THE EFFECT OF INTERNAL CONTROL ON THE FINANCIAL PERFORMANCE OF MICRO FINANCE INSTITUTIONS IN BUEA

ABSTRACT

The purpose of this study was to determine the effect of internal controls on the performance of microfinance institutions in Buea. Specifically, the study aimed to determine whether the existence of an effective Internal Control System will affect the performance of MFIs, to ascertain the extent to which fraud and errors can be detected early and corrected to ensure the survival of category one MFIs, and to examine the extent to which the Internal Control System can be improved to help the management in achieving its goals and objectives. The study was based on two hypothesis. Hypothesis one was to test whether existence of effective internal control system has a significant effect on the performance of microfinance institutions and hypothesis two to test whether effective internal control system has a significant effect on the survival of microfinance institutions. The study made use of a descriptive survey study research design. The sample for the study was twenty (20) microfinance institutions in Buea. The study used a purposive sampling technique to sample the 20 MFIs. Primary data was used for the study which was obtained by use of structured questionnaires. The quantitative data obtained through the questionnaires administered was analysed with the help of the Statistical Package for Social Sciences (SPSS) using the multiple regression to find out the relationship between each of the internal control components and performance of MFIs. The findings were made through descriptive statistics and were presented using frequencies and percentages while inferential statistics was done through the multiple regression analysis. Results of the regression analysis shows that there is a very strong and statistically significant positive relationship between internal control and performance of microfinance institutions. Results also established that there is a very strong and statistically significant positive relationship between internal control and survival of these microfinance. Finally, the study recommends that management should develop and discover new ways to strengthen their internal controls because the dimension of malpractices in most organizations is growing at an alarming rate day by day.

Keywords: Microfinance Institutions, Internal control, performance, survival

CHAPTER ONE

 INTRODUCTION

1.1. Background Information  

Internal control is a process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of a firm’s objectives in the effectiveness and efficiency of operations, reliability of financial and management reporting, compliance with applicable laws, regulations and protect the organisation’s reputation (Kaplan, 2008). There are many controls that a microfinance institution (MFI) can institute to protect its resources against loss to improve performance. A collection of internal controls put in place by the MFI is what forms internal control system (ICS). An internal control is a topic that cuts across a number of disciplines including financial accounting and auditing. It can be traced back to ancient times. In Hellenistic Egypt there was dual administration where one side was involved in collation of taxes while the other supervising them. Internal controls became apparent at the beginning of 21st century following major corporate scandals.

Otieno (2014) holds that internal control consists of five related components which are derived from the manner in which management runs its business. These components are control environment; risk assessment; control activities; information and communication systems and monitoring. These components of internal control apply to all business entities though Micro-finance Institutions may apply them differently to large corporations. Micro-finance Institutions’ internal control systems could be less formal and unstructured but at the same time be very effective. According to Ledgerwood and White (2016), an internal control adopted by Microfinance Institutions need to be orderly, practical and efficient enough to help them conduct business.

Internal controls are most effective when they are directly incorporated in the process that support operations and enable quick response to changing economic conditions. Micro-finance Institutions use internal control mechanisms to make sure the staff respect its policies and procedures. Everyone in an organisation has the responsibility to ensure internal control succeeds to some extent. Virtually all employees produce information used in the internal control system or take other actions needed to effect control.

The evolution towards financial inclusion is driven by microfinance Institutions who combine the credit cooperatives’ willingness to serve poor people with the commercial banks’ capacity and professionalism (Research Insight, April 2013). Micro-finance Institutions in Kenya have been resilient despite local droughts and the high inflation rates that were experienced in the year 2008 and 2009. Microfinance Institutions have been projecting strong growth in borrowers in the recent past in line with the governments over emphasis on access to financial services as key to modernizing the economy.

Management has three objectives that guide the designing of an effective internal control system, (McPeak et al., 2012) it is entirely responsible for preparing financial statements for investors, creditors and other users. The second objective of an internal control system is to encourage efficiency and effectiveness of operations that is effective use of resources. Lastly the internal control encourages compliance with laws and regulations. The performance of an organisationis determined by how well and acceptable the internal control is and how it affects the financials of the companies.

The framework for internal control help microfinance institutions in managing their business in terms of regulations and policy. Frameworks for internal controls are factored by the processes affected by the board of directors, senior management and all levels of personnel. They are not entirely procedures or policies performed at certain point in time but rather continually operating at all levels within institutions.  Most microfinance institutions have embraced a more business-oriented outlook and maintained their target groups of economically-active poor, in order to achieve financial sustainability (Baguma, 2008). The micro finance institutions in developing economies are widely growing from time to time.

1.2. Problem Statement 

Recent incidence of corporate failures and accounting frauds like Worldcom and a host of other companies has heightened the demand for sound accountability practices on regular and timely basis. These scandals and frauds are mostly preceded by failure in companies’ internal control structures (Anyanzwa, 2013). Internal control systems have become very popular and important in recent times in the wake of these fraudulent financial reporting in different countries around the globe. 

For MFIs to carry out its business there must be some factors put in place for the smooth running of the institution like materials, machines, money etc. These need to be well coordinated in order for the success of the MFIs to be achieved. These factors are used by a group of persons known as management. Every organisation both profit or non-profit organisation has its objectives and goals in mind to achieve. In the effort to achieve these goals, supervision more often than not play a vital role. The size and scope of these organisations have sometimes made it hard for the executors to exercise personal and first hand supervision of operation. It is in this light that internal control established by management is initiated.

The absence of adequate internal control measures exposes the management of a MFIs to certain threats such as loss of assets and properties, mismanagement of MFIs through the stolen of vital documents which may be carried out by a staff or a host of them and due to the incorrect and unreliable financial records MFIs integrity may be loss.

According to Uwaoma and Urdu (2015), there is a general consensus that any organisation without an Internal Control system in place is generally exposed to several threats that are capable of crumbling the organisation in less or no time. Prominent amongst such threats are: Problem of incorrect financial statement and loss of the company’s’ assets; stealing and miss-management of organisational vital documents which may be done by an employee to take undue advantage. There is also the issue of incorrect and unreliable financial records which may lead to loss of organisational integrity; non implementation of accounting policies in consistent with the applicable legislation appropriate in presentation of financial statement as well as non-adherence of annual budgets and implementation of planning policies.  Internal controls check the governance of MFI’s to achieve profitability growth and development (Cha 2009). Microfinance Institutions are prone to risks that are life threatening to the existence and sustainability. Operational and strategic risks are of non-financial character and result mainly from human error, frauds, system failure, through regulatory environment. However, when they materialize, they lead to financial losses for the organisation. A number of MFI’s face collapse or near collapse if they are unable to set up internal controls. Therefore the study explores the effect of internal controls on performance of MFIs by answering the following research questions;

• Does internal control serve as a management tool for MFI?

• Does the existence of an effective internal control system have any effect on the performance of MFIs?

1.3. Objectives of the Study

1.3.1. Main Objective

The main objective of study is to evaluate the impact of effective internal control on the performance of MFIs.

1.3.2. Specific Objectives

The specific objectives that assist in the attainment of the main objective are as follows

• To determine whether the existence of an effective Internal Control System will affect the performance of MFIs.
• To ascertain the extent to which fraud and errors can be detected early and corrected to ensure the survival of category one MFIs.
• To examine the extent to which the Internal Control System can be improved to help the management in achieving its goals and objectives.

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