Internal Finance-Investment Relationship and Financial Constraint: The Case of Small and Medium-Scale Manufacturing Enterprises in Ghana

Abstract

This study examined the relationship between the level of investment and cash flow sensitivity as a measure of financial constraint of Small and Medium scale Enterprises (SMEs) in the manufacturing sector of Ghana. The most up-to-date 2013 World Bank Enterprise Survey (WES) data for Ghana comprising 720 private companies in Ghana's manufacturing, utility as well as other sectors was employed for the study. The dataset is country specific and the extant studies have been done using the same data justifying data credibility. The study was purely quantitative. The seemingly unrelated regression equations (SURE) model was used to model the simultaneity between investment and cash flow. The findings of the study revealed, among others, that the SMEs in the manufacturing sector adopted almost the same level of internal funds in financing their working capital. Also, the results of the study indicated a positive relationship between the percentage of working capital financed from internal funds and the level of investment among the SMEs in the manufacturing sector. Based on the investment-internal finance sensitivity criteria, the results was interpreted to imply that the SMEs in the manufacturing sector of Ghana are financially constrained. Further analysis revealed that enterprises were more likely to be externally constrained than internally constrained financially. The study recommends that, among other things, policy action by government agents such as the Central Bank and Ministry in charge of industries to improve access to finance among SMEs must target the manufacturing sector differently for an effective policy outcome since the nature of its constraint differ.