THE FINANCIAL MANAGEMENT PRACTICE AND PERFORMANCE OF LISTED MANUFACTURING COMPANIES IN NIGERIA

 

CHAPTER TWO

LITERATURE REVIEW

2.1       Introduction

This chapter presents a review of literature on the concepts under study. The chapter begins with a conceptual framework section 2.2, theories of management accounting; 2.3, reviews empirical studies  2.4 where a number of studies done on financial management practices together with their findings and their contribution to the present study is made. This is followed by a conclusion of the literature review section.

2.2  Conceptual Framework

2.2.1 Financial Management Practices

For the purpose of this section, financial management practices are defined and demarcated as the practices performed by the accounting officer in the areas of fixed asset management, accounting information systems, working capital management, financial reporting analysis and capital structure management (Bull, 2010).

2.2.2 Fixed Asset Management (FAM)

For the purpose of this research work,  the focus is on movable assets since the study is on manufacturing companies; the acquisition of capital assets can most certainly exert an effect on an organization’s competitive advantage over the long term. Capital equipment is characterized by large expenditure and non-recurring expenditure. Purchasing capital equipment usually requires a relatively large capital outlay, which may sometimes amount to millions and which may have particular financial implications. Buying capital equipment can therefore be regarded as an investment which is financed from long-term, rather than from working, capital.  It is important to consider not only the purchase price of capital equipment, but also the total cost of ownership (Seal, 2006).

Capital equipment is usually purchased at irregular intervals. It is used up gradually in the production process, rather than as a part of the end product. Owing to the relatively long lifespan of equipment, it could take several years before it needs to be replaced and, at the time of replacement, old equipment could prove to be technologically obsolete. If the correct purchasing decision is made, capital equipment generates profits for the organization. Incorrect decisions may have disastrous consequences for the enterprise, since it will not be able to sell capital equipment over the short term. For the above reason, top management should consider the acquisition of capital equipment, with care (Seal, 2006).

2.2.3 Accounting Information Systems (AIS)

Malamo, (2009) states that the AIS is a system of records usually computer-based, which combines accounting principles and concepts with the benefits of an information system and which is used to analyze and record business transactions for the purpose of preparing financial statements and providing accounting data to its users. AIS assists in the analysis of accounting information provided by the financial statements. Lambart, & Sponem,  (2005) purport that the biggest advantage of computer-based accounting information systems is that they automate and streamline reporting. Reporting is a major tool for organizations to accurately see summarized, timely information used for decision-making and financial management practices.

2.2.4 Financial Reporting Analysis (FRA)

As pertains to Financial Reporting Analysis (FRA), recording and organizing the accounting information systems will not meet objectives unless reports from systems are analyzed and used for making managerial decisions. Financial statements usually provide the information required for planning and decision making. Information from financial statements can also be used as part of the evaluation, planning and decision making by making historical comparisons (Karamanuo, & Vafeas, 2005).

2.2.5 Capital Structure Management (CSM)

Capital Structure Management (CSM) according to Hilton,  (2005) means overseeing the capital structure of an organization. A company’s capital structure refers to the combination of its various sources of funding. Most companies are funded by a mix of debt and equity. When determining a company’s cost of capital, the costs of each component of the capital structure are weighted in relation to the overall total amount. This calculates the company’s weighted average cost of capital (WACC). The WACC is used to calculate the net present value (NPV) in capital budgeting for corporate projects. A lower WACC will yield a higher NPV hence achieving a lower WACC is always optimal.

2.2.6 Working Capital Management

According to Ezeamama, (2002), Working Capital Management (WCM) refers to decisions relating to working capital and short term financing. These involve managing the relationship between a firm’s short-term assets and short-term liabilities. The goal of WCM is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses. The context of working capital management includes cash management, receivables and payables management, and inventory management.

2.3  Theoretical Framework

This study is anchored by two theories. The first theory is contingency theory of management accounting while the second is the new institutional sociology theory of management accounting as discussed by Ribeiro and Scapens (2006).

2.3.1 Contingency Theory of Management Accounting

Frank, & Bennard, (2001) discussed why financial management practices may be unalike when comparing one organization to the other. This can be related to organizations operating in different industries or sectors.

Brown,  (2006) applied contingency theory to financial management practices and explained that there is no single general standard accounting practice that can be applied to all organizations. In essence, each organization will have its own financial management practices. The theory looks at certain influential factors that will assist management to decide on an appropriate financial  management practice. These factors can either be technological changes and the infrastructure of an organization. For example, a manufacturing food company may want to change the technology used to a more modern hygienic and efficient way of handling, processing and packaging its food. It may then consider installing a computer based system that mass produces its products. However, the type of qualified personnel that is required to operate such highly complex equipment will influence the type of financial management practices selected and production costs.

Malamo, (2009) highlighted which financial management practices are widely used in manufacturing organisations. Those that were highly favoured were budgeting for controlling costs and performance evaluation. His findings revealed that budgeting plays an important role in the managing and directing process of the organization. This tells managers what costs to expect over the next budgeted period and also gives an indication when the company might expect to go through a seasonal change and the impact it will have on the company’s cash flows and revenues. Perhaps this is the main reason why this particular financial management practice is highly rated over many other practices.

Malamo further went on to mention that budgeting enables organizations to effectively plan and develop strategies to achieve their goals. Koontz, & Weihrich, (2005) also observed that the budgeting process is an integral part of managing and controlling costs in the manufacturing sector, for example, in the UK, South Africa and Australia.

2.3.2    New Institutional Sociology

The foundations of New Institutional Sociology (NIS) were laid by Meyer and Rowan's (1977) seminal paper, which came after a series of puzzling observations made in the 1970s by a group of researchers studying the educational sector in the USA.

Specifically, they had identified inconsistencies and observed the loose coupling of formal structures/procedures and actual work practices, which existing organizational theory could not explain (Hilton, 2005).

The key contention of NIS is that some organizations exist in highly institutionalized environments. In this sense, “environment” is not merely conceptualized as a source of task constraints or a relational network (of customers, suppliers and other near constituencies) that poses demands for operational coordination and control on an organization. Rather, it includes the cultural rules and social norms that are reflected in specific formal structures and procedures of the organization.  That is, institutionalized organizations tend to adopt structures and procedures that are valued in their social and cultural environment. They do this in order to achieve legitimacy and to secure the resources that are essential for their survival.

This search for legitimacy and resources explains why specific organizational forms and procedures are diffused across organizations operating in similar settings –, e.g. similar environments, societal sectors, or organizational fields (Adomon, and Schmidt, 2007).

Developing this insight, Pandey, (2002) suggested that this process of diffusion can create pressures that lead organizations to become isomorphic with other organizations in their institutional setting. Competitive isomorphism such as market forces, is not dismissed, but the emphasis is placed instead on three types of institutional isomorphism – coercive, normative and mimetic isomorphism – that highlight the social and political dimensions of the environment in which organizations are located.

An important aspect that runs through Alexander, and Britton  (2004) paper is that the formal structures and procedures of institutionalized organizations may become decoupled from actual work practices. Formal structures and procedures are adopted in order to acquire legitimacy and guarantee the resources required for the survival of the organization, but they are detached from the everyday organizational practices so as not to disturb the normal processes of daily operations.

Some argue that organizations are strategic in their response to the institutional pressures imposed on them (Prasanna, 2001). They may purposefully comply with regulations or adopt specific formal structures and procedures, but do so in a manipulative fashion, in order to gain legitimacy and thereby secure resources, grants, etc. on which they depend (Eboe, 2008).

However, this idea of “window-dressing” and decoupling from actual operations has been critiqued in another stream of NIS theorizing . Specifically, the observation that institutionalized structures are decoupled from actual practices conflicts with definition of institution: a reciprocal typification of habitualized action by types of actors (Hampton, 2002).

2.4  Financial Performance Measures in Manufacturing Companies  

Measures of corporate performance are numerous. Traditional common measures include; Return on Investments (ROI), Return on Assets (ROA), Return on Capital Employed (ROCE), Cost Benefit Analysis (CBA) and Economic Value Added (EVA). In this study all these measures are discussed.

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