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Effects of Financing on Performance of small and medium enterprises (SMEs) Emad Harash1, Suhail Al-Timimi2 and Jabbar Alsaadi3 1

Madenat Alelem University College, Department of Accounting [email protected] 2 College of admin and Economics, University of Basra [email protected] 3 Madenat Alelem University College, Department of Accounting [email protected]

ABSTRACT Small and medium enterprises (SMEs) remains one of the most reviewed topics in literature, especially as its impact on all kind economies cannot be over looked. Worldwide, the small and medium enterprises (SMEs) have been accepted as the engine of economic growth and for promoting equitable development. Without finance, small and medium enterprises (SMEs) cannot acquire or absorb new technologies nor can they expand to compete in global markets or even strike company linkages with larger companies. The main objective of this study is to examine the effect of finance on the performance of small and medium enterprises (SMEs) in Iraq. Previous studies, especially on large companies, have shown that finance affects company performance. Though the issue has been widely studied, largely missing from this body of literature is the focus on small and medium enterprises (SMEs) in Iraq. The main value of this study is the analysis of the effect of finance on the performance of small and medium enterprises (SMEs) in Iraq. Keywords: Small and medium enterprises (SMEs), Finance.

1. Introduction Small and medium enterprises (SMEs) remains one of the most reviewed topics in literature, especially as its impact on all kind economies cannot be over looked. Worldwide, the small and medium enterprises (SMEs) have been accepted as the engine of economic growth and for promoting equitable development (Harash et al. 2013; Harash et al. 2014). Small and medium enterprises (SMEs) are very important. The only way to reduce poverty in a sustainable way is to promote economic growth, through wealth and employment creation in the developing countries. Small and medium enterprises (SMEs) are the major source of income, a breeding ground for entrepreneurs and a provider of employment in many countries (Kraja & Osmani, 2013). Small and medium enterprises (SMEs) play a valuable role in job creation and make significant contributions to economic growth in developed and developing economies alike. As a result, establishing a dynamic Small and medium enterprises (SMEs) features prominently on the economic development agendas of practically all countries around the world (Tambunan, 2005; World Bank, 2014). In today's increasingly globalized economy, Small and medium enterprises (SMEs) are usually feeder industries for larger industries and they are crucial for economic growth and development (Kongolo, 2010; Harash et al. 2013; Harash et al. 2014). Small and medium enterprises (SMEs) are now considered to be the major source of dynamism, innovation and flexibility in emerging and developing countries, as well as to the economies of most nations. They contribute substantially to economic development and employment generation (Harash et al. 2013; Harash et al. 2014; Koh et al.,

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2007). Small and medium enterprises (SMEs) particularly have a vital role to play in the development of Iraq. For example the available data from the Central Organization for Statistics (COS) indicates that private sector in Iraq consists primarily of Small and medium enterprises (SMEs) where those companies represent 99 percent of all companies in Iraq (Harash et al. 2013; Harash et al. 2014). But despite their significance, Small and medium enterprises (SMEs) are faced with the threat of failure with past statistics indicate that three out five fail within the first few months. Centre for Entrepreneurship, Small and medium enterprises (SMEs) and Local Development in Organization for Economic CO-Operation and Development (OECD, 2009) stated that SMEs are generally more vulnerable in times of crisis for many reasons among which are: -It is more difficult for them to downsize as they are already small ; -They are individually less diversified in their economic activities ; -They have a weaker financial structure (i.e. lower capitalization)) -They have a lower or no credit rating ; -They are heavily dependent on credit and they have fewer financing options . The main challenges faced small and medium enterprises (SMEs) that inhibit adequate financing for these companies such as Poor customer knowledge, Poor business enablers, Lack of collateral or capital, Lack of credit data, Low profitability, Small and medium enterprises (SMEs) skills and literacy (IFC, 2013). Without finance, small and medium enterprises (SMEs) cannot acquire or absorb new technologies nor can they expand to compete in global markets or even strike business linkages with larger companies (World Bank, 2014). The relationship between financing and performance Small and medium enterprises (SMEs) has been the subject of an important debate in the business finance literature. This study investigates the effect that financing has on performance in a sample of Iraq Small and medium enterprises (SMEs). Our study is one of few that shed lights on how financing affects performance Small and medium enterprises (SMEs).

2. Financing Access to finance is essential to the survival and performance of any business enterprise. As it the life-blood of any business enterprise and no enterprise, no matter how well managed, can survive without enough funds for working capital, fixed assets investment, employment of skilled employees and development of markets and new products and the availability of finance is positively associated with productivity and growth (GFPI, 2011). Small and medium enterprises (SMEs) need financing for two basic purposes: i) financing the production cycle once it has been stabilized (i.e. working capital financing); and, ii) financing capital expenditures to expand the current business, to create new ones, or simply for maintenance purposes (e.g. plant and equipment maintenance or updates) (World Bank, 2014). Finance Small and medium enterprises (SMEs) needs quite different scenarios in terms of the amount of funds required, the repayment period and the nature of the specific risks involved, among other elements. most Small and medium enterprises (SMEs) rely on internal financing, and/or short-term credit from suppliers, and/or some specialized financial products (Mbaguta,

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2002; World Bank, 2014). Only rarely Small and medium enterprises (SMEs) recur to a direct loan from banks or other financial institutions to finance their needs. Small and medium enterprises (SMEs) sometimes rely on internal financing, often involving fresh capital injections from shareholders, although in many cases small and medium enterprises (SMEs) tend to recur to long-term financing from financial institutions, mainly in the form of outright loans from banks and some hire purchase and leasing products (Bonin & Wachtel, 2003; World Bank, 2014). The two basic forms of financing for businesses are internal financing and external financing. The basic internal financing sources are the retained or undistributed profits from the business obtained in previous years and fresh capital injections by the owner (s) of the Small and medium enterprises (SMEs). In turn, external financing can be provided by financial institutions, suppliers and other types of creditors (World Bank, 2014). Financing small and medium enterprises (SMEs) needs quite different scenarios in terms of the amount of funds required, the repayment period and the nature of the specific risks involved, among other elements (Wattanapruttipaisan, 2002; World Bank, 2014). Most Small and medium enterprises (SMEs) rely on internal financing, and/or short-term credit from suppliers, and/or some specialized financial products. Only rarely Small and medium enterprises (SMEs) recur to a direct loan from banks or other financial institutions to financing their needs (Wilkinson & Brouthers, 2006; World Bank, 2014). Small and medium enterprises (SMEs) sometimes rely on internal financing, often involving fresh capital injections from shareholders, although in many cases small and medium enterprises (SMEs) tend to recur to longterm financing from financial institutions, mainly in the form of outright loans from banks and some hire purchase and leasing products. The two basic forms of financing for businesses are internal financing and external financing. The basic internal financing sources are the retained or undistributed profits from the business obtained in previous years and fresh capital injections by the owner (s) of the Small and medium enterprises (SMEs). In turn, external financing can be provided by financial institutions, suppliers and other types of creditors (World Bank, 2014). Findings from previous studies Abor (2007), GFPI (2011), Kotey (1999), Kristiansen et al. (2003), Mohd Shariff et al. (2010), Mohd Shariff & Peou, (2008), Salam (2013), Swierczek & Ha (2003), and World Bank (2014) find a significant negative effect of financing on company performance. The estimated negative effect is stronger in the precrisis period, when taking into account the reverse causality between financing and company performance. In addition, we find that companies that had some foreign debt financing performed better than their counterparts. At the same time, the presence of foreign debt amplifies the negative effect of total leverage on company performance. Most of the companies depend on debt as against equity for financing, long-term debt relatively represents the major component of total debt. Furthermore, while some companies rely heavily on long-term debt as a financing scheme, companies in some economies on the other hand use more of short-term debt to financing their operations. Findings from previous studies also small and medium enterprises (SMEs) confirmed that access to financing is amongst the most critical factors determining the competitive readiness of regional small and medium enterprises (SMEs) (Grandon & Pearson, 2004). This in turn determines their ability to fully exploit and participate in the global economy, and the business opportunities stemming from regional economic integration (Harvie & Lee, 2002; Oum et al. 2011). Using various measures of performance, the results of study Abor (2007) indicate that financing influences performance, although not exclusively. By and large, the study results indicate that financing, capital structure, especially long-term and total debt ratios, negatively affect performance of small and medium enterprises (SMEs). This suggests that agency

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issues may lead to small and medium enterprises (SMEs) pursuing very high debt policy, thus resulting in lower performance. Study Salam (2013) studies the relationship between financing and company performance in cross- sectional data for each group of small and medium enterprises (SMEs). The study results show a positive correlation between financing and Return on Equity (ROE)/Return on Assets (ROA) through simple regression statistics. Study findings also suggest that small and medium enterprises (SMEs) should be consistently involved in their financing practices because financing has a significant impact on improving the financial performance of Bangladesh’s small and medium enterprises (SMEs), especially Medium enterprises small and medium enterprises (SMEs). Bowale & Akinl (2012) examined the factors influencing the capacity of SMEs to alleviate poverty in the south-western part of Nigeria. The study concluded that financing, business registration, business size, nature of business, financing were the major factors determining both income and employment generation potentials of small and medium enterprises (SMEs). As noted by Tung and Aycan (2008), insufficient access to financing is a significant barrier to the performance and growth of small and medium enterprises (SMEs). These are the major challenges that have accounted for the nonperformance and high rates of failure among small and medium enterprises (SMEs). As well as that small and medium enterprises (SMEs) owners face core difficulties in terms of discrimination by financial institutions such as high collateral demand, difficulties in accessing information and a lack of market exposure Also, SME owners lack business plan preparation, mentoring and management training in accessing external finance for transformation stages of microenterprises with growth potential for expanding (Pandya, 2012). Findings from previous literature also show

that financing was one of the major factors related to the

performance of small and medium enterprises (SMEs) (Kristiansen et al. 2003; Mohd Shariff et al. 2010; Mohd Shariff & Peou, 2008 and Swierczek & Ha, 2003). This suggests that agency issues may lead to small and medium enterprises (SMEs) pursuing very high debt policy, thus resulting in lower performance. On the whole, based on the findings of earlier research, this study assumes that financing includes the financial resources of small and medium enterprises (SMEs) owners and the total capital invested into their businesses. In the study the Financing will be measured using a number of dimensions such as Capital sources, Cash in hand, Additional capital, Find loan, financial institution requirements; Banks require collateral & interest, and financial institution. All items will be adopted from the previous studies (Mohd Shariff et al. 2010; Mohd Shariff & Peou, 2008).

3. Performance of small and medium enterprises (SMEs) The performance prism was introduced by Neely et al. (2001) based on three fundamental premises. First, the organizations should think about the wants and needs of all of their important stakeholders and endeavor to deliver value to each of them if the organization wants to survive and prosper in the long-term. It is no longer acceptable for organizations to focus on one or two of their stakeholders. Secondly, organizations have to align and integrate strategies, processes, and capabilities in order to deliver real value to its stakeholders. Thirdly, the relationship between organizations and their stakeholders is reciprocal – stakeholders have to contribute to organizations as well as to expect something from them.

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The literature on the concept of performance is extensive and the selection of references and the disposition have been made so that the broad spectrum of differences as well as similarities between different meanings will be as clear as possible (Palm, 2008). Early review indicates that defining performance of small and medium enterprises (SMEs) is a challenge across the world. performance of small and medium enterprises (SMEs) have been defined in various ways in the literature, and in any business, the related parties always want to see good performance in their business (Harash et al. 2014; Harash et al. 2013). Researchers in this stream of the performance literature, a wide variety of definitions of company performance have been proposed in literature (Korir & Imbaya, 2013, Uadiale & Fagbemi, 2012). literatures (Anderson & Reeb, 2003; Ittner & Larcker, 2003; Juhl et al. 2002; Petersen & Schoeman, 2008; Sabancı Özer, 2012; Sacristán-Navarro et al. 2011; Selvarajan et al. 2007; Thrikawala, 2011; Watson, 2007) defines performance as a measure of how well a company can use its assets from its primary mode of business and generate revenues. On the other hand, in the modern literature defines performance as the results of the activities of a company or investment over a given period. Performance can also be defined as the accomplishment of specified business objectives measured against known standards, completeness and cost (Davis & Cobb, 2010; Sabancı Özer, 2012; Sacristán-Navarro et al. 2011; Thrikawala, 2011). According to March & Sutton (1997) Performance is so common in research about small and medium enterprises (SMEs) management that its structure and definition is rarely explicitly justified; instead its appropriateness, in no matter what form, is unquestionably assumed. However, the Performance can also be defined as the accomplishment of specified business objectives measured against known standards, completeness and cost (Davis & Cobb, 2010; Sabancı Özer, 2012; Sacristán-Navarro et al. 2011; Thrikawala, 2011). In this context, this study focuses on financial (objective) and non-financial measures (subjective) measures (Dowling & Helm, 2006; Thrikawala, 2011; Watson, 2007) based performance measures: Financial measures of performance are derived from the accounts of a company or can be found in the company’s profit and loss statement or the balance sheet. In addition, financial measures are also referred to as objective measures because they can be individually measured and verified. However, it is essential to introduce non-financial measures of performance in conjunction with financial measures in order to fully measure performance (Ittner & Larcker, 2003; Juhl et al. 2002; Petersen & Schoeman, 2008; Selvarajan et al. 2007). The non-financial measures are also known as the subjective performance measures of performance (Petersen & Schoeman, 2008). Non-financial measures are measures not found in charts of accounts of a company (Ittner & Larcker, 2003; Selvarajan et al. 2007). The use of non-financial measures of performance supplements accounting measures and gives data on progress relative to customer requirements or competitors and other non-financial objectives that may be important in achieving profitability (Henri, 2004; Ittner & Larcker, 2003; Juhl et al. 2002; Kaplan, 2001; Selvarajan et al. 2007). 4. Contingency framework Many researches stress the importance of the financing to improve performance small and medium enterprises (SMEs) and sustainable competitive advantage for small and medium enterprises (SMEs).The independent variable is the finance and the dependent variable is the performance small and medium enterprises (SMEs). The model describes the effective mechanism of finance on performance small and medium enterprises (SMEs).The study uses financing as an independent variable to reflect the influence of financing on the performance small and medium enterprises (SMEs) in Iraq. Based upon the literature, ones can indicate the relationship between the financing variable and performance small and medium

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enterprises (SMEs). In Figure 1, The conceptual framework of this study below shows the relationship between the variables under study.

Financing

Performance of SMEs

Figure1. Proposed theoretical framework

5. Conclusion This research is based on contingency theory to show the effect of financing on the performance of small and medium enterprises (SMEs) in Iraq. The research in Contingency Theory is a basis of much that is taught today. In addition, scholars actively pursue contingency research in the contemporary era and it is being projected into the future in a series of exciting theoretical and empirical developments. The performance of these companies lead to some critical issues and many studies dealt with the subject matter from many different angles. The current study discusses one of the important issues: access to financing is a particular problem for small and medium enterprises (SMEs), they companies tend to have much higher rates of job growth but also are more likely to go out of business or remain stunted due to institutional and financial constraints. The value of the small and medium enterprises (SMEs) sector is recognized in economies worldwide, irrespective of the economy’s developmental stage. The contribution towards growth, job creation and social progress is valued highly and small and medium enterprises (SMEs) is regarded as an essential element in a successful formula for achieving economic growth. This study is one of the a few studies that tackled this subject. Thus, the lack of studies in this respect is due to the complex and the dynamic nature of the small and medium enterprises (SMEs) and the different objectives, especially in Iraq.

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First Author Personal Information Name: Emad Harash Address: Iraq, Baghdad, Madenat Alelem University College, Department of Accounting. Mobile: + 96407901792985 Email: [email protected] Date of Birth: February 15, 1965 Nationality: Iraq Gender: Male Education: - PhD in accounting information system, College of admin and Economics, University of Basra - Higher Diploma in specialization of taxes, Post graduate Institute of Studies Accounting and Finance, University of Baghdad. - B.Sc. accounting, College of admin and Economics, University of Baghdad Publications: • Harash, Emad, Fatima Jasem Alsaad, and Essia Ries Ahmed.(2013) Moderating Effect of Market practices on the Government policy -Performance Relationship in Iraq SMEs. 4th Global Conference for Academic Research on. Economics, Business and Management. (GCAR-EBM) 29-30- 2013 Kuala Lumpur, Malaysia. • Harash, Fatima Jasem Alsaad, Essia Ries Ahmed, Moderating Effect of Market practices on the Government Policy-Performance Relationship in Iraq SMEs, American Journal of Economics, Vol. 3 No. C, 2013, pp. 125-130. doi: 10.5923/c.economics.201301.21. • Harash, Emad, Fatima Jasem Alsaad, and Essia Ries Ahmed.(2013) “Moderating Effect of Government Policy on the Market Practices - Growth Relationship in Iraq SMEs.” Open Science Repository Business Administration Online.open-access (2013): e70081983. See more at: http://www.open science-repository.com/business-administration 70081983. html#sthash. AOGvXZiW. Dpuf

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• Harash E., Al-Tamimi, K., & Al-Timimi, S. (2014). The Relationship Between Government Policy and Financial Performance: A Study on the SMEs in Iraq. journal China-USA Business Review, Vol. 13, No. 4. • Harash, E., Al-Timimi, S. N., Alsaad, F. J., Al-Badran, A. Y. Z., & Ahmed, E. R. (2014). Contingency Factors and Performance of Research and Development (R&D): The Moderating Effects of Government Policy. Journal of Asian Scientific Research, 4(2), 47-58.

Second Author Personal Information Name: Suhail Al-Timimi Address: Iraq, Basra, Madenat College of admin and Economics, University of Basra Mobile: + 96407901792985 Email: [email protected] Date of Birth: July 15, 1971 Nationality: Iraq Gender: Male Education: - PhD in Management accounting, College of admin and Economics, University of Basra - MSc Accounting, College of admin and Economics, University of Basra. - B.Sc. accounting, College of admin and Economics, University of Baghdad Publications: • AL-Timimi, S. Amran, A., and Yahya,S. (2012) .The Influencing of Contingency Factors on the Performance of R and D in the Research Units at the Iraqi Universities: A Conceptual Framework. Advancec in Management, 5, 4, pp: 218-224. • Harash E., Al-Tamimi, K., & Al-Timimi, S. (2014). The Relationship Between Government Policy and Financial Performance: A Study on the SMEs in Iraq. journal China-USA Business Review, Vol. 13, No. 4. • Harash, E., Al-Timimi, S. N., Alsaad, F. J., Al-Badran, A. Y. Z., & Ahmed, E. R. (2014). Contingency Factors and Performance of Research and Development (R&D): The Moderating Effects of Government Policy. Journal of Asian Scientific Research, 4(2), 47-58.

Third Author Personal Information Name: jabbar alsaadi Address: Iraq, Baghdad, Madenat Alelem University College, Department of Accounting. Mobile: 07901475861 Email: jabbar [email protected] Date of Birth: 1/7/1954 Nationality: Iraq Gender: Male - C.P.A Arab Institute Of Certified pubiic Accountants . - B.Sc. accounting, College of admin and Economics, University of Baghdad.

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