sabaragamuwa volume 18number 1 august 2020pp 1-15

SabaragamuwaUniversityJournal

Volume 18 Number 1 August 2020 pp 1-15 ISSN 1391-3166 eISSN 2386-2041

http://doi.org/10.4038/suslj.v18i1.7750© 2020 Sabaragamuwa University of Sri Lanka

The Impact of Financial Reporting Practices on Performance:A Study of Small and Medium Enterprises in Rathnapura District,

Sri Lanka

Jayawardane, H. and Gamlath, G. R. M.∗

Vavuniya Campus of the University of Jaffna, Sri Lanka

∗[email protected]

AbstractThe objective of the study is to examine the impact of financial reporting practices on the financial

performance of small and medium enterprises (SMEs) in Rathnapura District, Sri Lanka. This empiricalstudy is based on the primary data through face to face interviews and administered questionnairesand secondary data through examining subject related books, published research papers, websites,statistical reports of the Central Bank of Sri Lanka and other institutions, and their specific regulatoryfactsheets. Data were collected from the total selected sample of 60 SMEs Statistical tools; hypothesistesting, descriptive statistics, and Multiple Regression Analysis are used to analyze and find the resultof the study. The designated measures of financial reporting practices are financial reporting practices,investment analysis practices, Inventory management practices, cash management practices, and fixedassets management practices. The findings revealed that among the five selected independent variables,there was a variation of 93% (Approx.) of the financial performance of SMEs due to changes in financialreporting practices, investment analysis practices, inventory analysis practices, cash managementpractices and fixed assets management practices that have been depicted in the model. Out of fivevariables, FR, IA, and FA management practices are highly supported to better financial performancethan that of the INA and CM practices. This paper provides useful information to the GovernmentMinistries, Central Bank of Sri Lanka, Professional Bodies SME owners, researchers, accountingpractitioners and other stakeholders in Sri Lanka for their involvement in making efforts to the futuredevelopment of SMEs.

Keywords: Financial reporting practices, Financial performance, Small and Medium Enterprises,Rathnapura District

Introduction

Financial reporting practices play an importantrole in the success or failure of contemporarySME institutions. These practices are utilized forrecording, analyzing, monitoring and evaluatingthe financial condition of SMEs, preparation ofvarious kinds of documents necessary for decision-making purposes, regulatory requirements, taxcomputation and payments, providing informationsupport to many other organizational functions[Chapman, 1997]. Accounting systems provide asource of information to owners and managers ofSMEs operating for the use in measuring financialperformance [Uddin et al., 2017]. In this juncture,financial reporting practices involve the disclosureof financial information to the various stakeholders;investors, creditors, public, debt providers, govern-ments and government agencies on the financialperformance and financial position of the orga-nization. The Government of Sri Lanka, Central

Bank of Sri Lanka (CBSL) and the Instituteof Chartered Accountants of Sri Lanka (ICASL)in associations with many other business andprofessional bodies have issued various accountingstandards and guidance to apply for financialreporting to SMEs. This ensures uniformity acrossvarious diversified industries when they prepareand present their financial statements. Accordingto the International Accounting Standard Board(IASB), the objective of financial reporting is “toprovide information about the financial position,performance and changes in the financial positionof an enterprise that is useful to a wide rangeof users in making economic decisions”. Giventhe above, the importance of financial reportingcannot be overemphasized. In such a way, SMEsrequire the use of these practices to use for differentdecision-making purposes, consequently, financialreporting practices help SMEs organizations toraise capital both domestic as well as overseasfor their investment creation, promotion and

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http://dx.doi.org/10.4038/suslj.v18i1.7750

Sabaragamuwa University Journal 2020, V.18 NO.1 pp 1-15

diversification and based on financials, the publicin large can analyze the performance of theorganization as well as of its management [Atuilik& Salia, 2018].

There are many SMEs in Rathnapura Districts.Out of those, most of them are in very small andsome are in a medium. The basic objective of theentrepreneur is to maintain their livelihood alongwith the contribution to the economic developmentaccording to their business performance. All of theSMEs use financial reporting practices in a level;good, fair, and poor. Some SMEs used financialreporting practices properly and they know them.But in Rathnapura District, more than 75% [CCI,2017] SMEs are not in a position to use thesepractices well. These SMEs used these practiceswithout having a good level of knowledge of finan-cial management and reporting. The main reasonsbehind having such a poor environment are the lackof public accountability, lack of knowing the above-specified regulations, lack of mandatory auditrequirements, and lack of resources. Therefore,the owners and managers of these SMEs shouldunderstand the role of financial reporting in theform of clear information requirements ensuring aproper justification for business transactions andoperations. There is a significant negative impact ofpoor financial management and reporting practiceson the growth and sustainability of SMEs [Uddin etal., 2017]. Moreover, business decisions are requiredto be comprehensively supported with good qualityfinancial information in a relevant, user friendlyand promptly accessible manner. However, manyowners or managers operate their business activi-ties without any reporting or financial perspectiveand take much important investment, financing,operating and profit decisions without any properfinancial analysis. On the same, most probably,SMEs fail to understand the actual financial statusof their own business.

The accounting systems provide a source ofinformation to owners and managers of smallbusinesses operating in any industry for theuse in the measurement of financial performance[Maseko & Manyani, 2011]. Further to McMahon& Holmes (1991) and Firer et al. (2004), financialmanagement decisions include Investment decision(capital budgeting decision). Investment decisionrefers to the process of planning and managinga firm’s long-term investments. Capital budgetingis used to evaluate whether investments in fixed

assets such as new machinery, new plants, newproducts, and research development projects areworth pursuing. Capital budgeting techniquesinclude non-discounted cash flow techniques (pay-back period and the accounting rate of return) andthe discounted cash flow techniques (net presentvalue, internal rate of return, profitability index,and discounted payback period). Besides, Oduware(2011) expressed that, financial management en-tails planning small businesses supply completeand relevant financial information needed to im-prove economic decisions made by entrepreneurs.To date, there have been limited researches onfinancial reporting practices by SMEs and even lessis known about the users and uses of SME financialstatements in the context of developing economies[Sutthirat, 2012, Sian & Roberts, 2006, Evans etal., 2005]. Besides, in the debate on SME financialreporting presently occurring in various countries,there are arguments made on the lack of empiricalevidence on the financial reporting needs of SMEs.This current study seeks to investigate the impactof financial reporting practices on the performanceof SMEs in Rathnapura District, Sri Lanka. Itis expected that the empirical findings of thisstudy will be of interest to future researchers, fieldstakeholders and accounting standards setters inSri Lanka, especially those who are consideringsimplifying financial reporting requirements forSMEs. Therefore, researchers selected the above-mentioned research topic to know the actuallandscape of financial reporting practices on theperformance of SMEs with special reference toRathnapura District.

Theoretical Foundation

SMEs are defined in a variety of ways byvarious countries using such parameters as noof persons employed, amount of capital invested,amount of turnover or nature of the businessSMEs (International Monetary Fund, 2018). Then,SMEs can be defined by the Department of SmallIndustries as an enterprise with fewer than 50people and capital investment less than LKR. 05million and/or an enterprise with less than LKR. 08million investment and less than LKR. 50 millionannual turnover (Export Development Board).Hence, a clear definition is needed to: provideconcessionary financial facilities on a targeted basisand provide specific business development services.Therefore, the Department of Census & Statisticshas started an “Economic Census” in 2013/14 with

2 © 2020 Sabaragamuwa University of Sri Lanka


Table 1: Definition of SMEs

Size/Sector Criteria Medium Small Micro

Manufacturing Sector Annual Turnover RsMn 251-750 RsMn 16-250 Less than RsMn 15No. of Employees 51- 300 Nov-50 Less than 10

Service Sector Annual Turnover RsMn 251-750 RsMn 16-250 Less than RsMn15No. of Employees 51-200 Nov-50 Less than 10

Source: [National Policy Framework SME, 2016]

a key objective to prepare a unique definitionfor Micro- Small, and Medium Enterprises in SriLanka. As the same, World Bank states that: if anyenterprise has below 99 people, it can be definedas an SME. The term SME is used to denotemicro, small and medium enterprises. Differentcountries use different definitions for SMEs basedon their level of development. The commonly usedyardsticks are total number of employees, annualturnover and total investment. In the Sri Lankancontext, the SME policy framework defines SMEsbased on the number of employees and annualturnover [National Policy Framework SME, 2016]as in table 1.

The category of Small and Medium-sized En-terprises (SMEs) is made up an enterprise, whichemploys less than 300 employees and which has anannual turnover not exceeding Rs.750 Mn. In thiscontext, micro-enterprises are also read with SMEsfor any policy related measures [National PolicyFramework SME, 2016]. In terms of definition,both criteria are considered in defining SMEs.In the event of an enterprise, falling under morethan one category, then the number of employeesshould be the deciding factor. The ceiling applies toindividual enterprises only. Subsidiaries of holdingcompanies shall not be considered as SMEs.However, in the event of turnover and the numberof employees of the whole group is within the abovelimits this exclusion will not arise. The purpose ofSME definition is to provide an instrument for thetargeting of policy, provision of national statisticson SMEs, serve as the basis for directing the statesupport for SMEs and targeting a broader rangeof policy measures. This definition is revisited oncein three years and amended where necessary basedon the economic and business development in thecountry [National Policy Framework SME, 2016].

Financial Reporting Practices

Gitman (2007) defines financial managementas the area of business management devoted to

judicious use of capital and a careful selection ofsources of capital to enable an organization tomove in the direction of reaching its goals. Thisdefinition points to certain essential aspects offinancial management namely prudent or rationaluse of capital resource and achieving the goal ofthe firm. According to Oduware (2011), financialmanagement entails planning for the future of abusiness enterprise to ensure positive cash flow.Brinckmann et al. (2010) andMSG (2019) definefinancial management as managerial activities thatconcern the acquisition of financial resources andthe assurance of their effective and efficient use. Fi-nancial management involves planning, organizing,directing and controlling the financial activitiessuch as the procurement and the utilization offunds of the enterprise. According to Firer (2004),Firer et al. (2004), Gitman (2007) and Ampah& Jagongo (2015) financial management decisionsinclude investment decision (capital budgetingdecision). Investment decision refers to the processof planning and managing a firm’s long-terminvestments. Capital budgeting is used to evaluatewhether investments in fixed assets such as newmachinery, new plants, new products, and researchdevelopment projects are worth pursuing. Capitalbudgeting techniques include non-discounted cashflow techniques (payback period and the account-ing rate of return) and the discounted cash flowtechniques (net present value, internal rate ofreturn, profitability index and discounted paybackperiod). Working capital management involvesmanaging the short-term assets and liabilities of afirm. Working capital management ensures that afirm has sufficient cash flow to meet its short-termdebt obligations and operating expenses. Financialdecision (capital structure) relates to the raising offinance from various sources depending on the typeof source, the period of financing, cost of financingand the returns [Turyahebwa, et al., 2013]. Capitalstructure refers to the way a company finances itsassets through some combination of equity, debt,



or hybrid securities. Dividend decision involvesthe decision concerning the net profit distribution(dividend payment to shareholders and retainedearnings).

Holmes & Nicholls (1989) summarize that man-agement accounting information is associated withsuccess and failure in SMEs depending upon howthey are produced and utilized in their companies.However, Horngren (1995) as cited by Tanvogswaland Pinvanichkul (n.d); Rathnasiri (2014) arguesthat cost accounting or management accountingconcepts and techniques are neutral instruments. Itis not the cause of poor management but managersof the firms may use primarily symptoms sinceit wisely or stupidly. Drury & Tayles (1995) 8conclude that the same rules and procedures estab-lished for external reporting (financial accounting)are likely also to be applied to internal reporting(management accounting). Though external andinternal reporting tend to employ the same rules,it does not mean that management accountingis subservient to financial accounting. The reasonthat most companies adopt the identical practicesfor both reporting systems is that firms prefertheir internal profit to be reported consistentlywith external financial accounting requirementsso that they will be comparable with outsiders’assessments of overall company performance. Inother words, companies would like to ensurethe internal accounting system does not haveany conflicts with external financial accountingrequirements. There have been many empiricalstudies conducted in other countries investigatingthe types of financial reports produced by SMEs,the frequency of their preparation, and theirperceived usefulness for management purposes.Comprehensive reviews of this empirical evidenceand the findings of comparable research conductedinternationally, up to the early 1990s are providedby McMahon & Holmes (1991).

Financial Performance of SMEs

As explored by Firer et al. (2004), the goal offinancial management is to maximize the wealthof the owners of the firm. The goal of the firm isto maximize its value to its shareholders. Value isrepresented by the market price of the company’scommon stock, which, in turn, is a reflection ofthe firm’s investment, financing, and dividend deci-sions. The market price of a firm’s stock representsthe focal judgment of all market participants as

to what the value is of the particular firm. Ittakes into account present and prospective futureearnings per share, the timing, duration, and riskof these earnings, and any other factors that bearupon the market price of the stock. The marketprice serves as a performance index or reportcard of the firm’s progress. Further, for Maseko& Manyani (2011), accounting systems provide asource of information to owners and managers ofsmall businesses operating in any industry for usein the measurement of financial performance. Itis crucial therefore that the accounting practicesof small businesses supply complete and relevantfinancial information needed to improve economicdecisions made by entrepreneurs. Ismail & Zin(2009) note that business strategy is one of themain components that contributes to the growthamong small firms. Padachi (2010) points out thatthe main factors that contribute to the successor failure of small businesses are categorizedas internal and external factors. The externalfactors include financing (such as the availabil-ity of attractive financing), economic conditions,competition, government regulations, technologyand environmental factors. The internal factorsare managerial skills, workforce and accountingsystems.

Findings from studies done earlier and gov-ernment reports on the state of affairs of small-scale enterprises reveal that the sector facesnumerous problems and constraints that affecttheir performance. While much research has beendone on the small business, little has been donespecifically on financial and reporting analysispractices of SMEs in Sri Lanka. The overallproblem, therefore, is that relatively little isknown about the impact of financial reporting andanalysis practices in the financial performance ofthe small and medium enterprises in Sri Lanka.The high rate of failure among small firms, duemainly to inefficient management underscores theneed to develop sound managerial skills. The smallbusinessman who learns how to collect, analyzeand interpret information and how it is relevantto specific problems will increase his firm’s chancesfor survival, growth and profitability [Yoo & Kim,2015].



Empirical evidence on Financial Report-ing Practices on performance

As per the constructive and rationalized stud-ies, it was noted that the empirical evidenceon financial reporting and analysis practices onperformance could be identified. Thomas III &Evanson (1987) studied 398 small pharmacies (inMichigan, North Carolina, Nebraska, Rhode Islandand Washington) to examine the extent to whichfinancial ratios were used in a specific line of smallretail business and tested for a relationship betweenuse of financial ratios and business success. Thestudy used regression analysis to examine the rela-tionship between financial ratio usage and SMEs’profitability. However, they could not demonstrateany significant relationship between earnings-to-sales and the number of financial ratios used bythe owner in operational decision-making. Also,D’Amboise & Gasse (1980) studied the utilizationof formal management techniques in 25 small shoemanufacturers and 26 small plastic manufacturersin Quebec, Canada found that 88 percent ofthe businesses used a cost accounting system.Regarding accounting standards, DeThomas &Fredenberger (1985), in a survey of over 360 smallenterprises in Georgia, found that the standards offinancial record-keeping were very high. In additionto cheque and deposit receipts, around 92 percentof respondents had some form of record-keeping.Subsequently, to the use of financial information,Farhoodman & Hryck (1985) reported on themost important applications of computers, andit was found that accounting has been ratedas the highest percentage. Similarly, Ministry ofIndustry and Commerce in Sri Lanka [NationalPolicy Framework SME, 2016] interviewed 36small independent retail owner-managers andfound that 33 percent of the sample businessesused computerized accounting systems. Reviewingprevious research results shows accounting andfinancial management applications dominated theuse of computers in small and medium enterprisesin North America in the 1980s and 1990s. Inparallel to the study conducted by Cooley & Pullen(1979), cash management was seen as the process ofplanning and controlling cash flows. It consisted ofthree basic components: cash forecasting practices,cash surplus investment practices, and cash controlpractices. Cooley & Pullen (1979) examined cashmanagement practices of 122 small businessesengaged in petroleum marketing and reported that

73 percent of respondents had experienced a cashsurplus.

Furthermore, the previous studies done oninventory management practices, D’Amboise &Gasse (1980) studied the utilization of managementtechniques in small shoe and plastic manufacturingindustries in Canada and found 64 percent ofthe shoe and 65.4 percent of plastic businessesemployed formal inventory control systems. WhileGrablowsky & Rowell (1980) found that mostof the respondents had above 30 percent oftheir capital invested in inventory, the generalstandard of inventory management was poor.Only six percent of businesses in their surveyused a quantitative technique such as economicorder quantity for optimizing inventory and 54percent had systems which were unable to provideinformation on inventory turnover, reorder points,ordering costs, or carrying costs. Similarly, itwas emphasized that Grablowsky (1983) comparedmethods used by a sample of 94 small enterpriseswith those used by large enterprises and foundthat large enterprises used methods to determineinventory levels far more than small enterprises.

Findings from studies done earlier and gov-ernment reports on the state of affairs of small-scale enterprises reveal that the sector facesnumerous problems and constraints that affecttheir performance. While much research has beendone on the small business, little has been donespecifically on financial and reporting analysispractices of SMEs in Sri Lanka. The overallproblem, therefore, is that relatively little isknown about the impact of financial reporting andanalysis practices in the financial performance ofthe small and medium enterprises in Sri Lanka.The high rate of failure among small firms, duemainly to inefficient management underscores theneed to develop sound managerial skills. The smallbusinessman who learns how to collect, analyzeand interpret information and how it is relevantto specific problems will increase his firm’s chancesfor survival, growth, and profitability [Balagobei,2020].

CBSL (2017) stated that SMEs play an impor-tant role in both developed and developing coun-tries. Accordingly, SMEs contribute to the growthof the economy in many ways such as employmentgeneration, new venture development and openingup new avenues for the growth in the economy.However, it was found that there are many failures



of SMEs in Sri Lanka such as inadequate capital,inadequate institutional credit facilities and properstandardized reporting, use of outdated technology,improper accounting techniques, inadequate salespromotion competencies and inattentiveness ofsmall business by the Sri Lankan SME sector.Further financing has become a big challenge,even though the state owned banks and otherdevelopment institutions have taken various mea-sures to assist SMEs in providing finances overthe period [NEDA, 2011]. Those obstacles haveresulted from inefficient business administrationand, lack of experience in some important businessfunctions. Especially accounting and finance. Thehigh rate of failure among small firms, mainlydue to inefficient management underscores theneed to develop sound management skills. Thesmall businessperson who learns how to collect byanalyzing and interpreting information on how it’srelevant to specific problems will increase his firm’schances for survival, growth and profitability [Yoo& Kim, 2015].

As defined by MSG (2019), financial manage-ment means planning, organizing, directing andcontrolling the financial activities such as procure-ment and utilization of funds of the enterprise.It means applying general management principlesto the financial resources of the enterprise. Thisdefinition points to certain essential aspects offinancial management namely prudent or rationaluse of capital resource and achieving the goal ofthe firm as well as financial management entailsplanning for the future of a business enterprise toensure positive cash flow. Brinckmann et al. (2010)and MSG (2019) define financial management asmanagerial activities that concern the acquisitionof financial resources and the assurance of theireffective and efficient use. Financial manage-ment involves planning, organizing, directing andcontrolling the financial activities such as theprocurement and the utilization of funds of theenterprise. According to Firer et al. (2004) andGitman (2007), financial management decisionsinclude investment decisions (capital budgetingdecision). Investment decision refers to the processof planning and managing a firm’s long-terminvestments. Capital budgeting is used to evaluatewhether investments in fixed assets such as newmachinery, new plants, new products, and researchdevelopment projects are worth pursuing. Capitalbudgeting techniques include non-discounted cash

flow techniques (payback period and the account-ing rate of return) and the discounted cash flowtechniques (net present value, internal rate ofreturn, profitability index and discounted paybackperiod). Working capital management involvesmanaging the short-term assets and liabilities of afirm. Working capital management ensures that afirm has sufficient cash flow to meet its short-termdebt obligations and operating expenses. Financialdecision (capital structure) relates to the raising offinance from various sources depending on the typeof source, a period of financing, cost of financingand the returns. Capital structure refers to theway a company finances its assets through somecombination of equity, debt, or hybrid securities.Dividend decision involves the decision concerningthe net profit distribution (dividend payment toshareholders and retained earnings).

In a research on the insight on the adaptationof different financial reporting practices of SME’sin Sri Lanka conducted by Jagoda et al. (n.d.),the findings revealed that there is a significantrelationship between financial reporting practicesand financial performance of the small andmedium-sized enterprise in Western province, SriLanka. Further, it was proved that the problemsrelated to finance have been considered as thecritical and foremost reasons for increasing thefailure rate of SMEs. The weak financial basemay depend on other problems like upgradingof technology, expansion of production capacity,production efficiency, lack of access to bankfacilities, etc. On the other hand, many studiesprove the fact that sound financial reportingpractices not only control the financial positionbut also significantly contribute to improving andincreasing the profitability of SME’s governmentand non-governmental organizations that providelending to the SME’s. All these need to bestructured in a better way for rating the financialrisks that are faced by the SME’s.

Methods

This study is conducted through a descriptiveresearch design applying a quantitative method.In this instance, the important considerationis to assess factor- oriented research or studyby using identified characteristics or variablesinter-alia. Also. It is important to note thatdescriptive research is essential to identify andeducate problem situations of any research or



Figure 1: Conceptual model

study. Primary data was used in the study bydistributing a structured questionnaire to SMEsconsisting 40 questions according to Likert scale(1 to 5 - one - Strongly Disagree, two Disagree,three Neutral, four Agree, five - StronglyAgree) as operationalized. Besides, the reading andother tools were used to collect study aids fromdifferent sources like annual reports, textbooks,internet, newspapers, magazine, and journals. Thepopulation includes 300 SMEs registered underthe chamber of commerce in Rathnapura. Thesample was selected according to the definitionof the Department of Small Industries (DSI), theentire group of SMEs who does not exceed thecapital investment of Rs.5 million and employeesshould be fewer than Rs.50 million, for thisstudy, the researcher selected 60 SMEs by usingthe simple random sample method. The SMEsrunning the business were selected in Rathnapura,Balangoda, and Weligepola secretariat divisions inthe Rathnapura District.

To test the hypotheses, questionnaires weredistributed among SMEs and collected 40 question-naires along with the discussions on their financialreporting practices. The structured questionnaireconsists of 40 questions which is covered allindependent variables and dependent variables, aswell as the questionnaire consists of three parts aspersonal information, information on their level offinancial reporting and analysis practices and theirfinancial performance.

The research has selected five factors asindependent variables which affect the financialperformance of SMEs. These are financial reportingpractices, investment analysis practices, inventoryanalysis practices, and cash management practicesand fixed assets management practices. First,financial reporting is very important and mostvoluble and considerable terms when conductingany kind of business. Because financial reporting

is essential to gain success in the business, andbecause every large-scale organization prepares andpresent financial statements after the year endedit is compulsory for information users. Becauseinformation uses are related parties in a particularorganization they want to know about the orga-nization’s performance, expenses, profit and otherthings. Some SMEs are not keeping proper financialreporting methods .Most SMEs are kept in asingle entry system to record their transactions.Then it will affect their financial performanceindirectly. Without financial reporting they cannotmanage their properties. Then financial reportingis a very important factor for growth in thelong-term. Second, investment decisions refer tothe process of planning and managing the firm’slong- term investments. Sometimes SMEs investin fixed assets such as new machinery, newplants, and new products. Most SMEs invest theirmoney in micro-finance institutions and short-terminvestment projects. Most SMEs think about theinvestment period, return on investment and risk ofinvestment. Third, inventory analysis practices areimportant to the firms as the inventory is the mainresource of manufacturing firms. Then they mustproperly manage their inventories. Most SMEs usephysical safeguards for inventory against the theft.Also, firms periodically count their inventories.Some firms use computer-assisted software inrecording inventory, and most small businessesdetermine inventory levels are based on the owner’sexperience. Some SMEs use historical data todetermine inventory levels. Fourth, the purpose ofthe cash management practices is to ensure positivecash flows. Moreover, cash management activitiesare concerned about the acquisition of financialresources and the assurance of their effective andefficient use. Cash management practices involveplanning, organizing, directing and controlling thefinancial activities such as the procurement and theutilization of funds of the enterprise. Because cash



is the main dependent factor of any organization.Therefore, SMEs also want to keep good attentionto their cash management practices. Fifth, everyorganization should acquire and manage their fixedassets for the long term business survival. Everyfirm must have a proper method for purchase andutilization in fixed assets.

Table 2: Age of the SMEs

Age No. of SMEs

6-May 32

10-Jun 3

15-Nov 2

16- 20 5

Above 20 18

Source: Collected data from the survey

Table 3: Education level of SMEs

Education level of the owner No. of SMEs

Primary 4

Secondary 9

Tertiary 6

University 11


Dependent variable of this study is the fi-nancial performance of the SMEs. The financialmeasurement of performance is the traditionaland most commonly used tool as a measure ofan organization’s performance. Financial measuresfocus on profitability, the market value of the firm,return on assets, investment and equity, liquidityand various other ratios. According to this study,performance was measured by specially designedquestions.

Based on the above variables the researcherdeveloped a conceptual framework in accordanceto the research problem as shown in figure 1.

After designing the above framework, theresearch hypotheses were formulated to test theimpact of financial reporting practices on thefinancial performance of SMEs in RathnapuraDistrict.

H0 = There is no impact on financialreporting and analysis practices onfinancial performance of SMEs inRathnapura District, Sri Lanka.

H1 = There is an impact on financialreporting and analysis practices onfinancial performance of SMEs inRathnapura District, Sri Lanka.

The objective of this study is to identifythe impact of financial reporting and analysispractices on the financial performance of SMEs.The researcher used multiple regression analysismethods. The following regression model was usedin this study.

Y =β0 + β1 · FR+ β2 · IAP + β3 · INAP+

β4 · CMP + β5 · FAP + ε

where Y = Financial Performance, β0 = constant,β1, β2, β3, β4, β5 are the coefficients of eachindependent variable and ε =error term.

Reliability coefficient as Cronbach’s Alpha coef-ficient shows average correlation. Among the itemsthat include under a variable, this Alpha valuecan range from 0 to 1. Sekaran & Bougie (2009)indicated that if the Cronbach’s value is less than0.6 it is considered to be poor, those in the range0.7 acceptable and those over 0.8 good. Reliabilityrefers to the degree of consistency in measurementand the lack of error. By using the methods asexplained in this section the performance of theresults and discussion on the research findings willbe provided in the next section.

Results and Discussion

The objective of this study is to find theimpact of financial reporting and analysis practiceson financial performance of small and mediumenterprises in Rathnapura District in Sri Lanka.To achieve this objective, the study focused mainlyconsists of sixty (60) SMEs. The study constitutesregression results in determining the relationshipbetween financial reporting and analysis prac-tices on the financial performance of SMEs inRathnapura District, Sri Lanka by carrying outa correlation and regression model using SPSSsoftware to ascertain the impact of the independentvariables on the dependent variable. All firmsresponded to the questionnaire and the result ofthe survey concluded to analyze and find therelationship and impact of the financial reportingand analysis practices and financial performances



of SMEs in Sri Lanka. Data was gathered by usingquestionnaires while selecting the whole populationof the SMEs in Rathnapura District. Accordingto the demographic data collected, those werepresented as follows.

The age categories and number of SMEs undereach category are shown in the table 2. It explainsthe age of the SMEs in Rathnapura indicating thatsampled 53% of SMEs (32 no) are in the years 1-5 level and balanced (46%) SMEs are in the levelbeyond that.

Levels of education and number of SMEs undereach category are shown in table 3. It describes theeducation levels of the SMEs in Rathnapura. Inthis case, twenty-nine SMEs are reluctant to givetheir educational level even though they operatetheir businesses well. Out of balanced thirty 31SMEs, twelve (12) firms are well- educated withuniversity degrees and functioning their businesseswell. Eleven (11) SMEs completed their educationup to primary and education levels. Six (06) SMEsrepresent the tertiary education level completingvocational qualifications and starting businesses.However, all sampled SMEs are in successfulbusiness operations

Table 4: Form of Business Organization

Form of Buss. Organization No of SMEs

Sole proprietor 48Partnership 12


Table 5: Account and financial related knowledge

Knowledge of accountsand finances

No of SMEs

Yes 49No 11


The form of the business and number of SMEs,which are falling under each category, can beshown as in table 4, which depicts the proprietyof sampled SMEs indicating that forty-eight (48)no of SMEs are sole proprietors and twelve (12) noof SMEs’ having partnership business.

Table 5 shows the number of SMEs whose owneror manager has financial related knowledge or not.Most of SMEs (49) has accounting and financial

related knowledge and the balanced (11 no) SMEsdo not have any accounting and financial relatedknowledge.

To measure the reliability of items of thequestionnaire, Cranach’s Alpha Coefficient wasused. Based on the result of this test, it was notedthat all the values were valuated over 0.7 indicatingthe confirmation of reliability on variables and itsmeasures of the questionnaire.

After testing the reliability of responses onvariables, the Cronbach’s Alpha values of eachindependent variable with the dependent variablewere received (table 6). All independent variables(financial reporting, investment analysis practices,inventory analysis practices, and cash managementpractices) have shown in the required level ofacceptance that all the values being over 0.7.Therefore, the reliability of various parts ofquestionnaires is confirmed.

Table 7 shows the values of the range, min-imum, maximum, mean, and standard deviationof independent and dependent variables. In theprocess of comparing the independent variables(financial performance) as; financial reporting,inventory analysis practices, cash managementpractices and fixed assets management practicesall variables have high mean values in a rangeof more than 3, except the mean value 2.97 ofinvestment management practices. However, IAPis also closer to mean value 3 and it can beaccepted. According to table 7, all independent anddependent values have low maximum value in arange of 1 to 2 and financial performance has lowmean value too than other variables. The maximumand minimum values for each measure indicatethat all variables vary considerably among eachother. In aggregate, all the variables have recordedresults closer to the highest among comparingall descriptive values so that the factors affectingfinancial reporting and analysis practices are highlyeffected by the financial performance of SMEs inRathnapura District.

In this study, a multiple regression analysis wasconducted to test the influence among predictorvariables. The research used the statistical packagefor social sciences (SPSS V 20) to code, enterand compute the measurements of the multipleregressions. Likert scale was used to determinethe relationship between financial reporting andanalysis practices and the financial performance



Table 6: Reliability Test

Variable Cronbach’s Alpha No. of Items

Financial Performance of SME’s 0.838 6Financial Reporting 0.771 6Investment Analysis Practices 0.842 6Inventory Analysis Practices 0.874 6Cash Management Practices 0.779 6Fixed Assets Management Practices 0.718 4

Source: Researchers data analysis through SPSS

Table 7: Data Analysis Results under Descriptive Statistics on Financial Performance

N Minimum Maximum Mean Std. Deviation

FR 60 1 5 3 0.974IAP 60 1 5 2.97 1.067INAP 60 1 5 3.04 1.106CMP 60 1 5 3.02 0.983FAP 60 1 5 3.05 1.124FP 60 1 5 3.01 1.043Valid N (list wise) 60

Source: Researchers’ data analysis through SPSS

Table 8: Model Summary

Model 1R 0.966R2 0.933Adjusted R2 0.927Std. Error of the Estimate 0.278

a. predictors:(constant). FAP, CMP, FR, IAP,INAPSource: Researchers data analysis through SPSS

of the small and medium enterprises in theRathnapura District. The Likert questions werequantified through SPSS and run for the multipleregression analysis on the Impact of financialreporting and analysis practices and financialperformance of small and medium enterprises inRathnapura district.

Adjusted R2 is called the coefficient of deter-mination and it shows how the change in theindependent variable results to changes in thedependent variable. From the data, the valueof R2 is 0.933. This implies that there wasa variation of 93% (Approx.) of the financialperformance of SMEs dues to changes in financialreporting, investment analysis practices, inventoryanalysis practices, cash management practices andfixed assets management practices, at the 93%

confidence interval (table 8). The remaining 7%(Approx.) of profitability variance explained byother factors have not been depicted in the model.

The R square value of the model is 0.933.It indicates that 93.3% of variation an impacton financial performance is explained by the fiveindependent variables. Variance Inflation Factor(VIF) is calculated to test the multi-collinearityof the independent variables in the model sothat all VIF values are well below 10 confirmingthat there are no multicollinearity issues in theregression model. Based on the significance ofregression coefficients, only the variables financialreporting, investment analysis factors and fixedassets management practices have been acceptedfrom the model as the highly significant indepicting the effect of financial performance.This indicates that higher the level of financialreporting, investment analysis practices and fixedassets management practices the higher the effectfor financial performance. The result shows thatfinancial reporting, investment analysis factors,and fixed assets management practices contributemost to the overall financial performance whichshould be considered by the financial managersfor their decision-making. From the above re-gression model, it revealed that holding financialreporting, financial analysis, financial management



Table 9: ANOVA F test

Model Sum of Squares df Mean Square F Sig.

1 Regression 57.261 4 11.452 147.864 0.000Residual 4.105 54 0.077

Total 61.366 58

a. Dependent variable: FPPredictors (constantan) CMP, FR, INAP, IAPSource: Researchers data analysis through SPSS

Table 10: Summary of Regression Coefficients

Model Unstandardized Coefficients Standardized Coefficients Co linearity StaticsB Std. Error Beta t Sig. Tolerance VIF

1 Constant -0.04 0.133 -0.304 0.762FR 0.569 0.106 0.533 5.391 0 0.129 7.735IAP 0.27 0.093 0.277 2.907 0.005 0.139 7.206

INAP -0.111 0.095 -0.12 -1.174 0.246 0.121 8.26CMP -0.015 0.088 -0.14 -0.167 0.868 0.18 5.542FAP 0.302 0.075 0.325 4.039 0 0.195 5.137


and management accounting to constant zerofinancial performance would stand at- 0.040. Aunit increase in financial reporting would lead toincrease in financial performance by 0.569 units,a unit increase in investment analysis would leadto increase in the financial performance of SMEsby 0.270 units; and a unit increase in fixed assetsmanagement practices would lead to increase in thefinancial performance of SMEs by a factor of 0.302.

Y =β0 + β1 ·X1 + β2 ·X2 + β3 ·X3 + β4 ·X4+

β5 ·X5 + ε

FP = − 0.040 + 0.569X1 + 0.270X2 − 0.111X3−0.015X4 + 0.302X5 + ε

Among the above five independent variables,financial reporting is more significantly influenc-ing financial performance than other indepen-dent variables. The coefficient value of financialreporting is 0.569 and it explains that whenthe financial reporting increased by 1% financialperformance will be increased by 0.569% assumingthat other independent variables are constantand it is statistically significant at 5% level.Second, the variable, fixed assets managementpractices are then significantly influencing financialperformance than the other three independentvariables as investment management practices,inventory analysis practices and cash management

practices. The coefficient value of fixed assetsmanagement practices has 0.302 and it explainsthat when the fixed assets management practicesare increased by 1% financial performance willbe increased by 0.302% assuming that otherindependent variables are constant and it is statis-tically significant at 5% level. Third, the variableinvestment analysis practices are then significantlyinfluencing financial performance than the othertwo independent variables as inventory analysispractices and cash management practices. Thecoefficient value of investment analysis practiceshas 0.270 explains that when the investmentanalysis practices are increased by 1%, financialperformance will be increased by 0.270% assumingthat other independent variables are constantand it is statistically significant at 5% level.Fourth variable, cash management practices is thennegatively influencing financial performance thaninventory analysis practices. The coefficient valueof cash management practices remain at -0.015and it explains that when the cash managementpractices are increased by 1% financial performancewill be decreased by 0.015% assuming that otherindependent variables are constant and it isstatistically insignificant. Fifth variable, inventoryanalysis practices are then negatively influencingfinancial performance than inventory analysis prac-tices. The coefficient value of cash managementpractices is -0.111 and it was explained that when



the inventory analysis practices are increased by1% financial performance will be decreased by -0.111% assuming that other independent variablesare constant and it is statistically insignificant.

According to the hypotheses formulated in thesection, hypothesis H1 is accepted since the p-valueof regression coefficients the three variables; finan-cial reporting, fixed assets management practicesand investment analysis practices are less than the0.05 level (60% of total variables and 93% of theimpact is derived for the financial performance).On the other hand, the null hypothesis H0 isrejected. In this section the researcher analyzedthe findings from the data collected to achievethe research objectives and prove the hypothesisto find out the impact of financial reporting andanalysis practices to the financial performance byusing descriptive statistics and regression analysis.According to those analyses, the researcher found asignificant impact between financial reporting andanalysis practices which are affecting the financialperformance.

Conclusion

This study is empirical in its nature thatevaluates the financial reporting practices in SMEsand investigates the impact of the selected functionor methods of financial reporting on SMEs ofRathnapura District. Most SMEs follow indirectfinancial reporting. The study reveals a lack offinancial management knowledge of the majorityof SMEs in considering the practicing of theoperation. To achieve this task questionnaires com-prising various aspects of the financial reportingsystem of SMEs were administered at the datacollection phase, the hypothesis was formulatedand tested where the alternative hypothesis wasselected. Findings show that an effective financialreporting system in SMEs has a reflective impacton financial performances. Thus financial reportingsystems show the books, records, and files andrelated supporting documents resulting from theapplication of the financial reporting process ofthe studied enterprises. So, this study examinesthe profiles of financial information usage in SMEsin Rathnapura Districts in Sri Lanka. The studyfindings revealed that there are some mentionableobservations regarding the use of financial reports.This study revealed that the level of awareness onthe importance of financial management is still toapply since the financial reporting system very low

in SMEs. Most of the owners and managers (InRathnapura District, more than 75% SMEs) arenot in a position to use these practices correctly.These SMEs used such practices without havinga low level of knowledge of financial managementand reporting). The main reasons behind havingsuch a poor environment are the lack of publicaccountability, lack of knowing the above-specifiedregulations, lack of mandatory audit requirements,and lack of resources. They are not aware of theimportance of keeping a sound financial reportand supporting documents. These reports mustbe prepared and used in an orderly manner andcomplete along with all the important informationregarding their business operations. According tothe multiple regression results, the value of R2 is0.933 and it implies that there was a variationof 93% (Approx.) of the financial performance ofSMEs due to the changes in the financial reportingpractices, investment analysis practices, inventoryanalysis practices, cash management practices andfixed assets management practices. The remaining7% (Approx.) of financial performance variancewas explained by other factors that have notbeen depicted in the model. It means that theuse of these practices is highly significant tomaintain a sound financial reporting system thataffects optimal decision making for obtainingbetter financial performance of the SMEs in theRathnapura District. In this juncture, financialreporting practices, investment analysis practices,and fixed asset management practices are highlysupported to the achievement of better financialperformance than that of the practices of inven-tory management practices and cash managementpractices. Therefore, SMEs are strongly requestedto express their opinion of what could be done toimprove the financial reporting practices for thefulfillment of their decision-making requirementsas well as all other on-time organizational andstatutory requirements of SMEs. A list of somesuggestions was presented to respondents. Basedon the findings, it is observed that the respondentsagree that educating and encouraging managersand owners on the need to keep financial reportsis the best solution. This is in agreement with thefact that most of the respondents who do not keepthe records believe that it is not useful to keepfinancial reports and documents, organize trainingfor managers and owners, and hire consultants forSMEs for financial statement analysis. Make useof financial reports and reports are to be made



Table 11: Hypotheses Testing

Hypotheses Coefficient P value Decision criteriaSupported/

Not supported

H1aThere is significant relationship be-tween FR and FP

0.569 0 P<0.05 Supported

H1bThere is significant relationship be-tween IAP and FP

0.27 0.005 P<0.05 Supported

H1cThere is significant relationship be-tween INAP and FP

-0.111 0.246 P>0.05 Not supported

H1dThere is significant relationship be-tween CMP and FP

-0.015 0.868 P>0.05 Not supported

H1eThere is significant relationship be-tween FAP and FP

0.302 0 P<0.05 Supported


mandatory in all aspects of decision making inthe areas of investment, financial, operating anddividend decisions. Moreover, the study suggestedthat offering free record keeping and advisoryservices and user-friendly management informationand regulatory guidelines are to be formulated withthe stakeholders’ involvement under the governingauthorities of the government and professionalbodies are to be concentrated as a must. Finally,authorities of the government, promotional andinfrastructural and professional bodies shouldexactly motivate managers/owners to adopt stan-dardized financial management reporting withother managerial aspects, strengthen monitoringand supervision, inform managers/owners on theneed to keep record-keeping and reporting on-timeand to provide more potential training center andcourses for SMEs.

Finally, this research, following its researchgap, was focused only on the financial reportingpractices of small and medium entrepreneurs in asmall area in Sri Lanka. Therefore, an extensionof this study or other related research shouldbe conducted for increasing the avenues in thisparticular field. Such research should keep thefollowing additional themes in mind. The futureresearcher may spend more time visiting andcollecting data from the highest sample of SMEs.The future researchers can increase the size of thesample in the study and find more variables thanthis research to measure the financial reporting andanalysis practices.

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