Abstract

This study examines the effects of Internal Control on the Financial Performance of Micro Finance Institution in Buea municipality. The research explores how internal control dimensions such as control environment, risk assessment and control activity how they influence financial performance. A cross-sectional research design was employed. The study used census sampling technique method and data were collected from 50 employees using structured questionnaires.

The study revealed that control environment and control activities have significant positive effect financial performance of MFIs in Buea Municipality. While, risk assessment has weak effect on financial performance. The study recommends that MFIs should invest in developing comprehensive internal control frameworks, including risk assessment, monitoring, and evaluation procedures.

Regular training programs should be implemented to ensure staff understand and effectively apply internal control policies. Regulatory bodies should develop guidelines and standards to ensure MFIs maintain effective internal control mechanisms.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

In the aftermath of the high profile scandals involving companies like Enron and WorldCom, Internal Control (IC)has emerged as a crucial mechanism for safeguarding Organizations against failure (Rae and Subramaniam, 2008; hussaini and Muhammed, 2018). Internal Control is recognized globally as essential for enhancing performance and protecting asset while preventing errors and fraud (IFAC, 2020). Defined as a continuous process initiated by key leadership, Internal Control aims to provide reasonable assurance in achieving organizational objectives (COSO, 1992). These objectives encompass performance effectiveness, asset protection, and compliance with laws. A strong Internal Control framework is vital for promoting good governance and effective monitoring throughout an organization (shaiti el al, 2013; Turnbull 1999)

Internal Control systems comprise protocols designed to protect assets and reduce fraud risk, ultimately enhancing operational efficiency (Adams, 2012). Organizations whether for profit, strive to achieve their objective, particularly in the complex landscape of non- profit where direct supervision can be challenging (frost, 2011). Consequently, management implements Internal Control measures that mitigate the risk of fraud, as the absence of such controls led organization to suffer significant losses (Gendron & Cooper, 2013). Tools for monitoring, including segregation of duties and performance verification are crucial for effective management and operational integrity (Magala, 2012; Morgan 2013).

(Otien, 2014), Holds that Internal Control consist of five related components which are derived from the ways in which management runs its business. These components are control environment, risk assessment, control activities information and communication system and monitoring.  These components of Internal Control apply to all business entities though Micro Finance Institutions may apply them differently to large corporations. Micro Finance Institution’s Internal Control system could be less formal and unstructured but at same time be very effective, According to Ledgerwood and White (2016), an Internal Control adopted by Micro Finance Institutions needs to be orderly, practical and efficient enough to help them conduct business.

Failure in Internal Control has led to major accounting scandals, with Enron serving as a notable example (Spillane, 2014). Before its collapse in 2001, Enron’s reported profit where significantly inflated due to fraudulent practices. This collapse resulted in massive financial losses for investors and employees and highlighted the critical need for effective Internal Controls. Holtfreter (2010) identified various fraud cases, emphasizing that despite existing audits many companies managed to commit fraud without detection, underscoring the ineffectiveness of current Internal Control system (Widener, 2013).

Many developing nations struggle with ineffective governmental Internal Control systems. Which facilitate public fund misappropriation and corruption (Van Horne, 2012).  For instance , Zambia has faced challenges such as capacity constraint and inadequate information processing, leading to non-compliance with Internal Control System (ICS) relies on five  key components control environment, risk assessment, control activities information and communication, and monitoring (COSO, 2013). Each component plays a significant role in ensuring the overall effectiveness of the Internal Control framework (okonkwo and Linda 2016).

The control environment reflects the integrity and ethical values of an organization and is influenced by top management’s governance oversight (Akwaa- Sekyi & Rene, 2016; PWC, 2012). Risk assessment entails identifying potential errors and implementing controls to mitigate them (Gamage, Lock, Fernando, 2014) Control activities includes majors to  establish acceptable risk level and safeguard asset while effective communication ensures timely and accurate data exchange within the organization ( Mathiew, 2011; Abiola and Oyewole, 2013).

Monitoring is essential for evaluating the performance of the Internal Control System and ensuring quality control (Etengu & Amony, 2016). COSO (2013) recommends a combination of continuous and periodic assessment to evaluate Internal Control System effectiveness. The role of Internal and External audits is critical in this context, especially in the banking sector, where Internal Control System requirements are vital for maintaining financial stability (Kumuthinidevi 2016). Organisations must engage in regular evaluation for their Internal Control to identify and rectify weaknesses (Hayali el al, 2013).

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

Management has three objectives that guide the designing of an effectives Internal Control System, (Mcpeak et al,2012) it is entirely responsible for preparing financial statements for investors, creditors and other users. The second objective of an Internal Control System is to encourage efficiency and effectiveness of operations that is effective use of resource. Lastly, Internal Control encourages compliance with laws and regulations. The performance of an organization is determined by how well ans accepted the Internal Control is and how it affect the financial performance of a company.

Financial performance is assessed through various financial statements and metrics, including revenue, profitability and cash flow (jenning et al 2008). Internal Control systems are dsigned to enhance the reliability of financial performance, fostering accountability among information providers (Donald and Delno 2009). As noted by Ondieki (2013), effective control measures can prevent fraud, thereby supporting organizational profitability and resource management.

Microfinance Institution (MFIs) provides essential financial service to low income population, contributing to economic development (Christen et al, 2003). The origins of Micro Finance date back to the 18^th century, evolving into a structured approach in countries like Cameroon, where MFIs have proliferated since the late 1980s (Armendaris et al, 2010; long, 2009). Today Cameroon boasts the highest number of registered MFIs in the CEMAC region, holding significant shares of total deposit and loan portfolios (Coulter & Abene, 2010).

The framework of internal control helps Micro Finance Institutions in managing their business in terms of regulations and policy. Frameworks for Internal Control are factored by the processes affected by the board of directors, senior management and all levels of personnel. They are not entirely procedures or policies performed at certain point in time but rather continually operating at all levels within institutions. Most Micro Finance Institutions have embraced a more business orientation out book and maintained their target groups of economically active poor, in order to achieve financial sustainability (Baguma, 2008). The Micro Finance Institution in developing economies is widely growing from time to time.

1.2. Problem Statement

Micro Finance Institutions (MFIs) in Buea, Cameroon, plays a crucial role in promoting financial inclusion and supporting the economic development of underserved populations. However, many of these Institutions face significant challenges related to their Internal Control Systems which directly impact their financial performance. The Financial Performance of Micro Finance Institution (MFIs) is critically linked to the effectiveness of their Internal Control system. In many cases, inadequate Internal Control leads to poor liquidity management, reduced profitability, operational inefficiencies and compliance failures. Liquidity issues arise when MFIs cannot efficiently manage their cash flows, hindering their ability to meet short term obligations and thus affecting their sustainability (Bourn & Neerly, 2003).

Furthermore, profitability is directly impacted by financial mismanagement and fraud, as weak Internal Control create opportunities for resource misallocation and financial losses (Beaseley, Brandon & Hancock, 2009) operational efficiency suffers as well with delay in loan processing and a lack of proper oversight leading to increase operational costs and diminished customer satisfaction. Additionally, compliance with regulatory requirements become challenging, exposing MFIs to legal penalties and reputational risk when Internal Control are insufficient (van Horne, 2012).

Extensive study have been carried out by other researchers on the impact of Micro Finance Institution on the financial performance of Micro Finance Institution and their view towards their findings are that strong control environment  obtain through strong cultural and  governance  structure will significantly enhance profitability, with a correlation coefficient. Effective risk identification and mitigation strategies also lead to operational outcome. Risk assessment positively impact financial performance, this suggest that MFIs should prioritize risk management to achieve better financial results. Inadequate control activities measures can hinder financial results, as shown by a significant negative correlation. This highlights the importance of implementing robust control activities.

If Micro Finance Institutions (MFIs) fail to implement internal control variables such as risk assessment, control environment, and control activities, they may face significant challenges. Without a robust control environment, Micro Finance Institution (MFIs) may struggle with integrity and ethics, leading to increased fraud and errors. Inadequate risk assessment can expose MFIs to unforeseen risks making them vulnerable to financial losses and reputation damage. Similarly weak control activities can lead to poor asset management, inefficient operations and noncompliance with regulations.

To address these challenges, MFIs needs to enhance their Internal Control frameworks. One effective approach is to implement the committee of sponsoring Organizations of the Treadway commission (COSO) frame work which offers a structured model for designing and evaluating Internal Controls (COSO, 2013). This framework emphasizes the importance of establishing a strong control environment, conducting thorough risk assessments and implementing robust control activities. Regular training of staffs on the principles of Internal Control and Financial management can strengthen the organizations ability to mitigate risk and improve operational performance (ganiyu, 2018). Empowering employees with the necessary knowledge and skills will enable them to recognize and address inefficiencies proactively, information and communication to investigate how they affect Financial Performance.

1.3. Research Question

1.3.1 Main Research Question

What is the effect of Internal Control on the financial performance of Micro Finance Institutions in Buea?

1.3.2. Specific Questions

1. How does risk assessment affect the financial performance of Micro Finance Institutions in Buea?
2. What is the effect between control environment risk component and financial performance of micro finance institutions in Buea?
3. What is the effect of control activities on the financial performance of Micro Finance Institutions in Buea?

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