created in public enterprises in Enugu
State, there must be right sizing of men, material and money. This means that appropriate
heads and hands must be put in their suitably fit places to take care of both tangible and in
tangible assets of their enterprises. Capital is a scarce commodity. Capital allocations are not
expected to be done on anyhow basis, and capital allocation should be based on scientific
logic based on mathematical models. Mathematical models are adopted to calculate cash
flow (in flow and out flow) estimates of investment. Cash flow estimates must be computed,
tabulated and ranked and investment projects allocated according to this ranking. Equally,
funds must be rationed in accordance with the allocation of these projects. Additional
budgets must not be provided for to accommodate other less viable projects.
Table 4(6) shows that both ESMC and NLR do adopt payback period and average rate of
return. In addition, NLR adopts net present value during project evaluation. They conduct
market surveys to obtain information on the current selling prices of their intended products
or products of close substitutes. These selling prices are used to estimate cash inflows from
the products. Hence, using their respective cash inflow estimates, and the prevailing interest
rates, they appraise these investment projects. However, we recall here that pay back period
technique does not require interest rate for calculation. After the appraisal, they rank the
investments according to the rule guiding the appraisal model adopted. This ranking is
followed by the selection of investment projects. This selection is made in such a way that
their invested capital does not exceed the capital outlay. Finally capital is rationed to these
investments. The use of investment criteria like internal rate of return and profitability index
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or cost benefit ratio is not recognized in all the enterprises. Impliedly, the enterprises that
have favourable growing environment are those ones adopting one or two investment
appraisal techniques. The F calculated is 33.5 and the F table value is 3.01. This shows that
the employment of capital budging decision in public enterprises in Enugu State has
significant influence on investment in profitable projects. Investing in viable projects yields
high financial returns. High financial return is used to diversify investment.
From this discussion, we can infer that the growth of public enterprises depends to a large
extent on the adoption of investment appraisal techniques during the evaluation of
investment projects. This is evidenced by the fact that all the public enterprises in Enugu
State (ESMC and NLR) that employ capital budgeting decisions are growing and the ones
that do not employ them (ENTRACO and IKH) are not growing. The extent to which capital
budgeting decisions practices were instituted in public enterprises in Enugu State was low in
ENTRACO, low in IKH, average in ESMC and high in NLR.
5.2 Control Practices in Public Enterprises in Enugu State
The adoption of regular project reports, rotation of duties, just-in-time technique and
auction of inventory whose expiry date is at hand by all public enterprises in Enugu State
table 4(7) could be adjudged to be interesting methods of controls. The adoption of regular
reports implies that all the enterprises do in fact monitor their investments with serious
attention. Investment monitoring is one of the most important aspects of control practices as
it ensures that proper specification is followed, cash flows (inflow and outflow) are
accounted for and that daily stock taking is maintained. Rotation of duties facilitates an
independent internal checks, reviewing of previous activities and most importantly relieves
employees of fatigue (Chime, 2003). Rotation of duties enhances the vertical growth of
167
employees’ job enrichment. The use of just-in-time as a method of control saves the cost
that could be lost to damage especially as it affects perishable goods. In this case goods are
brought in as the need arises.
In addition, IKH considers the capital stand and collateral or asset which a customer
can offer before granting credit to him. Even though other components of customer quality
are important for the securing of debt, collateral is the most important component. This is
because the creditor can fall back on it should the debt become doubtful or bad. ENTRACO
adopted consideration of the condition character of the applicant before granting credit to
him.
In addition to the above control methods adopted by ESMC and NLR, they also
adopt; reappraisal of investment projects, taking into cognizance: quality of customer before
granting credit to him. This means that the characters of applicant before granting credit to
him, applicants capacity before granting credit to him, reorder level method, training and
retraining of employees are adopted. Manpower development enhances personnel decision –
making and control skill. Reappraisal of investment projects is important as it reveals
whether there is need to review cost upwards or downwards. NLR take into consideration,
the condition of applicant before offering him credit facility. This involves ascertaining his
goodwill and credit worthiness. Good character of a customer is demonstrated in his ability
to deliver his promise at appropriate time. The reliability of a customer to pay back his debt
as contracted determines whether he will be given credit facility or not. Customer’s capacity
indicates his ability to borrow from other sources in order to be able to repay his debt on or
before the agreed date. Customer’s condition is built in the prevailing economic and other
conditions which can enhance or impede on his ability to payback his debt on the stipulated
date. The inability of all public enterprises in Enugu State to adopt all the components of the
168
customer quality as adopted by Indian steel companies (Pandey, 2009) could pose problems
should the problem of bad debt occur in the enterprises. Comprehensive adoption of
customer quality (character, capacity, collateral, condition and capital) will in no small way
protect the enterprises from encountering bad debt. Ideally, information concerning
customer quality should be obtained before granting credit facility to him. The F calculated
is 1.34 and the F table value is 3.01 (table 4(12). This means that the adoptions of proper
control practices in public enterprises in Enugu State has no significant influence on cash
inflows in the enterprises. At this point, we can therefore draw inference that any observed
poor cash inflows in any of public enterprises in Enugu state is attributable to unwise
investment. The extent to which control practices were adopted in public enterprises in
Enugu state was average in ENTRACO average in IKH, high in ESMC and high in NLR.
5.3 Motivation Practices in Pubic Enterprises in Enugu State
Motivation practices in public enterprises in Enugu State are not impressive.
ENTRACO and IKH adopt only: suggestion scheme, conducting market surveys, decreasing
of time to process invoice of sold goods and writing letter of reminder to defaulting debtor
to pay his debt (table (8)). The adoption of these few motivational techniques jeopardizes the
extent to which employees are mobilized for investment generation. Both ESMC and NLR
have more expanded motivation approaches to encourage employees for greater
participation and commitment more than ENTRACO and IKH. For instance in addition,
both ESMC and NLR embrace integration of employees in decision making by allowing
project initiation to come from divisional management and plant level, conducting market
surveys on project initiation, sending executive officers to international trade fair to identify
new product, modernization of existing project for enhanced revenue generation, expansion
169
of existing business level in order to enhance revenue generation, establishing auxiliary
enterprises as a means of raising revenue generation, making telephone calls to remind
debtors to clear their debt and paying personal visit to the home of debtors to recover
money. In addition to the above motivation practices in ESMC and NLR, NLR encourages
its employees to visit research centers for project initiation, and review researches done on
project initiation in the country or abroad. The level of motivation practices adopted in
ESMC and NLR is encouraging because both companies adopt almost the motivation
variables raised in this questionnaire. However, the inability of all the enterprises to embrace
motivation variable of sponsoring employees for studies in project initiation poses a serious
threat to implementing other motivation techniques which they adopt. This is because
training and retraining of employees improve the extent to which employees can digest and
adopt their knowledge to their organization. The case of ENTRACO and IKH is the worst,
out of the fifteen identified motivation variables in this study, only four motivation variables
are practiced by ENTRACO and IKH. The implication of this is poor motivation of
employees for investment generation. Consequently, this led to the possession of 0 auxiliary
enterprise by each of ENTRACO and IKH. From this discussion, we can understand that
investment generation depends to a large extent on the motivation practices adopted. In
effect ENTRACO and IKH employed motivation practices to a lesser extent and ESMC and
NLR employed motivation practices to a large extent. The F calculated is 20.11 and the F
table value is 3.01 (table 4(14). This means that the adoption of proper motivation practices
in public enterprises in Enugu State has significant influence on the participation of
employees in investment initiation and revenue collections strategies.
170
CHAPTER SIX
SUMMARY, RECOMMENDATIONS AND CONCLUSION
6.1 Summary
In this research work, we examined investment management practices and growth of
public enterprises in Enugu State. The findings from this study led us to categorize public
enterprises in Enugu State into three groups. These groups included: poor growth
enterprises, moderate growth enterprises and high growth enterprises. Poor growth
enterprises consisted of two enterprises namely. Ikenga Hotels Ltd and Enugu State
Transport Company. One enterprise namely Enugu state Marketing Company Ltd belonged
to moderate growth. Similarly, only Nike Lake Resort Hotels belonged to high growth
enterprise. In order to prosecute this research, we studied capital budgeting decision
practices, control practices and motivation practices in public enterprises in Enugu State.
These are the components of investment management practices. Preliminary findings from
this study showed that ENTRACO and IKH adopted low technology and each of ESMC and
NLR adopted moderate technology. For instance, this study found that in ENTRACO, IKH
and ESMC manual labour was used in the processing of their products even in data storage
and data retrieval. However, ESMC differed from ENTRACO and IKH in that machines
were used to keep its environment clean as we found. Even though the level of technology
which NLR employed was moderate, it was found that its data storage and retrieval are
electronically based. Furthermore, findings from this study showed that all public enterprises
in Enugu State raise their capital mix from internal financing and debt. Thus, they obeyed
financing hierarchy of pecking order model as propagated by Myers (1984).
On the application of capital budgeting decision practices in public enterprises in
Enugu State, we found that 2 enterprises namely ENTRACO and IKH did not integrate them
171
as reference points during capital investment projects. This made them to embark on unwise
investment projects that is investing in unviable project, and consequently resulting to poor
returns. The internal rate of return on investments in ENTRACO was 19.8% and that of IKH
was 10.21%. This work also found that ESMC and NLR adopted payback period and
average rate of return. In addition NLR adopted net present value during evaluation of its
investment projects. ESMC invested in viable projects. NLR also invested in viable projects.
These enterprises had high returns on invested capital. For instance, the internal rate of
return on investment in ESMC was 33.9% and the internal rate of return (IRR) on
investment in NLR was 34.2%. Impliedly, both ENTRACO and IKH were not growing
while ESMC and NLR were growing. The growth potential of ENTRACO was 0 and that of
IKH was also 0. The growth potential of ESMC was 33 and that of NLR was 75. This study
found that the hypothesis which stated that the application of appropriate capital budgeting
decision practices in public enterprises in Enugu state had no significant influence on
investment in profitable projects was not valid.
On control practices, it was found that all public enterprises in Enugu state adopted
the use of regular project reports, rotation of duties, just-in-time techniques and auction of
expiring inventory as methods of control. We also found that in addition, ESMC and NLR
adopted reappraisal of investment projects, assessment of customer’s character, assessment
of customer’s capacity, use of reorder level model, and training of employees as methods of
control in public enterprises in Enugu state. Furthermore in NLR only, assessment of
condition of customer is also adopted as control practices. Control practices in public
enterprises in Enugu state were inadequate. It was found that the hypothesis which stated
that the adoption of proper control practices in public enterprises in Enugu State had no
significant influence on financial and material returns was valid. Both growing and declining
172
enterprises were adopting similar and near equal control practices. Hence the problem of
lean financial and material returns to some enterprises is due to unwise investments.
As it concerns motivation practices, our findings showed that all public enterprises in
Enugu state did of course provide for suggestion scheme aimed at project initiation. This
action motivated employees as it gave them a sense of belonging. This was an indication
that they were being carried along. This finding also showed that all the studied enterprises
were encouraged to conduct market surveys on project initiation for enhanced revenue
generation. It was also found that reduction of time to process invoice of sold goods was
also adopted as a strategy for enhanced revenue collection by the enterprises. However, our
findings showed that the other enterprises ESMC and NLR went further to incorporate other
motivating variables. For instance, in ESMC and NLR, project initiation emanated from
divisional management and plant level. In ESMC and NLR, executive officers were
encouraged to attend international trade fair to identify new product or new technology for
the advancement of revenue generation of the enterprises. This finding also showed that
modernization of existing projects, expansion of existing business level and establishment of
auxiliary enterprises were adopted to encourage employees for greater commitment to
project idealization. Other ones used by the duo according to our findings were use of
telephone calls to remind their debtor to pay their dept and making personal visit to the
home of their debtor to recover their debt. The incorporation of more motivating variables
made employees of ESMC and NLR to be initiating investment ideas for the growth of their
enterprises. In addition to the already identified motivation practices of NLR, this enterprise
further encouraged her employees to visit research centre for project initiation NLR also
encouraged employees to review researches done an project initiation in both domestic and
foreign arena. The hypothesis which stated that the adoption of appropriate motivation
173
practical in public enterprises in Enugu State had no significant influence on the
participation of employees in the generation of investment and revenue collections strategies
was not valid. This is evidenced by the fact that all those enterprises that adopted proper
motivation practices (ESMC and NLR) were initiating investment projects and the ones that
did not employ appropriate motivation practices (ENTRACO and IKH) were not initiating
investment projects. For instance, ENTRACO had 0 auxiliary enterprise, IKH had 0
auxiliary enterprise, ESMC had 1 auxiliary enterprise and NLR had 3 auxiliary enterprises.
6.2 Recommendations
Based on the findings of this study, we make the following recommendations:
1. Public enterprises in Enugu state should adopt internal rate of return technique.
Internal rate of return techniques will help the enterprise to ascertain the progression of
the returns on invested capital. Low internal rate of return on investment shows that
the enterprise’s growth is descending because it indicates that the enterprise cannot
finance diversification of investment. On the other hand high internal rate of return on
invested capital is an indicative that the enterprise’s growth is ascending because it
depicts that the enterprise can finance investments in auxiliary enterprises. Internal rate
of return on investment is not externally determined. It also ascertains the level of
interest an investment can withstand.
2. Public enterprises in Enugu state should adopt as control practices, consideration of the
capacity and collateral (asset which a customer can offer) before granting credit to
him. They should also adopt other control practices like reappraisal of investment
projects, training and retraining of employees to enhance their project initiating skill.
3. Public enterprises should be sponsoring employees for studies in project initiation.
This will improve their investment generation skill.
174
6.3 Conclusion
From the analysis and discussion of this study, it can be seen that not all public
enterprises in Enugu state do employ capital budgeting decision practices. And even those
that employ some, do not employ profitability index and internal rate of return. The one that
employs net present value does not apply weighted average cost of capital as discount rate.
We therefore conclude by arguing that the problems challenging the growth of public
enterprises in Enugu state are adoption of inadequate investment appraisal techniques during
the evaluation of their investment proposal. This continued inadequacy can lead to unwise
investment and consequently poor returns on invested capital.
It can also be seen from the analysis that some public enterprises in Enugu state do
not consider capital stand and collateral which customers can offer before giving them
credit. Two enterprises do not employ reappraisal of investment and training and retraining
of employees as means of control. Leniency in control practices could lead to doubtful debt
and bad debt in an organization and because of this, control practices in public enterprises in
Enugu state should be comprehensive as raised in this study questionnaire. Inadequate
adoption of motivation practices hinders the encouragement of employees of public
enterprises in Enugu state for the idealization of investment. This has adversely affected the
expansion of the business scope of the enterprises. For instance public enterprises in Enugu
state have few auxiliary enterprises to support their existing level of operations. The
continued adoption of inadequate motivation practices in public enterprises in Enugu state
will not only hinder the commitment and participation of workers but in addition may make
them to leave the job. Employee retention is very important in an organization as already
trained employee will contribute his wealth of knowledge for its growth. What is needed
now in Nigerian public enterprises is turn around management. The hub of turnaround
175
management is the improvement of financial management principles which is rooted in the
inculcation of appropriate investment management practices in Nigerian public enterprises
and public enterprises in Enugu state in particular.
176
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ORAL SOURCES
Akubue, J: Procurement Manager ESMC. Interview 17 and April 22 April 2013
Alumona, T. Manager. IKH Interview 12 and 24 April 2013
Nwakwe, S. Human Resource Manager NLR. Interview 17 April 2013 and 22 April 2013
Aneke, L. Administrative Manager ENTRCO Interview 17 and 24 April 2013
187
Department of Public Administration And Local Government University of Nigeria Nsukka 22nd January, 2012
Dear Respondent,
REQUEST TO COMPLETE QUESTIONNAIRE
I am a doctoral candidate (Reg, No.PG/PhD/03/35329) in the above-
mentioned department in the University of Nigeria I am carrying out a study
titled, “Investment Management Practices in Public Enterprises in Enugu
State” (IMPPEES).
I strongly request you to provide me with necessary information and data
as requested in the questionnaire. This is an academic exercise and will be
treated as such. May you regard this request as part of your contribution to my
completion of the Ph.D. programme.
Thanks for your maximum co-operation.
Yours faithfully,
Odo Frederick C.
188
QUESTIONNAIRE ON
INVESTMENT MANAGEMENT PRACTICES IN PUBLIC ENTERPRIS ES
IN ENUGU STATE
SECTION A: BACKGROUND
1. Name of the Enterprise ………………………………..………………..
2. Number of Employees ……………………………………………..…..
3. Annual Sales in Naira ………………………………………………….
4. Net Fixed Assets ………………………………………………….
5. Annual Capital Expenditure…………………...…………………………….
6. Level of Technology ………………………………………………….
7. Year of Establishment ………………………………………………….
SECTION B: CAPITAL BUDGETING DECISION PRACTICES
S/No Items Strongly
Agree
Agree Undecided Disagree Strongly
Disagree
1. Payback period technique is
used to appraise projects before
investment is made
2. Net present value techniques is
used to appraise projects before
investment is made
3. Profitability Index cost-benefit
ratio technique is adopted when
appraising projects for
investment
189
4. Internal rate of return technique
is used to appraise projects
before investment decision is
made
5. Average Rate of return is used
to appraise projects before
investment decision is made
6. Weighted average cost of
capital is used as the discount
rate
7. Capital rationing approach is
adopted when embarking on
investment projects
8. Current ratio of2:1 (current
assets: current Liabilities) is
used as indication of cash
liquidity.
9. First in first out is used as a
criterion for issuing out stock
10. Last in first out is used as a
criterion for issuing out stock
190
SECTION C: CONTROL PRACTICES
S/No Items Strongly Agree
Agree Undecided Disagree Strongly Disagree
11. We embark on reappraisal of investment proposal as a means of control
12. We practice control through the
use of regular project reports
13. We consider applicant’s character before granting credit to him.
14. We consider applicant’s capital background before granting credit to him
15. We consider applicant’s condition before granting credit to him
16. We consider applicants’ collateral before granting credit to him.
17. We consider applicant’s capacity before granting credit to him.
18. Rotation of duties amongst employees is adopted as a means of control
19. Just-in-time technique is used as a source of inventory control.
20. Re-order level model is adopted
as a means of inventory control
21. We auction inventory whose
expiry date is at hand
22. Our employees are trained to
enhance their responsibility
191
SECTION D: MOTIVATION PRACTICES FOR ENHANCING INVES TMENT
GENERATION AND COLLECTION STRATEGIES
S/No Items Strongly
Agree
Agree Undecided Disagree Strongly
Disagree
23. In order to motivate our
employees, project initiation
come from divisional
management and plant level
24. We encourage our employees
to go to research centres for
project initiation
25. Management sponsors
employees for studies in project
initiation
26. Workers are encouraged by
giving room for suggestion
scheme for project initiation
27. Employees are given the
provision to review researches
done on project initiation in the
country or abroad
28. Workers are encouraged to
conduct market surveys on
project initiation
29. Executive officers are sent to
international trade fair to
identify new product or new
technology
192
30. We embark on modernization
of existing projects as means of
enhancing revenue generation.
31. We embark on the expansion of
existing business level in order
to raise revenue.
32. We embark on establishing
auxiliary enterprises as a way
of promoting revenue
generation
33. One of the strategies for
revenue collection is the
reduction of time to process
invoice of sold goods.
34. We write letter of reminder to
our defaulting debtor to pay his
debt.
35. We make telephone calls to
remind our debtor to pay his
debt.
36. We pay personal visit to the
home of our debtor to collect
our money
37. We collect money from our
debtor through legal action.
193
ORAL INTERVIEW ITEMS
1. In what year was the company established?
2. Do you have organizational structure chart (organigram)?
3. Do you use loyalty card scheme to promote the relationship between you
and your customers?
4. What are the sources of your finance (company’s finance)?
5. Do you obtain funds from money lenders or do you use hedge funds to run
your business?
6. (a) May you please explain to me your budgetary process; (b) What are
your control tools? (c). What are your control mechanisms?
7. How does the government fund the enterprise?
8. What are the sources of your investment generation?
9. What are your revenue collection strategies? Or How do you collect money
from your customers?
10. How are the members of the board of directors appointed?
11. How do you control your finances?
12. How do you control your inventory?
13. What are the activities that you use to promote customer patronage of your
business?
14. Do you use shares to raise capital for your company?
15. What investment appraisal techniques do you use?
16. How are your workers motivated?
17. Do you raise debt within and or outside the country?
18. When do you issue equity (share) capital?
19. What are your expenditure planning phases?
20. Does your company have an optimal leverage ratio?
194
APPENDIX 1 (A)
Calculation of Pearson’s Correlation Coefficient
Pearson’s Correlation coefficient formula: ∑xy – (∑x) (∑y) R = N ------------------------------------ √ (∑x2 – (∑x)2 ) ((∑y2 – (∑y)2 N N Source: (Downie and Heath, 1974) CALCULATION OF r: S/N Even No. Odd No. X Y X2 Y2 XY 1. 6 6 36 36 36 2. 6 6 36 36 36 3. 6 6 36 36 36 4. 6 5 36 25 30 5. 6 6 36 36 36 6. 6 6 36 36 36 7. 6 4 36 16 24 8. 6 3 36 9 18 9. 6 5 36 25 30 10. 6 6 36 36 36 11. 6 6 36 36 36 12. 6 6 36 36 36 13. 6 6 36 36 36 14. 6 4 35 16 24 15. 3 6 9 36 18 16. 6 6 36 36 36 17. 6 6 36 36 36 18. 5 6 25 36 30 ∑x=104 ∑y= 99 ∑x2= 610 ∑y2= 359 ∑xy= 570 r = 570 – (104) (99) 37 ---------------------------
√ (610 – (104)2 (559 – (99)2
37 37
195
R = 291.729 ------------------- √ 93430.99197 R = 291.729 ------------- 305.664836 R = 0.954408115
1 (B)
Spearman Brown prophecy formula for correcting errors inherent in the half length
correlation coefficient calculation:
R = 2r1/2 ---------- 1 + r1/2 R = 2 x 0.954408115
1 + 0.954408115
= 1. 90881623
1. 954408115
= 0.97667
= 0.98
This is a very high correlation.
196
APPENDIX 2A
CALCULATION OF SINGLE CLASSIFICATION ANALYSIS OF VA RIANCE
X1 X2 X3 X4
NLR ESMC IKH ENTRACO 21X 2
2X 23X 2
4X
1. 46 38 25 25 2116 1444 625 625
2. 45 40 30 30 225 1600 900 900
3. 48 40 38 31 2304 1600 1444 961
4. 50 42 25 23 2500 1714 625 529
5. 48 35 31 27 2304 1225 961 729
∑ 1X ∑ 2X ∑ 3X ∑ 4X ∑21X ∑
22X ∑
23X ∑
24X
237 195 149 136 11249 7633 4555 3744
Total Sum of squares
( )N
XXX
2
221
∑∑ −=
( )20
136149195237374445557633249,11
2+++−+++=
20
51408927181−
45.2570427181−=
55.1476=
The between sum of – squares
( )N
X
n
XXb
222 ∑∑ −=
20
514089
5
136
5
149
5
195
5
237 2222
−+++=
45257042.36992.444076058.11233 −+++=
197
45.257042.26978 −=
75.1273=
Within sum of squares
( )∑
∑−=n
XXX
2
121
21
( )5
23711249
2
−=
8.1123311249−=
2.15=
( )∑
∑−=n
XXX
2
222
22
( )5
1957633
2
−=
76057633−=
28=
( )5
2
323
23
∑∑ −=
XXX
( )5
1494555
2
−=
2.44404555−=
8.114=
( )∑
∑−=5
242
424
XXX
198
( )5
1363744
2
−=
2.36993744−=
8.44=
∑∑ ∑ ∑ +++ 24
23
22
21 XXXX
2.4408.114282.15 +++=
8.202=
The between sum of squares added to within sum of squares should give total sum of
squares is 55.147678.20275.1273 =+
Degree of freedom
NLR, n – 1 = 5 – 1 = 4
ESMC, n – 1 = 5 – 1 = 4
IKH, n – 1 = 5 – 1 = 4
ENTRACO, n – 1 = 5 – 1 = 4
20 – 1 =19
3
16−
Analysis of variance for the data
Source of variance
Degree of freedom (df)
Sum of squares
Means squares
F Ratio calculated
F table
Between squares 3 1273.75 424.5833
Within squares 16 202.8 12.675 33.5 3.01
Total 19 1476.55
199
APPENDIX 2B
Calculation of Single Classification Analysis of Variance
X1 X2 X3 X4
NLR ESMC IKH ENTRACO 21X 2
2X 23X 2
4X
1. 46 48 20 37 2116 2304 400 1369
2. 36 41 30 38 1296 1681 900 1444
3. 50 43 28 43 2500 1849 784 1849
4. 42 30 38 27 1764 900 1444 729
5. 47 49 40 29 2209 2401 1600 841
=∑ 1X =∑ 2X =∑ 3X =∑ 4X =∑21X =∑
22X =∑
23X =∑
24X
215 211 156 145 9885 9135 5128 6232
Total Sum of squares
( )N
XXX
2
221
∑∑ −=
( )20
1451562112156232512891359885
2+++−+++=
20
52852930380−=
45.2642630380−=
55.3953=
The between sum of squares
( )N
X
n
XXb
222 ∑∑ −=
20
528529
5
145
5
156
5
211
5
215 2222
−+++=
45.264264252.48672.89049245 −+++=
95.794=
Within sum of squares
200
( )∑
∑−=n
XXX
2
121
21
( )5
2159885
2
−=
5.9249885−=
640=
( )∑
∑−=5
2
222
22
XXX
( )5
2119135
2
−=
2.89049135−=
8.230=
( )5
2
323
23
∑∑ −=
XXX
( )5
1565128
2
−=
2.48675128−=
8.260=
( )∑
∑−=5
242
424
XXX
5
1456232
2
−=
42056232−=
2027=
∑∑ ∑ ∑ +++ 24
23
22
21 XXXX
20278.2608.230640 +++=
6.3158=
201
The between sum of squares added to within sum of squares should give total sum of
squares 55.39536.315895.794 =+
ANOVA for the data
Source of variance
Degree of freedom (df)
Sum of squares
Means squares
F Ratio F table
Between squares 3 794.95 264.9833
Within squares 16 3158.6 197.4125 1.34 3.01
Total 19 3953.58
202
APPENDIX 2C
Calculation of Single Classification Analysis of Variance
X1 X2 X3 X4
NLR ESMC IKH ENTRACO 21X 2
2X 23X 2
4X
1. 44 43 27 23 1936 1849 729 529
2. 50 20 30 18 25 400 900 324
3. 45 38 25 15 2025 1444 625 225
4. 42 37 32 21 1764 1369 1024 441
5. 48 45 21 17 2304 2025 441 289
∑ 1X ∑ 2X ∑ 3X ∑ 4X ∑21X ∑
22X ∑
23X ∑
24X
229 183 135 94 10529 7087 3719 1808
Total Sum of squares
( )N
XXX
2
22 ∑∑ −=
( )20
9413518322918083719708710529
2+++−+++=
20
41088123143−=
05.2054423143−=
95.2598=
The between sum of squares
( )N
X
n
XX
222 ∑∑ −=
20
410881
5
94
5
135
5
183
5
229 2222
−+++=
05.205442.176736458.66972.10488 −+++=
05.2054422598−=
203
15.2054=
Within sum of squares
( )∑
∑−=n
XXX
2
121
21
( )5
22910529
2
−=
2.1048810529−=
8.46=
( )∑
∑−=5
2
222
22
XXX
( )5
1837087
2
−=
8.66977087−=
2.389=
( )5
2
323
23
∑∑ −=
XXX
36453719−=
74=
( )∑
∑−=5
242
424
XXX
2.17671808−=
8.40=
∑∑ ∑ ∑ +++ 24
23
22
21 XXXX
8.40742.3898.46 +++=
8.544=
204
The between sum of squares added to within sum of squares should give total sum of
squares 8.40742.3898.404321 +++=+++ xxxx
Within sum of squares 8.544=
95.259815.20548.544 =+
ANOVA for the table
Source of variance
Degree of freedom (df)
Sum of squares
Means squares
F Ratio F table
Between squares 3 2054.15 684.727
Within squares 16 544.8 34.05 20.11 3.01
Total 19 2598.95
205
APPENDIX 3
Calculation of Internal Rate of Return NLR – By Method of Interpolation
Internal rate of return (IRR) (35%) (Trial)
(1.35) A>H
(4.I=)J + A>?
(4.I=)K + AC=
(4.I=)L + IMM
(4.I=)N + IH=
(4.I=)O + HAM
(4.I=)P - 706, 000,000
629657397.3-706,000,000 = -76342602.7
(1.34) A>H
(4.IH)J + A>?
(4.IH)K + AC=
(4.IH)L + IMM
(4.IH)N + IH=
(4.IH)O + HAM
(4.IH)P - 706,000,000
= 726239337.9-706,000,000 = 2023933.7.94
IRR = 33%+ (35-34) (AMMAICII>.CH)
AMAAICII>.CH 5 >?IHA?M.>
= 34% + (1) (AMAICII>.CH)C?=B4CHM.?H)
= 34% +0.209 = 34.21%
IKH
IRR 11% (Trial)
H(4.44)J + I.=
(4.44)K + A.=(4.44)L + A.I
(4.44)N + A(4.44)O + A
(4.44)P - 12,150,000
= -1064745
10% H
(4.4M)J + I.=(4.4M)K + A.=
(4.4M)L + A.I(4.4M)N + A
(4.4M)O + A(4.4M)P - 12,150,000
= 198934.0761
206
By interpolation
IRR = 10% + (11-19) (4CBCIH.M>?4)?H>H=54CBCIH.M>?)
= 10+0.157
=10.16%
ESMC
Try 33%
(1.33) 4M=
(4.II)J + 4IA
(4.II)K + 4HM
(4.II)L + 4H=
(4.II)N + 4=A
(4.II)O + 4=?
(4.II)P - 311,000,000
= 324137663.8
Try 34%
(1.34) 4M=
(4.IH)J + 4IA
(4.IH)K + 4HM
(4.IH)L + 4H=
(4.IH)N + 4=A
(4.IH)O + 4=?
(4.IH)P - 311,000,000
= -34322708.38
IRR = 33+ (34-33) (IAH4I>??.B)
IAH4I>??I.B5IHIAA>MB.IB
= 33+(1) IAH4I>??I.B)I=BH?MIBA.A)
= 33+0.9
= 33.9%
ENTRACO
(1.20) =I
(4.AM)J + HB
(4.AM)K + I=
(4.AM)L + IM
(4.AM)N + IM
(4.AM)O + IM
(4.AM)P - 134,500,000
= 134325388.6 – 134, 500,000
= - 1745114
(1.19) =I
(4.4C)J + HB
(4.4C)K + I=
(4.4C)L + IM
(4.4C)N + IM
(4.4C)O + IM
(4.4C)P – 134,500,000
= 140397519.3 – 134,500,000
207
= -5897518.30
IRR 19% + (20-19) (=BC>=4BI)
4>H=44H5=BC>=4B.I)
= 19% +0.771
= 19.8%
Table 4(3)E
IRR
ENTRACO 19.8%
IKH 10.2%
ESMC 33.9%
NLR 34.2%