CHAPTER ONE

INTRODUCTION

Background of the Study

Current business trends have made it imperative for almost all Micro-finance institutions to maintain effective internal control systems. Internal control has attracted intense debate and scholarly attention across industries in control environment and activities, information and communication, accountancy and auditing literature over the past decades.

For financial institutions to be able to function effectively and contribute meaningfully to the development of a country, the institution must be stable, safe and sound. And for these conditions to be obtained there must be a sound accounting system, which is occasioned by an effective internal control system.

Moreover, the quality of a company’s internal control affects not only reliability of financial data, but also the ability of the company to make good decisions and remain in business. Recent business failures can all be attributed to ineffective internal control systems, which most often are circumvented by top management.

Internal control is a process effected by the entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the categories; reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations (Ray and Kurt, 2001).

Internal control consists of five related components which are derived from the manner in which management runs its business. These components are control Environment; risk assessment; control activities; information and communication systems and monitoring. These components of internal control apply to all business entities though Micro-finance Institutions may apply them differently to large corporations.

Micro-finance Institutions’ internal control systems could be less formal and unstructured but at the same time be very effective. According to Ledger wood and White (2006), an internal control adopted by Micro-finance Institutions need to be orderly, practical and efficient enough to help them conduct business.

Internal controls are most effective when they are directly incorporated in the process that support operations and enable quick response to changing economic conditions.

Micro-finance Institutions use internal control mechanisms to make sure the staffs respect its policies and procedures. Everyone in an organization has the responsibility to ensure internal control succeeds to some extent. Virtually all employees produce information used in the internal control system or take other actions needed to effect control.

Microfinance is an organisation that carries out financial activities which occupy a central position in the nation’s financial system and are essential agents in the development process of the economy. By intermediating between the surplus and deficit spending units, institutions increase the quantum of National savings and investments and hence national output.

According to the Consultative Group to Assist the Poor (CGAP, 2006), microfinance is the provision of basic financial services to impoverished clients who otherwise lack access to financial institutions. Microfinance institutions help to reduce poverty by providing the poor with sustainable credit facility to start small businesses.

Three features distinguish microfinance from other formal financial Institutions: the smallness of loans’ advances and or savings collected, the absence of asset-based collaterals, and simplicity of operations.

The goal of microfinance institutions as development organizations is also to service the financial needs of new markets as means of meeting development objectives (Ledgerwood, 1999).

Investigating internal control systems in microfinance institutions is important because of the significant resources they leverage in regard to poverty alleviation. Internal control has been identified as a key tool to strengthen the financial performance of MFIs and increase outreach of microfinance.

Internal control will ensure that errors and irregularities are avoided or made apparent. With internal control, Micro-finance Institutions can look forward to increased efficiency and better client outreach.

Micro-finance institutions are an important contributor to the Cameroonian economy. The sector contributes to the national objective of creating employment opportunities, training entrepreneurs, generating income and providing a source of livelihood for the majority of low-income households by financing the businesses that they run.

The general perception is that enforcement of proper internal control systems always leads to improved financial performance. Nevertheless, available Literature still point out that in spite of elaborate system of controls in organizations, financial performance has been elusive in most of these organizations (OAG, 2010).

Commercial banks traditionally lend to medium and large enterprises which are judged to be creditworthy and tend to avoid doing business with the poor and the micro enterprises because the associated costs and risks are considered to be relatively high.

Micro-finance Institutions have therefore become the main source of funding for micro enterprises in Africa and in other developing regions. Internal control has five key components, for the sake of this study it was limited to control environment as the major component.

Control environment embraces all the other four key components of internal control as it sets the tone for the organization and it also influences the consciousness of its employees (Committee of Sponsoring Organizations of the Treadway Commission (COSO).

Despite an extensive study on internal control in Cameroon institutions, there is still need for further emphasis on undertaking continuous studies on individual components of internal control and how it can lead to better financial performance which is the backbone objective of most business organizations and the need for research to be undertaken to evaluate internal controls and establish its effects on organizational performance.

Given that MFI would continue to go out of business if internal control is not adequately implemented to increase the performance of MFI. It is within this backdrop that there was seen a need to undertake this study.

Also the regulatory and institutional framework has improved significantly over the years yet still the Micro-finance institutions are faced with lots of challenges including extensive poor performance, alleged corruption and malpractices.

It is against this background that this study was conducted to investigate the effectiveness of the internal control systems adopted by Micro-finance institutions so as to establish the causes of persistent poor financial performance from the perspective of internal controls.

Statement of the Problem

Globalization and advancement in technology has become the hallmark for businesses today and Microfinance institutions are not an exception. Microfinance institutions have been expanding their operations and activities beyond their domestic borders and as a result, businesses are also exposed to increased risk, fraud, alteration and other irregularities.

This has made internal control an imperative system to be maintained by every business. The globalization of businesses, advancement in technology, increased risk of business failure, fraud and alterations that emerged in the business sector in Africa calls for proper maintenance of an effective internal control system.



Although the microfinance industry has proved its worth as a weapon against poverty, it is still going through a critical phase especially with regards to internal control practices within these organizations (Labie, 2001).

Most Microfinance Institutions (MFIs) face the challenge of achieving sustainability, but are also faced with the problem of internal control, in order to improve the performance of MFIs and make microfinance a more effective weapon against poverty and hunger, it is important that we start by understanding the influence of internal control on the sector.

Internal controls are put in place to safeguard Micro-finance Institutions assets; to avoid misappropriation of its assets and to detect against probable frauds. However, despite all the above findings, Micro-finance Institutions struggle with liquidity problems, operating and financial expenses are relatively high for Micro finance Institutions.

There are also cases of alleged corruption and financial malpractices. This is because of weak and inadequate internal control systems given that some internal control systems are costly and the cost might outweigh the benefit.

In auditing standards, the concept of reasonable assurance recognizes that the costs of control should not exceed the benefits that are expected from controls. However, there is no measure of how small internal control should be to be considered insignificant and if the tone set by management is not effective, internal control can be minimized to the extent that it can drastically pull down performance.

This research will therefore attempt to investigate the effect of internal control on the financial performance of Microfinance institutions which has hitherto been ignored.

Aims and Objectives

The aim of this study is to determine the effect of internal controls put in place and establish their effects on the performance of Micro-finance Institutions specifically CCC PLC.

This goal or aim is quite broad and in order to achieve it, we need to break it down into specific objectives that can easily be handled at various levels. Three specific objectives filtered from this breakdown and they seek to;

1. Assess the adequacy and effectiveness of control activities on performance.
2. Examine the extent to which the control environment influences the performance of MFI.
3. Determine the effect of information and communication systems on the performance of MFI.

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