Luận văn Finacial management and profitablity of small and medium enterprises - Kiều Minh Nguyễn

A THESIS SUBMITTED TO THE GRADUATE COLLEGE OF MANAGEMENT IN PARTIAL FULFILLMENT OF REQUIREMENTS FOR THE DEGREE OF DOCTOR OF BUSINESS ADMINISTRATION AT SOUTHERN CROSS UNIVERSITY, N.S.W., AUSTRALIA Certificate I certify that the substance of this thesis has not already been submitted for any degree and is not currently being submitted for any other degree or qualification. I also certify that, to the best of my knowledge, any help received in preparing this thesis, and all sources used have been acknowledged in this thesis. Signature: Kieu Minh Nguyen ______________________ Date: ___________________________________________ ii Acknowledgements I owe a debt of gratitude to many people who helped me complete this thesis. I would like to acknowledge the help of all. First of all I would like to express my deepest acknowledgement to my supervisor, Professor Geoffrey Grant Meredith from the Graduate College of Management (SCU), for his valuable advice and recommendations. I acknowledge Dr. Lyndon Brooks, his assistants from the Graduate Research College (SCU), and Mr. Tho Dinh Nguyen from the School of Marketing (UTS) for their support with statistical techniques and data analysis. I also acknowledge Ms. Rosemary Graham from the International Office (SCU) for her comments on English in earlier drafts of my thesis. In the process of data collection for this research, many people contributed to the task and I am particularly grateful for their contributions. I am greatly indebted to Dr. Pham Van Nang, Dr. Le Bao Lam, and Dr. Le Thanh Ha from Ho Chi Minh City University of Economics for their introduction to contacts with the small and medium enterprises (SMEs) community located in Ho Chi Minh City. I also wish to thank Mr. Nguyen Trong Hanh, Vice Director of Department of Taxation, Mr. Du Quang Nam, Vice Director of Statistical Office – Ho Chi Minh City; and Mr. Tran To Tu, Managing Director of Investment Consulting Corporation for providing secondary data related to the current practices of SMEs in Vietnam. I would like to thank the following organizations which supported me in completing my thesis and degree: the Swiss Agency for Development and Cooperation (SDC), the Swiss – AIT – Vietnam Management Development Program (SAV), the Mekong Project Development Facility (MPDF), the Small and Medium Enterprise Promotion Centre (Vietnam Chamber of Commerce and Industry – VCCI), HCM City University of Economics, HCM City Statistical Office, HCM City Department of Investment and Planning, HCM City Department of Taxation. Specially, I would like to extend my sincere gratitude to the Government of Switzerland and Dr. Hans Stoessel, Director of SAV for granting the scholarship which enabled me to participate in a doctoral degree at Southern Cross University, New South Wales, Australia. iii I would particularly like to thank the following friends for their support related to data collection: Mr. Doan Thanh Tuan, Ms. To Ngoc Huong, and Mr. Bui Hai Binh from Truong Doan Company Limited, Mr. Hoang Trong from Ho Chi Minh City University of Economics, Mr. Vo Sy Nhan from Ho Chi Minh City Department of Investment and Planning, and all my students who worked as fieldworkers for data collection. Finally, to my parents and my wife, I wish to extend my loving thanks for their encouragement. My greatest debt of gratitude is to my wife, Mrs. Que Thi Tran, who was patiently waiting me during my study in Australia. This thesis could not have been written without her daily encouragement. iv Abstract After a decade of reforming policy, building and developing the multi-sector market economy, Small and Medium Enterprises (SMEs) in Vietnam have developed strongly and contributed to creating employment, increasing GDP, and raising the nation’s volume of exports. However, SMEs have found difficulties on the way to development due to lack of management experience and financial resources, and due to uncertainty within the business environment. As a result, SMEs often faced obstacles during their operations. This thesis examines the relationship between financial management and profitability of SMEs to determine whether financial management practices and financial characteristics impact on SME profitability. Objectives of the thesis are (1) to investigate and describe features of financial management practices and financial characteristics of SMEs in Vietnam, (2) to develop and test a model of SME profitability, and (3) to contribute knowledge of the relationships between financial management and characteristics to improve SME profitability by using tools of efficient financial management. In terms of structure, the thesis has six chapters. The thesis begins by defining the research problem and questions, and providing a justification for the research study. Chapter one also reviews the research background, and presents definitions of terms, significance and scope of the study. Chapter two examines the economic background, business structure and the development of SMEs in Vietnam. This chapter also reviews previous research related to financial management for SMEs in Vietnam to identify gaps between financial management for SMEs in Vietnam and financial management for SMEs worldwide. Chapter three reviews financial management including financial management practices, financial characteristics and profitability of SMEs around the world, especially in the developed economies such as the United States of America (USA), the United Kingdom (UK), Australia and Canada. This review emphasizes profitability and the impact of financial management practices and financial characteristics on SME profitability. Objectives of this chapter are to review previous research related to the areas of financial management practices, financial characteristics, and profitability of v SMEs and to build a model of the impact of financial management practices and financial characteristics on SME profitability. Chapter four discusses aspects of the research methodology including research design, data collection and data analysis methods, and hypothesis testing to support the model. Objectives of this chapter are: (1) to justify the research methodology of this study, (2) to explain research methodology used in the study, and (3) to demonstrate how research design, and data collection and analysis can be utilized in this study to answer the research questions outlined in the chapter 1. Data analysis and findings are presented in chapter five. This chapter presents descriptive findings of financial management practices, financial characteristics and SME profitability and findings of the research study related to testing the model of SME profitability. Objectives of this chapter are (1) to systematically present the descriptive findings of the research study, (2) to interpret significance of these findings based on data analysis, (3) to present the results of testing the model of SME profitability, and (4) to explain how the model, developed from a literature review, was supported by data analysis. Finally, the thesis ends with chapter six where conclusions are summarized and applications of the research findings are indicated for the financial management practitioners. The thesis provides descriptive findings of financial management practices and financial characteristics and demonstrates the simultaneous impact of financial management practices and financial characteristics on SME profitability. In addition, the research study provides a model of SME profitability, in which profitability was found to be related to financial management practices and financial characteristics. With the exception of debt ratios, all other variables including current ratio, total asset turnover, working capital management and short-term planning practices, fixed asset management and long-term planning practices, and financial and accounting information systems were found to be significantly related to SME profitability. With the findings as presented above, this research study provides many implications for financial management practices and contributes to knowledge of financial management of SMEs. The model of SME profitability can be used as guidance for actions to improve the profitability of SMEs in Vietnam. vi Glossary of terms and abbreviations AFTA ASEAN Free Trade Agreement ANOVA Analysis of variance APEC Asia Pacific Economic Cooperation ASEAN Association of South East Asian Nations CED Committee of Economic Development CF Cash flows CUR Current ratio DER Debt ratio E.q Equation EBT Earning before tax EBIT Earning before interest and taxes EFF Efficiency of financial management practices EOQ Economic order quantity FAIS Financial and accounting information system FALP Fixed asset management and long-term planning practices FDI Foreign direct investment FSSB Financial Studies of the Small Business GDP Gross domestic products GSO General Statistical Office IFC International Financial Corporation IRR Internal rate of return MIRR Modified internal rate of return MPDF Mekong Project Development Facilities NOI Net-operating-income NPV Net present value PRO Profitability RE Retained earnings ROA Return on assets vii ROE Return on equity ROI Return on investment ROS Return on sales SBA The Small Business Administration (United State of America) SBV The State Bank of Vietnam SME Small and medium enterprise SMENET Small and Medium Enterprise Net SPSS The Statistical Package for Social Science TA Total assets TAT Total asset turnover UK United Kingdom USA United States of America USM Unlisted Securities Market VCCI Vietnamese Chamber of Commerce and Industry VIDB Vietnam Investment and Development Bank VN Vietnam VND Vietnam dong Vietcombank Vietnam Bank for Foreign Trade WTO World Trade Organization WCSP Working capital management and short-term planning practices viii Table of Contents CERTIFICATE.......................................................................................................................................... ii ACKNOWLEDGEMENTS ....................................................................................................................... iii ABSTRACT .............................................................................................................................................. v GLOSSARY OF TERMS AND ABBREVIATIONS ................................................................................ vii TABLE OF CONTENTS .......................................................................................................................... ix LIST OF TABLES..................................................................................................................................... xiii LIST OF FIGURES .................................................................................................................................. xvii CHAPTER ONE: INTRODUCTION TO THE STUDY 1.1 INTRODUCTION ...................................................................................................................1 1.2 RESEARCH BACKGROUND .................................................................................................3 1.3 RESEARCH PROBLEM .........................................................................................................4 1.3.1 Research questions ...................................................................................................6 1.3.2 Research objectives ..................................................................................................6 1.4 METHODOLOGY....................................................................................................................7 1.5 JUSTIFICATION FOR THE STUDY.......................................................................................8 1.6 DEFINITIONS OF TERMS USED IN THE STUDY ................................................................10 1.7 SIGNIFICANCE AND SCOPE OF THE STUDY ....................................................................13 1.8 ANALYTICAL MODEL FOR THE STUDY..............................................................................13 1.9 STRUCTURE OF THE STUDY ..............................................................................................15 1.10 CONCLUSIONS .......................................................................................................................16 CHAPTER TWO: THE ECONOMIC STRUCTURE AND SMEs IN VIETNAM 2.1 INTRODUCTION ....................................................................................................................17 2.2 VIETNAM: BACKGROUND INFORMATION..........................................................................19 2.2.1 Overview of the country .............................................................................................19 2.2.2 The Vietnam economy...............................................................................................23 2.2.3 The Vietnam population and labour...........................................................................38 2.3 VIETNAM BUSINESS STRUCTURE .....................................................................................40 2.3.1 Types of business in Vietnam....................................................................................41 2.3.2 Overview of enterprises in Vietnam...........................................................................43 2.3.3 Small and medium enterprises in Vietnam ................................................................44 2.3.4 Policies for supporting SMEs.....................................................................................50 ix 2.4 SMALL AND MEDIUM ENTERPRISE FINANCE IN VIETNAM .............................................51 2.4.1 Types of finance.........................................................................................................52 2.4.2 Use of finance............................................................................................................53 2.4.3 Financial management for SMEs...............................................................................54 2.4.4 Problems in financial management............................................................................55 2.5 BUSINESS STRUCTURE AND SMEs IN HO CHI MINH CITY .............................................56 2.6 CONCLUSIONS......................................................................................................................58 CHAPTER THREE: FINANCIAL MANAGEMENT AND PROFITABILITY OF SMEs 3.1 INTRODUCTION ....................................................................................................................59 3.2 DEFINITIONS OF SMEs.........................................................................................................61 3.2.1 Qualitative definitions.................................................................................................61 3.2.2 Quantitative definitions ..............................................................................................64 3.2.3 The forms of ownership of SMEs...............................................................................65 3.3 FINANCIAL MANAGEMENT FOR SMEs...............................................................................67 3.3.1 Defining financial management .................................................................................68 3.3.2 Objectives of financial management..........................................................................69 3.3.3 Major decisions of financial management .................................................................71 3.3.4 The specific areas of financial management .............................................................72 3.4 FINANCIAL MANAGEMENT PRACTICES.............................................................................76 3.4.1 The context of financial management practices ........................................................76 3.4.2 Accounting information systems................................................................................77 3.4.3 Financial reporting and analysis ................................................................................83 3.4.4 Working capital management ....................................................................................89 3.4.5 Fixed asset management ..........................................................................................95 3.4.6 Capital structure management...................................................................................100 3.5 FINANCIAL CHARACTERISTICS OF SMEs .........................................................................104 3.5.1 Identifying financial characteristics ............................................................................104 3.5.2 Measuring financial characteristics............................................................................107 3.5.3 Previous findings related to financial characteristics .................................................111 3.6 SME PROFITABILITY.............................................................................................................119 3.6.1 Importance of profitability...........................................................................................119 3.6.2 Defining and measuring profitability...........................................................................120 3.6.3 Factors influencing profitability ..................................................................................123 3.7 RELATIONSHIPS BETWEEN FINANCIAL MANAGEMENT AND SME PROFITABILITY ....126 3.8 MODEL OF THE IMPACT OF FINANCIAL MANAGEMENT ON SME PROFITABBILITY....128 x 3.9 CONCLUSIONS......................................................................................................................131 CHAPTER FOUR: RESEARCH METHODOLOGY 4.1 INTRODUCTION ....................................................................................................................132 4.2 APPRAISAL OF PRIOR RESEARCH METHODOLOGIES ...................................................134 4.3 RESEARCH DESIGN .............................................................................................................137 4.3.1 Classification of research design ...............................................................................137 4.3.2 Selecting research design or paradigm .....................................................................140 4.3.3 Selecting research methods or techniques ...............................................................141 4.4 VARIABLE DEFINITIONS, SURVEY INSTRUMENT AND MODEL DEVELOPMENT..........144 4.4.1 Variable measurements and survey instrument ........................................................144 4.4.2 Model development....................................................................................................162 4.4.3 Hypothesis statements ..............................................................................................165 4.5 DATA COLLECTION METHODS ...........................................................................................168 4.5.1 Secondary data collection..........................................................................................169 4.5.2 Primary data collection ..............................................................................................170 4.6 DATA TRANSFORMATION ..................................................................................................174 4.7 DATA ANALYSIS METHODS.................................................................................................175 4.7.1 General consideration................................................................................................175 4.7.2 Descriptive statistics ..................................................................................................176 4.7.3 Bivariate analysis .......................................................................................................177 4.7.4 Multivariate analysis...................................................................................................178 4.8 CONCLUSIONS......................................................................................................................183 CHAPTER FIVE: DATA ANALYSIS AND FINDINGS 5.1 INTRODUCTION ....................................................................................................................184 5.2 LINKS BETWEEN DATA ANALYSIS AND RESEARCH OBJECTIVES AND QUESTIONS.186 5.3 DESCRIPTIVE FINDINGS OF THE RESEARCH STUDY.....................................................187 5.3.1 Sample descriptions and SME characteristics ..........................................................187 5.3.2 Descriptive findings of financial management practices............................................190 5.3.3 Descriptive findings of financial characteristics .........................................................206 5.3.4 Descriptive findings of profitability of SMEs...............................................................211 5.4 ASSOCIATIVE ANALYSIS AND FINDINGS OF THE RESEARCH STUDY..........................215 5.4.1 Factor analysis and principal components of financial management practices ........216 5.4.2 Bivariate analysis and findings ..................................................................................221 5.4.3 Multiple regression analysis and findings ..................................................................225 xi 5.4.4 Test for the difference of average profits between efficient and inefficient financial management groups of SMEs....................................................................................234 5.5 CONCLUSIONS......................................................................................................................236 CHAPTER SIX: CONCLUSIONS AND IMPLICATIONS 6.1 INTRODUCTION ...................................................................................................................237 6.2 CONCLUSIONS RELATED TO RESEARCH QUESTIONS AND TESTING THE MODEL..239 6.2.1 Conclusions related to financial management practices ...........................................239 6.2.2 Conclusions related to financial characteristics.........................................................247 6.2.3 Conclusions of SME profitability ................................................................................249 6.2.4 Summary of research question answers ...................................................................255 6.3 IMPLICATIONS OF THE RESEARCH STUDY.....................................................................258 6.3.1 Implications for financial management practices of SMEs ........................................258 6.3.2 Contributions to knowledge of this research into financial management for SMEs ..262 6.4 LIMITATIONS OF THE RESEARCH STUDY .......................................................................263 6.5 IMPLICATIONS FOR THE FURTHER RESEARCH.............................................................264 Bibliography......................................................................................................................................266 Appendix 1 Appendix 2 Appendix 3 Appendix 4 xii List of tables Table Page 2.1 Changes in economic structure, 1986 – 1991 ............................................................27 2.2 State-budget revenue, 1986 – 89................................................................................28 2.3 State-budget revenue, 1991 – 93................................................................................29 2.4 Financial institutions in Vietnam, 1995.....................................................................30 2.5 GDP index by economic sector and rate of inflation.................................................31 2.6 Index of exchange rate of USD/VND........................................................................32 2.7 GDP index by economic industry ..............................................................................32 2.8 Agriculture development over the years ....................................................................33 2.9 Industry development over the years .........................................................................34 2.10 Export and import value by major countries..............................................................35 2.11 Population by sex and areas.......................................................................................38 2.12 Population growth rates and structure........................................................................39 2.13 Labor force by economic sector.................................................................................39 2.14 Labor force by the state and non-state sector.............................................................40 2.15 Unemployment rate of labour force in 1998..............................................................40 2.16 Number of businesses by economic sector and average capital ................................43 2.17 Number of businesses and employees on July 1, 1995..............................................44 2.18 Definitions of SMEs in Asian countries ....................................................................46 2.19 Number of enterprises in manufacturing industry by scale of employees and total capital.........................................................................................................................49 2.20 Business operation problems of SMEs in Vietnam ...................................................50 2.21 The kind of SME support programs...........................................................................51 2.22 Some financial characteristics of SMEs in Vietnam..................................................54 2.23 Business structure of SMEs in Ho Chi Minh City.....................................................57 2.24 Size of businesses in Ho Chi Minh City ....................................................................57 3.1 Summary of the quantitative definitions of small business .......................................65 3.2 Forms of SME ownership in the USA .......................................................................65 3.3 Legal status of small firms in the UK ........................................................................66 xiii 3.4 Summary of advantages and disadvantages of each form of ownership ...................67 3.5 Responsibility for the bookkeeping and accounting task ..........................................78 3.6 Responsibility for preparation and use of financial information ...............................78 3.7 The results of survey of computer software application............................................79 3.8 The most important applications of computer software ............................................79 3.9 The most important applications of computers..........................................................80 3.10 Percentage of awareness and utilization of costing systems......................................81 3.11 Evaluate the adequacy of accounting records............................................................82 3.12 Accounting information prepared externally or internally ........................................82 3.13 Summary of research areas related to the accounting system practices of SMEs .....83 3.14 Use of financial statement techniques by small manufacturers in Quebec................84 3.15 Responsibility for financial statement interpretation.................................................85 3.16 Proportion of respondents indicating use of selected financial ratios........................86 3.17 Percentage of use of financial ratios ..........................................................................87 3.18 Percentage of preparing accounting information both internally and externally.......88 3.19 Summary of the main research areas related to the financial reporting and analysis 89 3.20 Cash surplus investment practices .............................................................................90 3.21 Instruments of short-term investment used................................................................91 3.22 Awareness and utilization of credit control systems..................................................92 3.23 Methods used by small and large enterprises to determine inventory level ..............92 3.24 Working capital management: Frequency (%) of using or reviewing.......................93 3.25 Summary of working capital management practices .................................................95 3.26 Percentage of firms using capital project selection methods .....................................96 3.27 The extent of use of formal methods of the capital investment evaluation ...............96 3.28 Primary method of investment analysis.....................................................................97 3.29 Percentage use of different methods by small, medium, and large enterprises .........97 3.30 Percentage of kinds of screening rate used to evaluate the capital projects ..............98 3.31 Methods of determining the required rate of return as using discounted cash flow..99 3.32 Summary of fixed asset management practices .........................................................99 3.33 Viewpoint guiding firms’ financing decisions...........................................................102 3.34 Factors influencing percentage of bank debt usage ...................................................103 xiv 3.35 Summary of literature review of financial characteristic variables ...........................106 3.36 Summary of measurement of financial characteristic variables ................................110 3.37 Financial ratios used in the study of Meric and Meric (1997)...................................117 3.38 Comparison of liquid ratios between Korean and USA firms ...................................118 3.39 Summary of measurement of SME profitability........................................................123 4.1 Classification of research designs..............................................................................139 4.2 Summary of advantages and disadvantages of the most typical surveys...................143 4.3 Model classification ...................................................................................................163 4.4 Number and percentage of SME sample and population...........................................174 4.5 Summary of multivariate techniques for the analysis of dependence........................181 5.1 Structure of SMEs in the sample by type of industry and form of ownership...........187 5.2 Sample distribution by form of ownership within industry .......................................189 5.3 Business characteristics of SMEs in the sample ........................................................189 5.4 Characteristics of accounting system organization....................................................190 5.5 Responsibility – accounting information system.......................................................191 5.6 Using computer in accounting information system ...................................................192 5.7 Kinds of financial statements prepared......................................................................193 5.8 Frequency of preparing and analyzing financial statements......................................193 5.9 Responsibility – preparing and analyzing financial statements.................................194 5.10 Kinds of financial analysis and ratios used................................................................194 5.11 Preparing cash budgets ..............................................................................................196 5.12 Cash balance determination .......................................................................................196 5.13 Cash surplus or shortage ............................................................................................197 5.14 Sales on credit and credit polices...............................................................................198 5.15 Frequency of reviewing receivable levels and bad debts...........................................199 5.16 Percentage of bad debts compared to sales................................................................199 5.17 Frequency of reviewing inventory levels and preparing inventory budgets..............200 5.18 Basis of determining inventory levels and using EOQ Model ..................................201 5.19 Frequency of evaluating investment projects and reviewing efficiency of using fixed assets after investing .........................................................................................202 5.20 Methods used to evaluate investment projects...........................................................203 xv 5.21 Frequency of preparing and reviewing financial budgets..........................................204 5.22 Kinds of financial budgets prepared ..........................................................................204 5.23 Responsibility – preparing financial budgets.............................................................205 5.24 Frequency of comparing between budgeted and actual results .................................205 5.25 Descriptive statistics of financial ratios .....................................................................207 5.26 Test for difference of means of financial ratios between two groups........................208 5.27 Comparison of current ratios .....................................................................................208 5.28 Descriptive findings of SME current ratios ...............................................................209 5.29 Descriptive findings of SME debt ratios....................................................................210 5.30 Descriptive findings of SME activity ratio ................................................................211 5.31 Overview of SME profitability ..................................................................................213 5.32 Relationship between profitability and types of business..........................................213 5.33 Relationship between profitability and business characteristics................................214 5.34 Total variance explained and three principal components of financial management practices .....................................................................................................................217 5.35 Factor analysis results for measuring financial management practices .....................219 5.36 Three principal components of financial management practices...............................218 5.37 Correlation matrix of PRO, ROS, ROA, and ROE....................................................222 5.38 Correlation matrix of PRO and independent variables ..............................................223 5.39 Correlation matrix of ROS and the independent variables ........................................224 5.40 SME profitability regression model using profitability as dependent variable .........226 5.41 Descriptive finding of relationship between profitability and current ratio ..............227 5.42 Relationship between SME profitability and the efficiency of financial management practices................................................................................................230 5.43 Regression model of SME profitability after removing debt ratio ............................231 5.44 SME profitability regression model using return on sales as dependent variable .....232 5.45 Descriptive statistics of profitability of two groups of SMEs....................................235 5.46 Independent group test of mean profit difference......................................................235 6.1 Summary of conclusions related to financial management practices ........................246 6.2 Summary of conclusions related to financial characteristics of SMES .....................249 6.3 Summary of research questions and answers.............................................................257 xvi List of figures Figure Page 1.1 Structure of chapter 1.................................................................................................2 1.2 Fields of the research problem...................................................................................5 1.3 Analytical model for the research ..............................................................................14 1.4 Structure of the study.................................................................................................15 2.1 Structure of chapter 2.................................................................................................18 2.2 Political structure of Vietnam ....................................................................................23 2.3 Business structure in Vietnam ...................................................................................41 2.4 Breakdown of business by size ..................................................................................42 2.5 SME financial management practices and the gap ....................................................56 3.1 Structure of chapter 3.................................................................................................60 3.2 The central position and role of financial management.............................................68 3.3 The relations among objectives of financial management.........................................70 3.4 A model of financial management.............................................................................74 3.5 Interaction between theories and practices of financial management .......................75 3.6 Financial ratios linked to return on equity .................................................................125 3.7 Model of the impact of financial management on SME profitability........................130 4.1 Structure of chapter 4.................................................................................................133 4.2 Survey instrument for measuring accounting information system ............................148 4.3 Survey instrument for measuring financial reporting and analysis ...........................150 4.4 Survey instrument for measuring cash management practices ..................................152 4.5 Survey instrument for measuring receivable management practices.........................154 4.6 Survey instrument for measuring inventory management practices..........................156 4.7 Survey instrument for measuring fixed asset management .......................................157 4.8 Survey instrument for measuring financial planning.................................................159 4.9 Analytical model for the research study ....................................................................165 4.10 Structure of SMEs in Vietnam and the target population ..........................................171 4.11 A classification of multivariate methods ...................................................................179 xvii 5.1 Structure of chapter 5.................................................................................................185 5.2 Distribution of sample by industry ............................................................................188 5.3 Distribution of sample by ownership.........................................................................188 5.4 Relationship between profitability and debt ratio......................................................229 6.1 Structure of chapter 6.................................................................................................238 6.2 The revised model of SEM profitability ....................................................................254 xviii Chapter One: Introduction to the Study 1.1 INTRODUCTION This chapter provides a general introduction to the research study. The purpose is to establish foundations for following chapters and the study as a whole, by providing a general picture of the study. This chapter is structured into ten sections as presented by figure 1.1 (page 2). Section 1.1 provides a general introduction to the chapter and section 1.2 examines the research background where the research problem is identified. Section 1.3 defines the research problem, presents a statement of the problem and expands the research problem in two subsections 1.3.1 and 1.3.2. Subsection 1.3.1 addresses the research questions that will be respectively answered in chapters of the study. Subsection 1.3.2 presents research objectives that the study covers in the process of solving the research problem defined. Section 1.4 briefly discusses the general aspects of research methodology such as selecting from alternative types of research and research design, whereas the details of research methodology will be discussed in chapter 4. Section 1.5 provides some justifications for the study including the rationale and arguments for the study. Section 1.6 explains the context of specialized terms used in the study and section 1.7 points out the significance and scope of the study. Section 1.8 presents the analytical model of the study fully developed in chapter 3. Section 1.9 describes overall structure of the thesis, and finally section 1.10 summarizes conclusions drawn from the research. Figure 1.1 provides a visual representation of the structure of the chapter. Chapter One: Introduction to the Study Figure 1.1: Structure of chapter 1 1.3 Research problem 1.3.1 Research questions 1.3.2 Research objectives 1.4 Methodology 1.5 Justification for the study 1.6 Definitions of terms used in the study 1.9 Structure of the study 1.10 Conclusions 1.8 The analytical model for the study 1.7 Significance and scope of the study 1.2 Research background 1.1 Introduction Source: Developed for the thesis 2 Chapter One: Introduction to the Study 1.2 RESEARCH BACKGROUND In the mid-1980s, Vietnam could be characterized as having a strong command- economy system. However, difficulties from 30 years of war and the inefficiency of the command-economy system had led the national economy to the brink of disaster. Faced with stagnant growth, a severe shortage of food, deficit budgets, increases in inflation and chronic trade imbalances, the Government of Vietnam initiated an economic renovation policy in December 1986. Economic reform has taken place in many areas but typically has focused on four main areas (Le, 1992). The first was to change from a centrally planned and controlled economy to a market economy regulated by the government. The second involved a shift from the policy of giving priority to the state and collective sectors to the policy of developing multi-sector businesses and promoting private businesses. The third was to change investment policy that had formerly emphasized heavy industries into policies of priority for development of food and consumer goods production, and goods production for exports. In terms of international economic relations, the government has encouraged all economic sectors to diversify exporting products and markets instead of focussing on the traditional ones such as the former Soviet Union and Eastern European countries (Le, 1992). It is apparent that since the government introduced the series of economic reforms known as doi moi (renovation), the private sector has rapidly grown in terms of the number of businesses, capital and employees. From the base of zero in 1991, the number of private businesses and limited companies had quickly risen to 28,811 in 1998 (Tran, 1998, p. 54) and almost all are small and medium enterprises (SMEs). SMEs have contributed considerably to growing GDP and creating jobs for labour- age people. Vu (1998, p. 18) summarizes SME contributions as follows: • providing a large number of diversified products, occupying 26 percent of GDP and 30 percent of industrial outputs, • creating jobs for 4.5 million people, • mobilizing temporarily unused resources such as land, capital, labour and management skills to develop production, and • increasing export volume and lessening trade deficits. 3 Chapter One: Introduction to the Study In addition to achievements and contributions as mentioned above, SMEs in Vietnam are currently being faced with many serious difficulties such as shortage of capital for expanding and renovating equipment and technology, low productivity and competitiveness, lack of experience in terms of marketing, production management, and financial management. Of these difficulties, lack of financing resources and experience of financial management is currently one of the most serious issues (Ebashi, Sakai and Takada, 1997). Inefficient financial management may damage SME profitability and, as a result, the difficulties of SMEs will become greater. Conversely, efficient financial management will help SMEs to strengthen their profitability and, as a result, these difficulties can partly be overcome. Most commercial banks refuse to offer loans for SMEs because the banks think SME profitability could not cover loan risks. However, to date there has not been any research on SME profitability conducted in Vietnam. Conducting such research will enable commercial banks to evaluate SME profitability and make decisions on granting loans for SMEs. In addition, when the stock exchange is established in Vietnam, conducting research on SME profitability will help SMEs to improve their performances and reinforce financial management as a preparation to participate in stock exchange listing. Originating from recognition of the increasingly important role and contribution of SMEs as well as the recent promotion and supporting policy on developing SMEs, this research study is considered a contribution to improvement of financial management practices and profitability of SMEs in Vietnam. Firstly, it investigates financial management practices and financial characteristics of SMEs, and then, examines the impacts of financial management practices and financial characteristics on SME profitability. 1.3 RESEARCH PROBLEM Problem definition is essential before conducting a research project, especially quantitative research. Zikmund (1997, p. 82) recommends that formal quantitative research should not begin until the problem has been clearly defined. In Vietnam, defining the research problem of SMEs may begin with a consideration of the typical characteristics of management. Most SMEs have not appointed financial managers to be in charge of financial management of the company. Usually, the owner-managers 4 Chapter One: Introduction to the Study with the assistance of the chief-accountant control financial matters of the company. However, most owner-managers have no formal training in management skills, especially financial management. Moreover, the concepts of financial management have also only been recognized in Vietnam since the beginning of the 1990s when the economy was converted into a market economy. Currently, financial management is one of the challenges of SMEs. Lack of knowledge of financial management combined with the uncertainty of the business environment often lead SMEs to serious problems regarding financial performances. Regardless of whether owner-manager or hired-manager, if the financial decisions are wrong, profitability of the company will be adversely affected. Consequently, SME profitability could be damaged because of inefficient financial management. SMEs have often failed due to lack of knowledge of efficient financial management. Moreover, undercapitalization and uncertainty of the business environment cause SMEs to rely excessively on equity and maintain high liquidity and these financial characteristics probably affect SME profitability (Vuong, 1998). In summary, the problem that SMEs in Vietnam face appears to be that inefficient financial management practices have adversely affected their profitability. Therefore, the problem to be addressed in this research is to investigate the simultaneous effects of financial management practices and financial characteristics on SME profitability, and then, to determine the best measures for improving SME profitability in Vietnam by using efficient financial management tools. Figure 1.2 represents the fields of research problem in this study. Figure 1.2: Fields of the research problem Financial management practices SME profitability Financial characteristics Source: Developed for the thesis 5 Chapter One: Introduction to the Study 1.3.1 Research questions Research questions involve the research translation of “problem” into the need for inquiry (Zikmund, 1997, p.88). The research problem defined above leads to the following research questions: • How important are SMEs in Vietnam and are they profitable? (answered in chapters 2 and 5) • How have researchers in the literature review, identified the context of financial management practices and financial characteristics, and how have they proposed to measure SME profitability? (answered in chapter 3) • How important are financial management practices and financial characteristics to SME profitability? (answered in chapter 3) • What are the relationships between financial management practices, financial characteristics and SME profitability? (answered in chapters 4 and 5) • How do financial management practices and financial characteristics affect SME profitability? (answered in chapters 4 and 5) • What action can improve financial management and profitability of SMEs in Vietnam? (answered in chapters 5 and 6) 1.3.2 Research objectives A research objective is the researcher’s version of a business problem. Objectives explain the purpose of the research in measurable terms and define standards of what the research should accomplish (Zikmund 1997, p. 89). In solving the research problem and answering the research questions mentioned previously, this study has the following objectives: to collect descriptive evidence on financial management practices, financial characteristics and profitability of SMEs in Vietnam • • • to develop a model of the impacts of financial management practices and financial characteristics on SME profitability to contribute to knowledge of the relationships of financial management practices, financial characteristics and SME profitability. 6 Chapter One: Introduction to the Study 1.4 METHODOLOGY In choosing a research design, Zikmund (1997, p. 37) discusses three types of business research: exploratory, descriptive and causal research. • Exploratory research is usually conducted to clarify and define the nature of a problem. • Descriptive research is designed to describe characteristics of a population or phenomenon. • Causal research is conducted to identify cause-and-effect relationships among variables where the research problem has already been narrowly defined. Choosing a type of research depends upon the research questions that the researcher wants to answer. This research study is designed to describe characteristics of financial management practices of SMEs and investigates the impact of the financial management practices and financial characteristics on SME profitability. Thus, “descriptive” was viewed as an appropriate research type. Also, this research is designed to identify the cause-and-effect relationships between efficient financial management practices and profitability of SMEs. Thus causal research was also implemented in combination with descriptive research. In summary, a combination of descriptive and causal research has been chosen for this research. Selecting research design is the next step after choosing type of research. There are four types of research design from which to select: survey, experiments, observation and secondary data (Zikmund, 1997). Selection of research design is based on the advantages and disadvantages of each kind of research designs and circumstances in which the research problem is defined. In this research, both survey and secondary data methods are used in combination. Survey was chosen as a research technique in this study to investigate and describe financial management practices of SMEs in Vietnam. Questionnaires were designed and directly delivered to SMEs to collect data related to financial management practices. The argument for choosing survey was twofold. Firstly, surveys provide quick, efficient and accurate means of assessing information about the population. Secondly, surveys are more appropriate in cases where there is lack of secondary data. 7 Chapter One: Introduction to the Study The secondary data method was used to examine the financial characteristics of SMEs. The variables such as liquidity ratios, financial leverage ratios, activity ratios, and profitability ratios are derived from financial statements. These financial statements are available from taxation departments of Vietnam and sometimes from businesses directly. One of the objectives of collecting data related to financial management practices, which are collected from the survey, and data related to financial characteristics of SMEs, which are derived from the financial statements, was to test hypotheses. This research study was designed to test two kinds of hypotheses. The first was the hypothesis of the simultaneous impacts of financial management practices and financial characteristics on SME profitability. The second was the hypothesis related to differences in the average profits between SMEs with efficient financial management practices and SMEs with inefficient practices. 1.5 JUSTIFICATION FOR THE STUDY Concerned with financial management practices, most previous researchers have concentrated on examining, investigating and describing the behaviour of SMEs in practising financial management. Five specific areas of financial management practices including accounting information systems, financial reporting and analysis, working capital management (including cash management, receivables management, inventory management and payables management), fixed asset management and capital structure management have long attracted the attention of researchers (McMahon, et al. 1993). Their findings are mainly related to exploring and describing the behaviour of SMEs towards financial management practices. Although they provided much descriptive statistical data and empirical evidence on SME financial management practices, it appears that there still are some gaps in the literature, which need to be addressed. • Firstly, most empirical evidence comes from the developed economies such as the United States of America (USA), the United Kingdom (UK), Canada and Australia (McMahon et al. 1993). There seems to be a lack of evidence from emerging economies, especially from transiting economies such as Vietnam and China. 8 Chapter One: Introduction to the Study • Secondly, most previous researchers focus on investigating and describing financial management practices whereas there has been little research examining the impact of financial management practices on SME profitability (McMahon et al. 1993). These are major gaps and it is difficult to convince business financial management practitioners of the need for changes in practices until evidence of the effects of financial management practices on SME profitability is provided and the relationship between the two variables are discovered. In addition to financial management practices, previous researchers provided valuable findings related to financial structures/characteristics of SMEs. Four variables including liquidity, financial leverage, activity and profitability are popularly used by previous researchers to identify and measure financial characteristics of SMEs (McMahon et al, 1993). There are many studies on financial characteristics of SMEs conducted by researchers over several decades. However, there still exist gaps in the literature related to financial characteristics of SMEs, which need to be supplemented. • Firstly, it appears that the financial characteristics of SMEs in developing countries, especially in transiting economies such as Vietnam and China have not been investigated and empirical data has not been produced. • Secondly, to date, there is no study, which examines the relationship or the impact of three variables: liquidity, financial leverage, and activity on profitability variable. This lack of empirical evidence from emerging economies and the lack of examination of the impact of financial management practices and financial characteristics on SME profitability are major gaps in the knowledge of financial management practices and financial characteristics of SMEs. Based on previous research findings and recognition of these gaps, a study of the impact of financial management on SME profitability is justified and a model of the impacts of financial management practices and the financial characteristics should be developed and tested by using the empirical data from emerging economies. Vietnam is one of many 9 Chapter One: Introduction to the Study appropriate countries to provide such data. Therefore, this study will extend previous studies by focusing on examining the simultaneous impacts of financial management practices and financial characteristics on SME profitability using the empirical evidence from Vietnam. 1.6 DEFINITIONS OF TERMS USED IN THE STUDY Specialized terms used in this study include SMEs, private company, limited company, stock companies, efficient financial management and profitability. These terms are adopted for Vietnamese context. In this study, SMEs refers to small and medium enterprises. Currently, Vietnam has not uniformly defined which criteria a business has to fulfil to be viewed as an SME. In this study, SMEs are understood to have the same definition given by the Vietnamese Chamber of Commerce and Industry (VCCI, 1998). According to VCCI, a SME is defined as a business unit that fulfils the following criteria, depending on its size: • Small business: − Manufacturing: less than 200 employees and VND5 billion capital − Trading and services: less than 200 employees and VND5 billion capital • Medium business: − Manufacturing: 200 – 500 employees and VND5 – 10 billion capital − Trading and services: 50 – 100 employees and VND5 – 10 billion capital As will be examined in more detail in chapter two, SMEs include many forms of business organization such as private enterprises, limited companies, joint stock companies, cooperatives and business households or family businesses. However, this study only focuses on the forms of business that set up a formal system of financial management. Based on this criterion, private enterprises, limited companies, and joint stock companies are the objects of this study whereas others such as cooperatives and family businesses are beyond the study. Also, the term “company” is used synonymously with the term “enterprise” in this study. Private enterprises are companies that are registered under the Vietnam Private Business Law. These companies have one owner who is responsible for all his or her assets. Limited companies are companies that are registered under the Company Law and they have 10 Chapter One: Introduction to the Study larger initial capital than private enterprises. Owners’ liability is limited to the initial capital that they have to invest in full at the time of establishment of the company. If there are more than 12 owners, a formal owner meeting and boards of director meetings must be held. Financial management is concerned with all areas of management which involve finance – not only the sources and uses of finance in the enterprise, but also the financial implications of investment, production, marketing or personnel decisions and the total performance of the enterprise (Meredith, 1986). Financial management is concerned with raising the funds needed to finance the enterprise’s assets and activities, the allocation of these scarce funds between competing uses, and ensuring that the funds are used effectively and efficiently in achieving the enterprise’s goals (McMahon, Holmes, Hutchinson and Forsaith, 1993). However, financial management, in this study, is limited to a framework of five specific areas: (1) accounting information system (2) financial reporting and analysis, (3) working capital management, (4) fixed asset management, and (5) capital structure management. This limitation is necessary and appropriate to financial management practices of SMEs in Vietnam, given information available for research. Financial management objectives, in this research, refer to two main objectives: profitability and liquidity. Profitability management is concerned with maintaining or increasing a business’s earnings through attention to cost control, pricing policy, sales volume, stock management, and capital expenditures (McMahon, 1995). Liquidity management is concerned with avoiding any damage at all to a business’s credit rating, due to a temporary inability to meet obligation by anticipating cash shortages, maintaining the confidence of creditors, bank managers, pre-arranging finance to cover cash shortages (McMahon, 1995). Efficient financial management, in this research, is defined as financial management that achieves financial management objectives without wasting financial resources. Conversely, inefficient financial management is not to achieve financial management objectives or achieve the objectives but wasting or without minimizing financial resource utilization. Chapter 4 defines variables and criteria to measure the extent of efficiency of financial management. In this study the context of financial management practices include accounting information systems, financial reporting and analysis, cash management, receivable management, inventory management, 11 Chapter One: Introduction to the Study fixed asset management and financial planning. The extent of efficiency of each financial management component is measured by the sum of points of eight items on the nine-point scale (1 = not efficient at all, 9 = very efficient). If the sum of points of a financial management component of a business is greater than the average point of 40 (8 x 5 point average), the business is said to be “efficient” in practising that financial management component. Conversely, if that sum is less than the average point of 40, the business is said to be “not efficient” or “inefficient” in practising that financial management component. Lastly, a business is said to be “efficient” in financial management practices, if all components of financial management practices are efficient, that is, all sums of points of components are greater than the average point of 40. Manager refers to the person who is hired to run and manage the business whereas owner-manager refers to the person who plays the role of both owner and manager. Financial characteristics of the enterprise are represented by financial ratios, derived from financial statements. This information can be used to quantify the position of SMEs in terms of their profitability, liquidity, and leverage and to compare them with other or large enterprises (McMahon et al. 1993). In this study, financial characteristics are measured by three variables including liquidity, financial leverage and business activity, which are derived from financial statements. SME profitability is an abstract concept. There are many different ways to measure profitability. This research limits the measures of SME profitability at the following ratios: (1) return on sales, (2) return on assets, and (3) return on equity. This limitation is necessary to narrow the scope of the study and is suitable for financial management practices for SMEs in Vietnam. In addition, in this study, the concept of profitability is defined as a comparative concept. A business is said to be “profitable” if it produces annual average returns (average of return on sales, return on assets and return on equity) that are greater than the free-risk rate of interest, which was estimated as 5.4% percent at the middle of the year 2000 in Vietnam. Conversely, if the annual average profit of a business is not greater than the free-risk rate of interest, the business is said to be “not profitable”. The arguments for the concept of profitability will be explained in chapters 4 and 5. 12 Chapter One: Introduction to the Study 1.7 SIGNIFICANCE AND SCOPE OF THE STUDY Completing this study brings together aspects of theory and practice. For theory, this study is an expansion of previous studies on financial management practices and financial characteristics of SMEs by focussing on examining the simultaneous impacts of financial management practices and financial characteristics on SME profitability. In addition, utilizing data from Vietnam, one of the emerging economies, contributes to the literature of SME financial management, which traditionally concentrates on SMEs of developed economies rather than SMEs in other economies. Using data from Vietnam to test theories of financial management helps to confirm and expand the scope of theoretical applications. In practice, this study is significant for financial management practices in Vietnam. Results will indicate relationships between financial management practices, financial characteristics and SME profitability and will assist owner-managers and financial managers to improve performance and profitability of their businesses by managing financial matters efficiently and effectively. 1.8 ANALYTICAL MODEL FOR THE STUDY The analytical model for this research, which is developed and justified in the literature review chapters, and which ultimately provides structure to the empirical chapters, is illustrated in figure 1.3 (page 14). This analytical schema represents the model of the effects of financial management practices and financial characteristics on SME profitability. The model demonstrates that SME profitability is expected to be positively influenced by efficient financial management practices and financial characteristics. This analytical schema presented in Figure 1.3 can be expressed in mathematical notation as follows: Pm = f(As, Fa, Wo, Fi, Cs, Ls, FLa, ACo) (Eq. 1.1) where: Pm = SME profitability ratios, viewed as dependent variables 13 Chapter One: Introduction to the Study As = Accounting information system practices, viewed as independent variables Fa = Financial reporting and analysis practices, viewed as independent variables Wo = Working capital management practices, viewed as independent variables Fi = Fixed-asset management practices, viewed as independent variables Cs = Capital structure management practices, viewed as independent variables. Ls = Liquidity ratios, viewed as independent variables FLa = Financial leverage ratios, viewed as independent variables ACo = Activity ratios, viewed as independent variables. Figure 1.3: Analytical model for the research Source: Developed for the study Chapter 4 will present, in more detail, definitions and measures of dependent variable (profitability) and independent variables such accounting information system, financial reporting and analysis, working capital management (including cash management, receivables management, inventory management), fixed asset Financial management practices: • • • • • • Accounting information system Financial reporting and analysis Working capital management Fixed asset management Capital structure management Financial planning Efficient financial management SME profitability: • • • Return on sales Return on assets Return on equity Financial characteristics: • • • Liquidity ratios Financial leverage ratios Activity ratios 14 Chapter One: Introduction to the Study management, capital structure management, and financial planning. In addition, the model of simultaneous effects of financial management practices and financial characteristics on SME profitability will be developed from the literature review in chapter 3 and with variables defined in chapter 4 of the study. 1.9 STRUCTURE OF THE STUDY This research is structured into 6 chapters. Chapter 1 introduces the research including research background, research problem, research questions, research objectives and justifications for the research. Chapter 2 examines the economic structure, and the current practices and role of SMEs in Vietnam. Chapter 3 provides a literature review of financial management practices, financial characteristics and SME profitability. Chapter 4 discusses methodology utilized in the research. Chapter 5 analyses the data collected and presents the findings of the research. Chapter 6 points out conclusions and the implications of the research in the world of business administration. Figure 1.4 (page 15) illustrates the structure of the study and the relationships between chapters. Figure 1.4: Structure of the study Chapter 1: Introduction to the Study Chapter 2: The Economic Structure and SMEs in Vietnam Chapter 3: Financial Management Practices, Financial Characteristics and Profitability of SMEs Chapter 4: Research Methodology Chapter 6: Conclusions and Implications Chapter 5: Data Analysis and Findings Source: Developed for the thesis 15 Chapter One: Introduction to the Study 1.10 CONCLUSIONS This research examines the simultaneous impacts of financial management practices and financial characteristics on SME profitability using evidence from Vietnam. To date, there is no significant research related to financial management practices and financial characteristics of SMEs conducted in Vietnam and there is also no research that examines the simultaneous impact of financial management practices and financial characteristics on SME profitability. This research is designed as a combination of descriptive and explanatory research in which a sample of 160 SMEs are drawn from a list of over 14,000 SMEs in Ho Chi Minh City for personal interview. Gathered data will be processed by computer and the Statistical Package for Social Science (SPSS) is the main computer software utilized in data analysis. In term of data analysis, this study applies both descriptive and inferential statistics. Descriptive statistical techniques will be applied to describe characteristics of financial management practices and financial characteristics of SMEs in the sample. Inferential statistical techniques such as bivariate analysis for measuring the association, bivariate analysis for testing the difference, factor analysis, and multivariate analysis will be applied to test the hypotheses of association and differences (chapter 5). Findings of this study will be applied to increase efficiency of financial management practices and improve profitability of SMEs in Vietnam (chapter 6). To provide an in-depth picture of business environment in which SMEs operate, chapter 2 will respectively examine and present information on background of the economy, business structure and SMEs in Vietnam whereas chapter 3 reviews the literature of financial management for SMEs around the world. 16 Chapter Two: The Economic Structure and SMEs in Vietnam 2.1 INTRODUCTION As of 2000, Vietnam, a country suffering from 30 years of war and 10 years of economic mismanagement, stands on the threshold of a new era – an era of international relations and economic development. After a decade of strong efforts, its economy and finance have been substantially reformed, and is integrating into the world economy. Vietnam has made substantial progress in rearranging its foreign debt arrears and started to benefit from financial assistance and foreign direct investment (FDI) since the end of 1980s. Although challenges remain, Vietnam’s achievements over the past years foretell its capacity to prevail. This chapter provides an overview of Vietnam’s economy and performance of small and medium enterprises (SMEs) in Vietnam. Objectives of the chapter are (1) to provide a literature review of economic background, business structure and the development of SMEs in Vietnam, and (2) to identify gaps in financial management for SMEs in Vietnam compared with financial management for SMEs worldwide. This chapter is structured into 6 main sections. Section 2.1 provides a general introduction to the chapter, including the objectives and structure of the chapter. Section 2.2 examines information on Vietnam such as geographic location, history, political structure, the process of economic and financial development, and its population and labour force. Section 2.3 concentrates on examining Vietnam business structures with special emphasis on SMEs and the support policy for SME development. Section 2.4 analyzes all aspects of SME finance in Vietnam including types of finance, use of finance and financial management. Section 2.5 provides an overview of business structure of SMEs in Ho Chi Minh City where SMEs are considered the largest groups in term of numbers and are representative of SMEs in the whole country. Section 2.6 summarizes the conclusions drawn from reviewing the background of economy and SME performances in Vietnam. Figure 2.1 (page 18) provides a visual outline of the structure of the chapter. Chapter Two: The Economic Structure and SMEs in Vietnam Figure 2.1: Structure of chapter 2 2.1 Introduction 2.2 Vietnam: background information 2.2.1 Overview of the country 2.2.2 Vietnam economy 2.2.3 Vietnam population 2.2.4 Vietnam labour force 2.3 Vietnam business structure 2.3.1 Type of business 2.3.3 Small and medium enterprises 2.3.4 Policies for supporting SMEs 2.3.2 Overview of enterprises in VN 2.4 SME finance in Vietnam Source: Developed for the thesis 2.5 Business structure and SMEs in HCM City 2.4.3 Financial management for SMEs 2.4.1 Types of finance 2.4.2 Use of finance 2.6 Conclusions 18 Chapter Two: The Economic Structure and SMEs in Vietnam 2.2 VIETNAM: BACKGROUND INFORMATION Section 2.2 reviews information on Vietnam background including geographical location, historical overview, economic development process, population and labour. This section is structured into three subsections. Subsection 2.2.1 provides an overview of the country. Subsection 2.2.2 examines the process of economic development since the country was reunified in 1976. Section 2.2.3 reviews population and labour force in Vietnam. 2.2.1 Overview of the country When asked about Vietnam many around the world probably answer that it is a “poor country” damaged seriously by conflicts. That was the position in the late 1970s. As of 2000, the country has seen increasingly remarkable changes. Harvie (1996, p. 1) presents a current impression of Vietnam since the country has introduced its market- oriented economic policy. Vietnam has only recently emerged as a participant in the most rapidly growing region of the world economy, the Asia Pacific economy. It is poised to become one of Asia’s most vigorous market economies during the remainder of the 1990s and into the twenty-first century, having rejected central planning, and is widely tipped to become Asia’s next economic dragon. 2.2.1.1 The geographical location Schuwalow (1996, p.189) described Vietnam as the country that extends more than 1,600 kilometres along the east coast of Indochina, from the Chinese-border mountain and the Red River delta in the north, the Laotian and Cambodian borders, to the fertile Mekong River delta in the south. Although in its extreme north the country is more than 500 kilometres wide, much of the middle section is a relatively narrow strip of coastal land. For a considerable distance it is 80 kilometres wide, and in the south expands again to about double that width (see the map, page 20). Vietnam’s total land area is 325,360 square kilometres, and 75 percent is hill country or mountains. Climate is typically monsoon, and the temperature varies considerably according to latitude. In the tropical south, conditions are warm to hot throughout the year and the humidity is usually high. In the north, particularly in the highlands, markedly warmer and cooler seasons occur and temperatures are much lower than those at sea level. 19 Chapter Two: The Economic Structure and SMEs in Vietnam 20 Chapter Two: The Economic Structure and SMEs in Vietnam 2.2.1.2 Historical overview After the government of South Vietnam fell on 30 April 1975, the north and the south of Vietnam were reunified by a national election held in April 1976 and in July of the same year the Socialist Republic of Vietnam was established. This reunification came in an attempt to transform the south from a basically market economy to a planned economy. Collectivization and nationalization respectively happened in agriculture and other industries. In the meantime, trade with the western countries was greatly restricted due to the United States of America trade embargo. Vietnam’s conflict with Cambodia during 1977 – 80 and border conflict with China in 1979 further hampered the country’s progress. Throughout the 1980s most people associated Vietnam with the word “war”. However this perception is slowly fading as a new image of Vietnam emerges. Currently Vietnam is a country at peace with a vast variety of natural resources, a high literacy rate (90 percent), and an increasingly skilled and hard labour force. Although an often-difficult business climate has been experienced in the past, Vietnam is currently changing and amending many of its laws in order to attract more foreign investment and trade opportunities (Vietnam Embassy in USA, 1999). By the mid-1980s, a decline in the former Soviet Union aid and government’s tight control over economic policy proved to be an economic disaster leading to a decline of production in many sectors, and an increasing reliance on imports. In response to this inefficiency, the Vietnamese Government initiated a series of economic reforms known as doi moi ("renovation") in December 1986. The main goals of doi moi were to improve lagging productivity, to raise living standards, and to curb rapid inflation, which reached almost 500 percent a year in mid-1980s (Kimura, 1993). Renovation process included macro-economic stabilization, the recognition of Vietnam’s private sector, and the promotion of foreign trade and investment. Following this paradigm, Vietnam has attempted to transform itself into a market-oriented economy, and opened itself to the outside world. After more than a decade of doi moi, Vietnam has experienced huge growth in investment, industry and an expansion of trade (20% per annum on average) and has had considerable success in restructuring the economy (Vietnam Embassy in USA, 1999). The government has opened the country to foreign investment, by allowing many joint venture and wholly foreign-owned enterprises to flourish. Regulations and rules have more and more become liberalized. 21 Chapter Two: The Economic Structure and SMEs in Vietnam In July 1995, Vietnam became a full member of the Association of South East Asian Nations (ASEAN). On January 1st 1996, Vietnam became a member of the ASEAN Free Trade Agreement (AFTA) and in 1998 Vietnam was admitted into the Asia Pacific Economic Cooperation (APEC) and has since signed trade agreements with a number of countries and territories (Australian Department of Foreign Affairs and Trade, 2001). As of 2000, Vietnam is closer then ever to establishing a long-term trade relationship with the United States of America, and has submitted an application to enter the World Trade Organization (WTO). In recent years, the government has planned to establish a Vietnamese stock market and new laws on foreign investment are currently being promulgated and amended in order to make Vietnam more attractive to foreign investment. After many years of preparation, the stock market was finally opened and launched the first transaction on 26 June 2000 (USA Department of Commerce, 1998). 2.2.1.3 Political structure In Vietnam, leadership structure is divided into three levels. The General Secretary is in charge of representing and dealing with issues concerning the Vietnamese Communist Party. The Prime Minister is in charge of handling government affairs and day-to-day business of the country. Finally, the President focuses on security issues and the armed forces. Vietnam is a socialist country under the leadership of the Communist Party. The Communist Party has nearly 2 million members and strongly influences every aspect and at every level of Vietnamese life. The party holds a national congress every five years to outline the country’s overall direction and formalize policies (Commercial Chamber of Vietnam in USA, 1998). The National Assembly, which includes 450 members, representing all walks of life throughout the country, and is open to non-party members, is the highest state authority and the only body with constitutional and legislative power. The National Assembly elects the President of the State and the Prime Minister (figure 2.2, page 23). The Prime Minister is in charge of handling government affaires with assistance of 18 ministries. At its meeting, the National Assembly examines reports and plans presented by the ministries involved, and National Assembly members have rights to ask ministries to clarify and answer questions raised by members (Commercial 22 Chapter Two: The Economic Structure and SMEs in Vietnam Chamber of Vietnam in USA, 1998; Australian Department of Foreign Affairs and Trade, 2001). Figure 2.2: Political structure of Vietnam The National Assembly Source: Adopted from the Commercial Chamber of Vietnam in the U.S.A. and Australian Department of Foreign Affairs and Trade 2.2.2 The Vietnam economy Since unification of the north and south, the process of the Vietnam economy development can be divided into three main periods: the central-planned economy period (1976 – 1986), the policy reform period (1986 – 1990) and the transition economy period (1990 – present). This subsection reviews the development of Vietnam economy throughout each period with a special emphasis of the effects of the government’s economic policy. Its purpose is to review the background in which SMEs operate and develop because the process of SME development is linked to the process of economic policy reform. Supreme People’s Court Supreme People’s Procuracy Prime Minister President Ministry of Interior Ministry of Foreign Ministry of Defense Ministry of Planning and Investments Ministry of Transportation and Communications Ministry of Trade Ministry of Finance Ministry of Technology and Environment Ministry of Education and Training Ministry of Agriculture and Rural Development Ministry of Industry Ministry of Fishery and Aquatic Products Ministry of Health Ministry of Construction Ministry of Information State Bank of Vietnam Ministry of Justice Government Office 23 Chapter Two: The Economic Structure and SMEs in Vietnam 2.2.2.1 The central-planned economy period (1976 – 1986) The central-planed economy period is characterized by state intervention in almost all activities of the economy. When the war ended in 1975, along with the unification of the country, the integration of the economies of the north and the south of Vietnam was set in motion. Vu (1994, p. 4) mapped out points which characterized the Vietnam economy in that period as follows: • The state determined the important economic activities of the country through a system of production plans and product distribution and strictly regulated pricing and interest rates. • The state sector and the collectives constituted the foundation of the economy, the collectives being heavily subsidized in activities such as investment and loans and they quickly developed to become a sizable part of the national economy. • Large-scale private enterprises were not encouraged to expand further, but were singled out to be finally incorporated into either state or collective units. • The market mechanism operated only in small businesses and the household economy, that is to say, in only a part of the agricultural, handicraft, and consumer goods retailing sectors. Many input factors used for production were not allowed to be bought or sold on the market but were allocated by the state’s planned distribution systems. • The state monopolized foreign trade. Due to historical circumstances, Vietnam’s trade relations had been mainly with the former Soviet Union and Eastern European countries through bilateral treaties. Foreign trade companies under the control of the state implemented these trade treaties, and the profit- and-loss account of foreign trade was entirely taken care of by the state. • The finance of the state was not separated from that of state-owned enterprises. The state undertook to compensate for losses incurred by state- owned enterprises by means of subsidies, and when these enterprises produced profits, these profits were channelled back to the state budget. All production activities were subsidized by the state through its provisions of raw materials and other inputs of production. Machinery and equipment were imported with aid funds and credit loans, and sold at low prices to state-owned enterprises. 24 Chapter Two: The Economic Structure and SMEs in Vietnam For this reason, the budget deficits and foreign debt would have increased along with any increase in outputs. Such policies were not conductive to motivating individuals and companies to boost enterprising economic activities. The economic institutions had no room for private individual’s creativity and business dynamism. Thus, although income distribution was egalitarian and all members of society were assured the basic necessities of life, there was, however, no incentive for individuals to use their talents or assiduity in work to make larger contributions to the country. This is demonstrated by failure of the 1976 – 80 five-year plan. In 1980 food production attained only 69 percent of its target; coal, 52 percent; electricity, 72 percent; cotton fabric, 39 percent; paper, 37 percent (Vu, 1994). The economy’s growth was seriously hampered by the centrally planned system. 2.2.2.2 The policy reform period (1986 – 1990) The policy reform period is characterized by the changes in management mechanisms of the economy. After ten years, the practical results proved that the central-planned economic system was not efficient and effective. In 1986 the Government recognized that policy reform was the survival goal. The year of 1986 was viewed as the year of beginning policy reform. Vu (1994, p. 7) confirmed the path taken by Vietnam’s economic reform was marked by the important conclusions on the system of concepts regarding economic renovation drawn up by the Sixth National Congress of the Communist Party of Vietnam in December 1986. In this congress the following changes in policies were mapped out: • confirmation of the long-term development of the multi-sector economy, eliminating the former discrimination against the private economy, allowing private sector to compete with other sectors on an equal footing in a healthy competitive environment, • confirmation of the importance of market relations in the economy, • renovating the economic structure, using available resources to meet the main objectives: developing agriculture, promoting the production of consumer 25 Chapter Two: The Economic Structure and SMEs in Vietnam goods, increasing the export of goods and services, and enlarging its external economic relations, • stabilizing the socio-economic environment by reducing the inflation rate, the budget deficits, and excessive government expenditure, and improving the living standard of people, and • carrying out an open-door policy in relations with foreign countries. Policy reform mentioned above opened opportunities for changes in activities of the economy including changes in economic structure, financial and banking system, and price and market relations. Changes in economic structure Developing a multi-sector economy led to change in economic structure. In Vietnam’s economic ideology, the national economy could be divided into several economic sectors based on the form of ownership and means of production. Before policy reform, the economy consisted of two sectors: state-owned and collective. Since policy reform, the following main sectors were officially recognized (Le, 1992): • state sector, based on the state ownership, • collective sector, based on the voluntary contribution of capital by a group of people to set up joint units and use labour forces of the collective’s members and their relatives, • private sector including the family or household businesses and private companies, and • joint sector between state and other sectors. Table 2.1 (page 27) demonstrates changes in economic structure during the period 1986 – 1991 in which the non-state sector had increasingly risen in terms of national income, labour and labour in industry. For example, labour force working for state sector declined to 10.4 percent in 1991 from 14.7 percent in 1986 whereas labour force working for private sector increased to about 90 percent in 1991 from 85 percent in 1986. This showed that private sector played a major role in creating employment. 26 Chapter Two: The Economic Structure and SMEs in Vietnam Table 2.1: Changes in economic structure (1986 – 1991) 1986 (%) 1991 (%) State Non-state State Non-state National income 29.8 70.2 29.0 71.0 Labour 14.7 85.3 10.4 89.6 Gross industrial output 56.3 43.7 58.6 41.4 Labour in the industry 30.0 70.0 33.0 67.0 Source: Statistical data of Socialist Republic of Vietnam (1986 – 1991) Previously, the state and collective sectors constituted the main part of the national economy. The private sector, especially private companies, were not encouraged to develop but were instead the target of nationalization, collectivization or transformation to state-private joint ventures. With policy reform, enterprises of all ownership forms received equal treatment and competition in the market. There still existed differences in terms of motivations and attitudes between the state and non- state sectors but it was not necessary to distinguish between the various sectors as mentioned above (Vu, 1994). Creating equally competitive environment forces all enterprises regardless of the state, collective or private sectors to consolidate its competitiveness. Changes in financial systems There were three main changes in the financial system in this period (Vu, 1994). The financial reform in 1985 was the first comprehensive financial readjustment aimed at decreasing the state budget deficit and inflation rate. Details of this reform were as follows: • trimming subsidies allocated by the state to enterprises through the low prices of raw materials and other inputs of production, • switching from the price system fixed by the central government to the system in which the prices are determined by the market through negotiation by buyers and sellers, • reforming the wage system to do away with the rationing of fixed quantities of food and other necessities, and 27 Chapter Two: The Economic Structure and SMEs in Vietnam • readjusting the revenue and expenditure policy of the state budget to step by step reduce deficits and control the rate of inflation. Taxation reform was the second change in the financial system. Before 1989, taxes were collected from non-state economic sectors. The two main kinds of taxes were the agricultural tax, based on quantity and quality of land used, and the industrial and trade tax, based on turnover of collective and private businesses (Table 2.2). Table 2.2: State-budget revenue, 1986 - 89 (million dong) 1986 1987 1988 1989 Revenue from state sector 60,349 284,801 1,184,945 2,085,838 Net sales 56,908 270,220 1,027,627 1,616,870 Depreciation 893 4,911 3,724 71,300 Others and service revenue 2,548 9,670 78,634 144,000 Taxes on commercial export and import - - 74,960 253,668 Revenue from non-state sector 23,277 97,489 573,216 1,505,988 Industry and trade tax 8,325 38,055 184,084 427,949 Agriculture tax 3,834 12,176 136,456 308,093 Non-commercial export and import tax 6,171 17,441 56,368 108,715 Others 4,947 29,817 196,308 661,231 Total 83,626 382,290 1,758,161 3,591,826 Source: Statistical Yearbook, 1991 The state sector did not pay any tax but had to transfer most of its profit and turnover to the state budget. Therefore, one of the most important tasks of taxation reform was to eliminate the administrative supply-withdraw system of state enterprise finances and to build a new tax system applicable to every business. The new tax laws promulgated including the following kinds of taxes: agricultural tax, turnover tax, profit tax, special commodity consuming tax (cigarettes, alcoholic products, automobiles), import-export tax, tax on the use and exploitation of natural resources, tax on housing and the use of land, and personal income tax. After reforming tax systems, not only discrimination between the state and non-state sectors was eliminated but also the state-budget revenue was increased. Table 2.3 (page 29) shows changes in terms of sources and amounts of tax revenue compared with table 2.2, which shows the sources and amounts before reforming tax policy. 28 Chapter Two: The Economic Structure and SMEs in Vietnam Table 2.3: State-budget revenue, 1991-93 (billion dong) 1990 1991 1992 1993 Tax collected from state enterprises 2,080 3,817 5,887 8,878 Tax collected from joint ventures 1,091 1,942 4,242 5,104 Industry and trade tax 667 941 1,821 2,942 Agriculture tax 298 707 1,294 1,350 Export and import tax 732 1,099 2,194 6,398 Housing and land tax 2 5 18 241 Income tax - 62 154 181 Fees and others 1,036 1,271 2,905 4,138 Depreciation 247 239 1,660 1,939 Total 6,153 10,083 20,175 31,171 Source: Statistical Yearbook, 1994 The third change was to restructure the national financial apparatus and management. Formerly, Vietnam’s financial system had operated at two levels: central and local. At the local level there were three sub-levels: provincial, district and village in the countryside or residential in urban areas. During the Vietnam War and central-planned economy period, financial and fiscal decision-making had been strictly concentrated at the central level. With policy reform, it was to be decentralized and liberalized to grant more powerful decision-making in finance and fiscal issues for the lower (province and district) levels. Changes in banking systems Until 1988 there were only three state-owned banks in Vietnam: the State Bank of Vietnam (SBV), the Vietnam Investment and Development Bank (VIDB), and the Vietnam Bank for Foreign Trade (Vietcombank). Unlike other countries, in Vietnam the SBV played both roles of central and commercial banks (The World Bank Group, 1997). This was never seen in countries based on a market economy. The VIDB and Vietcombank basically operated as commercial banks. The VIDB was in charge of providing funds and loans for the state long-term investment projects while the Vietcombank specialized in providing loans and banking services for all international economic activities. Reform in the banking system was initiated in 1988 by issuing the Decree 53/HDBT to divide the banking system into two categories: the State Bank played the role of central bank and the specializing banks played the role of commercial banks. 29 Chapter Two: The Economic Structure and SMEs in Vietnam In addition, two other state-owned commercial banks: the Vietnam Industrial and Commercial Bank and the Vietnam Bank for Agricultural Development were established. Four state-owned banks were allocated primary funds from the state budget and operated as commercial banks (The World Bank Group, 1997). At the end of 1990, the Government started liberalizing the banking system. Since 1990 the non- state sectors have been allowed to establish commercial banks. Dozens of joint stock banks were established in cities such as Hanoi, Hai Phong, and Ho Chi Minh City. Some were based mainly on the participation of state units, others on mixture of state and private operations, while the rest were entirely private (Vu, 1994). Banking system reform quickly changed the banking system in Vietnam to comprise development and investment banks, state-owned commercial banks, foreign banks’ branches, joint-venture banks, joint stock banks, credit co-operatives, and financial companies (Table 2.4). All the banks are self-managed and operate as business organizations. Gradually the system of state subsidization providing low- interest-rate credits was removed, and interest rates were stabilized at higher levels than the rate of inflation. Table 2.4: Financial institutions in Vietnam, 1995 Institution Number of Institutions State Bank of Vietnam 1 State commerci