The Role of Microfinance on the Performance of Small and Medium Enterprises: A Case of Hossana Town

Introduction

Access to institutional financial services remains a vital driver of private sector development, yet approximately 90% of populations in developing nations lack access to formal banking systems. This exclusion pushes vulnerable and rural communities toward informal financial mechanisms, perpetuating income inequality and hindering macro-level socio-economic progress. Microfinance institutions (MFIs) serve as crucial intermediaries designed to bridge this gap by offering customized financial products, including microloans, micro-savings, and structural training programs.

In Ethiopia, Small and Medium Enterprises (SMEs) face persistent systemic bottlenecks. While empirical literature underscores the positive correlation between entrepreneurial activities and economic development, substantial hurdles such as rigid collateral mechanisms, inadequate financial skills, high interest rates, and structural capital deficits limit the expansion of these enterprises. The primary objective of this study is to investigate the structural impact of microfinance provisions specifically assessing loan volume, repayment periods, ease of access, frequency of disbursement, collateral conditionality, and targeted operational training on the overall performance metrics of SMEs operating within Hossana Town, Central Ethiopia.

Literature Review

Theoretical Framework

This study is anchored on five prominent economic and organizational theories:

• Institutional Theory: Stresses the value of institutional quality, public support models, and formal regulatory frameworks in driving financial integration and fostering cross-firm networks.
• Joint Liability Theory: Analyzes how group-lending frameworks minimize asymmetric information risks and enforcement costs, facilitating safe credit delivery to resource-constrained micro-entrepreneurs.
• Economic Theory: Identifies capital availability as a fundamental prerequisite for corporate scaling, demonstrating how macro-level financial environments shape firm behavior.
• Agency Theory: Explores potential conflicts of interest and information asymmetries between the lender (principal) and the borrower (agent), highlighting parameters that impact credit sustainability.
• Stockholder Theory: Evaluates standard strategies centered on wealth maximization, balance patterns, and long-term organizational value for active stakeholders.

Empirical Review

Prior global and regional empirical studies demonstrate that credit volumes and structural loan components heavily influence firm growth indicators like sales and asset buildup. Ethiopian research reinforces that structural aspects like timing, flexibility, and operational education directly govern borrower repayment efficiency. However, strict institutional collateral frameworks often form supply-side barriers that limit formal credit delivery.

Methodology

Research Design and Sample Structure

An explanatory research design relying on quantitative analytical methods was implemented. The target population comprised 1,084 active manufacturing, service, and urban agricultural SMEs in Hossana Town, which engage a collective workforce of 5,877 managers and employees. Applying Yamane's sample size formula with a 95% confidence level and an error margin of e = 0.05, the target sample was determined as follows:

A stratified random sampling strategy was applied across the sectors, followed by systematic selection techniques inside each stratum to identify individual business units.

Data Collection and Measurement Model

Primary data were gathered via self-administered, structured questionnaires rated on a 5-point Likert scale, ranging from 1 (Strongly Disagree) to 5 (Strongly Agree). Instrument reliability was validated using Cronbach's alpha (α). The diagnostic checks confirmed high internal consistency across all target dimensions:

Statistical Analytical Framework

Data processing was carried out via SPSS Version 25, integrating descriptive measures with multi-variable linear regression modeling. The empirical relationship is framed through the following linear equation:

Where:

• Y: Performance of SMEs (Dependent Variable)
• X₁: Loan Amount
• X₂: Loan Repayment Period
• X₃: Training Services
• X₄: Loan Accessibility
• X₅: Frequency of Loan Disbursement
• X₆: Collateral Requirements
• β₀: Intercept term; β₁ to β₆: Unstandardized coefficients; ↋: Stochastic error component

Results

Descriptive Profile and Diagnostic Tests

The survey achieved a 100% active response rate (N = 292). The gender breakdown indicated 65.4% male and 34.6% female participants. In terms of academic distribution, technical and vocational graduates comprised the largest group at 38.0%, followed by degree holders at 25.7%. Sector-wise, 43.8% of the firms operated in the manufacturing industry, 37.4% in the service sector, and 18.8% in urban agriculture.

Diagnostic checks for regression assumptions confirmed acceptable normality, with skewness values staying within the standard [-1, +1] range and kurtosis within [-2, +2]. Multi-collinearity tests showed high tolerance values (> 0.10) and low Variance Inflation Factors (VIF), well below the conventional threshold of 5:

Regression Output and Hypothesis Decisions

The comprehensive model summary yielded an R coefficient of 0.872, an R² of 0.761, and an Adjusted R² of 0.756. This demonstrates that 75.6% of the variance in SME performance is driven by the six selected microfinance predictors. The ANOVA test confirmed strong statistical significance for the overall linear combination (F{(6, 285)} = 151.328, p < 0.001).

The individual parameter test statistics are presented below:

The empirical findings confirm that capital size additions (B = 0.078, p < 0.05) help small firms tackle operational hurdles and fund expansion. However, extended repayment terms show a significant negative effect (B = -0.194, p < 0.05). This indicates that overly prolonged schedules may place heavy long-term interest burdens on small firms, tying up cash flow and weakening operational efficiency.

Conversely, MFI training programs show the strongest positive impact (B = 0.503, p < 0.05), highlighting how essential business skills enhance structural efficiency and strategy. Regular disbursement cycles (B = 0.501, p < 0.05) help firms balance their cash inflows and outflows, which mitigates liquidity risks and ensures steady operations. Finally, simple access criteria (B = 0.112) and manageable collateral frameworks (B = 0.126) significantly lower entry barriers, enabling target SMEs to secure vital funds for stability and growth.

Conclusion

This study demonstrates that microfinance provisions significantly influence the performance dynamics of manufacturing, service, and urban agricultural SMEs in Hossana Town. Training initiatives, predictable disbursement frequencies, transparent loan accessibility, and adequate capital sizing serve as vital drivers of enterprise growth. Conversely, prolonged loan repayment matrices present clear disadvantages by introducing long-term financial strain.

Future research should focus on tracking long-term capital allocation strategies across distinct industry sectors and evaluating how digital financial technologies can help lower traditional collateral barriers.

Acknowledgements

The authors thank the Bureau of Commerce and Industry in Hossana Town for providing technical access to baseline enterprise registries, and express gratitude to the participating SME managers and institutional advisors for their cooperation throughout the primary data collection phase.

Funding

This research project was supported and funded by the Authors only.

Conflict of Interest

The authors declare no competing financial or non-financial interests regarding the completion and publication of this research article.

Data Availability Statement

The primary datasets generated, processed, and analyzed during this study are preserved within institutional repositories and can be obtained from the corresponding author upon reasonable request.

AI Usage Disclosure

No generative artificial intelligence tools or automated language models were deployed during data processing, statistical regression analysis, or drafting stages of this manuscript.

Author Contributions

• Dagnachew Tamene Ano: Conceptualization, Methodology, Formal Analysis, Writing – Original Draft.
• Kibamo Kiranso Tefeso: Project Administration, Software Diagnostics, Validation, Writing Review & Editing, Investigation, Primary Data Collection, Resource Management, Final Validation.

References

1. G. Abdissa, A. Ayalew, A. Dunay, and C. Bálint Illés, "Determinants of Sustainable Growth of SMEs in Developing Countries: The Case of Ethiopia," Economies, vol. 10, no. 8, p. 189, 2022.
2. V. Abomugisha, K. David, J. Atubasise, and E. Bakashaba, "Micro Finance Loans and Financial Performance of Small and Medium Enterprises in Sembabule District: A Cross-sectional Study," Student Journal of Health Research, 2022.
3. C. Ahlin, "Group lending, matching patterns, and the mystery of microcredit: Evidence from Thailand," Quantitative Economics, vol. 11, no. 2, pp. 713–759, 2020.
4. H. Ahmad, S. Zulfiqar, and A. Shah, "Microfinance and Growth of MSMEs: The Moderating Role of Entrepreneurial Thrust," European Journal of Business and Management, vol. 8, no. 28, pp. 46–54, 2016.
5. T. Ajala, "Accessing Finance with Movable Collateral: The Flipside for Micro, Small and Medium Enterprises in Nigeria," Research Journal of Finance and Accounting, vol. 9, no. 22, pp. 23–31, 2018.
6. B. Alemu, "The Challenges of Financing Growth Oriented Micro and Small Enterprises: The Case of Hawassa City Mses, Ethiopia," Journal of Economics and Sustainable Development, vol. 8, no. 9, pp. 22–32, 2017.
7. B. Amoako-Adu and J. P. Eshun, "SME Financing in Africa: Collateral Lending vs Cash Flow Lending," International Journal of Economics and Finance, vol. 10, no. 6, p. 151, 2018.
8. P. W. Andabai and I. C. Jessie, "Microfinance banks’ credit and the growth of Small and Medium Scale Businesses (SMBS) in Nigeria (1990-2016): Investigating the nexus," Journal of Economics and Sustainable Development, vol. 9, no. 6, pp. 28–33, 2018.
9. L. P. Baranga and I. Zalinca, "Determination by the Settlement Systems of the Required Collateral Imposed to Participants," Proceedings of the International Conference on Business Excellence, vol. 14, no. 1, pp. 925–939, 2020.
10. J. Belás, S. Vojtovič, and A. Ključnikov, "Microenterprises and significant risk factors in loan process," Economics and Sociology, vol. 9, no. 1, pp. 43–59, 2016.
11. M. Bulla, E. Maronga, and C. Ngacho, "Influence of microfinance financial strategies on growth of small and micro enterprises in Homa Bay county, Kenya," International Journal of Scientific and Technology Research, vol. 8, no. 5, pp. 1–10, 2019.
12. D. Darsono and D. Darwanto, "Strengthening the MSME Through Institutional Cooperation Improvement Between MSME and Sharia Microfinance Institutions (SMFI)," Jurnal Ilmiah Al-Syir’ah, vol. 17, no. 1, p. 65, 2019.
13. M. Fersi, M. Boujelbéne, and F. Arous, "Microfinance’s digital transformation for sustainable inclusion," European Journal of Management and Business Economics, vol. 32, no. 5, pp. 525–559, 2023.
14. G. Fischer and M. Ghatak, "Repayment Frequency in Microfinance Contracts with Present-Biased Borrowers," Research Journal of Finance and Accounting, vol. 6, no. 3, pp. 322–331, 2010.
15. T. S. L. W. Gunawardana and D. G. N. Bandara, "Effectiveness of Entrepreneurship Development Training Programmes on Business Growth of SMEs," Asian Journal of Management Studies, vol. 1, no. 2, pp. 75–97, 2021.
16. S. H. Haider, M. Asad, M. Fatima, and R. Zain Ul Abidin, "Microfinance and Performance of Micro and Small Enterprises: Does Training have an Impact," Journal of Entrepreneurship and Business Innovation, vol. 4, no. 1, p. 1, 2017.
17. E. Herlinawati, R. N. Sumawidjaja, Y. Sudaryo, R. Chandra Jaya, and G. Dayona Ismail, "The Model for Improving Business Performance Using Microfinancial Institutions and Entrepreneurship Competencies," Sosiohumaniora, vol. 25, no. 1, p. 116, 2023.
18. A. Ilori and T. Ayoola, "The Role of Microfinance Banks on Growth and Sustenance of SMEs in Nigeria," Journal of Economics and Sustainable Development, vol. 8, no. 16, pp. 95–103, 2017.
19. M. J. Juliet Nakabugo, S. Muathe, and E. Mwasiaji, "Conceptualizing Microfinance Services, Government Regulation and Performance in the Context of Coffee Entrepreneurs: A Theoretical Review," International Journal of Business and Management, vol. 16, no. 4, p. 1, 2021.
20. K. Kamalu and W. H. B. Wan Ibrahim, "Access to Finance and Sustainable Human Development: Does Institutional Quality Matters in Developing Countries?" International Journal of Membrane Science and Technology, vol. 10, no. 3, pp. 33–45, 2023.
21. M. A. Khan and M. Burki, "Determinants of small and medium enterprises with the interaction effect of managerial activities," International Journal of Research in Business and Social Science, vol. 9, no. 4, pp. 153–160, 2020.
22. Y. Kiros, "Loan repayment performance and its determinants: evidence from micro and small enterprises operating in Dire-Dawa, Ethiopia," Journal of Innovation and Entrepreneurship, vol. 12, no. 1, p. 16, 2023.
23. T. N. Kueredza, "The extent of accessibility of microfinance services by SMEs owned by Women," Indonesian Journal of Business and Economics, vol. 5, no. 2, 2023.
24. V. Lefebvre, "Trade credit, payment duration, and SMEs’ growth in the European Union," International Entrepreneurship and Management Journal, vol. 19, no. 3, pp. 1313–1340, 2023.
25. J. Li, X. Li, and Wang, "Empirical Study on the Key Influencing Factors and Development Mechanisms for the Sustainability of Microfinance Institutions Based on a Survey of Chinese Microcredit Companies," Sustainability, vol. 15, no. 12, 2023.
26. T. S. Manyo, E. I. Ephraim, E. A. Okon, N. S. Ekpo, and E. C. Chike, "Microfinance Banks and the Growth of Small Scale Enterprises in Cross River State," Frontiers in Management Science, vol. 2, no. 3, pp. 10–14, 2023.
27. M. N. Mata, S. S. H. Shah, N. Sohail, and A. B. Correira, "The Effect of Financial Development and MFI’s Characteristics on the Efficiency and Sustainability of Micro Financial Institutions," Economies, vol. 11, no. 3, pp. 1–16, 2023.
28. M. J. Munguti and L. Wamugo, "Microfinance Credit Accessibility and Financial Performance of Small and Medium Enterprises in Machakos County, Kenya," Integrated Journal of Business and Economics, vol. 4, no. 1, p. 71, 2020.
29. S. P. Mwankemwa, "Credibility of Microfinance Institutions Loans to Financial Sustainability of Small and Medium Enterprises in Tanzania: A Case of Selected Enterprises in Arusha," Asian Journal of Economics, Business and Accounting, vol. 22, no. 22, pp. 108–120, 2022.
30. N. Ombi, S. N. A. Ambad, and I. Bujang, "The Effect of Business Development Services on Small Medium Enterprises (SMEs) Performance," International Journal of Academic Research in Business and Social Sciences, vol. 8, no. 3, pp. 114–127, 2018.
31. A. Omidiji, N. B. Redmayne, D. Ehalaiye, and E. Gyapong, "Internal audit in microfinance institutions - evidence from transitional and developing economies," Economics of Transition and Institutional Change, vol. 32, no. 1, pp. 109–141, 2024.
32. O. Oyedokun, G. Emmanuel, and B. S. Ade, "Effect of Micro, Small, and Medium Enterprises’ Performance on the Poverty Level in Nigeria," Asian Journal of Economics and Finance, vol. 4, no. 4, pp. 425–444, 2022.
33. N. Ranabahu and A. Wickramasinghe, "Sustainable Leadership in Microfinance: A Pathway for Sustainable Initiatives in Micro and Small Businesses?" Sustainability, vol. 14, no. 9, pp. 1–15, 2022.
34. A. Saifurrahman, "Enhancing the MSME Islamic Financial Inclusion in Indonesia: An Institutional Theory Perspective," Journal of Accounting and Finance, vol. 23, no. 2, pp. 6–25, 2023.
35. T. W. Wajebo, "Micro, Small and Medium Enterprises Access To Finance Challenges in Supply Side Perspective in Ethiopia," International Journal of Small and Medium Enterprises, vol. 5, no. 2, pp. 23–31, 2022.
36. G. Wang, Q. Su, and L. Wang, "Evolution of cooperation with joint liability," Journal of the Royal Society Interface, vol. 19, no. 188, pp. 1–21, 2022.
37. Y. Zhang and E. Y. Ayele, "Factors Affecting Small and Micro Enterprise Performance with the Mediating Effect of Government Support: Evidence from the Amhara Region Ethiopia," Sustainability, vol. 14, no. 11, 2022.