Determinants of Profitability and Financial Sustainability of Saving and Credit Cooperatives in Eastern Ethiopia

Abstract

This study investigated the determinants affecting financial sustainability and profitability of saving and credit cooperatives (SACCOs) in Eastern Ethiopia using unbalanced panel data of 43 SACCOs from 2015 to 2019. To realise the stated objective, a quantitative approach and an explanatory design were employed using secondary data sources mainly from audited financial statements of the SACCOs during the study period. The analysis revealed that SACCOs in Eastern Ethiopia are not profitable but financially sustainable. The robust random effect model result shows that deposit mobilisation, loan-to-deposit ratio and managerial efficiency have a statistically significant and positive effect on the profitability of SACCOs, while operational efficiency has a statistically significant and negative effect. Likewise, the leverage ratio and the number of active borrowers (a proxy of breadth outreach) have a statistically significant and positive effect on the financial sustainability of SACCOs in Eastern Ethiopia. However, operational efficiency and size have a statistically significant but negative effect on SACCOs’ financial sustainability. Finally, the study suggests that SACCOs in Eastern Ethiopia should perform their conventional activities such as saving mobilisation and credit provision properly to be financially healthy.

Keywords

Determinants financial sustainability profitability SACCOs Eastern Ethiopia

Introduction

The rich and the poor live on the same planet, and the latter takes the right-hand share in population size. It is a fact that nearly 1/2 of the world’s population worldwide live on less than $2.50 a day, including Ethiopia; its people are among the poorest on the planet. More than 1.3 billion live in extreme poverty less than $1.25 a day (UNDP 2014; Zergaw 2015). This circumstance revealed that in most countries, the question of equitable distribution of income remains unanswered. Lack of equal financial access is one of the biggest reasons for high-income inequality, which in turn, leads to crime and political instability, which hampers the economic development processes (Abera and Asfaw 2019; Sintayehu 2015). The poor, who constitute the majority of the population in developing countries, are always excluded from mainstream banking (Marwa and Aziakpono 2015).

One of the policy instruments of the Ethiopian government to reduce poverty and enable rural and urban poor peoples to generate income is the establishment and expansion of microfinance institutions (MFIs) which has achieved tremendous success in improving the livelihoods of the poor, through financial services provision (Abera and Milkessa 2019; Zergaw 2015). Thus, microfinance is considered as one of the important tools for socio-economic development effort and combating poverty by supplying credit for productive poor and allowing them to save, thereby ascertaining access to finance (Marwa 2015; Sintayehu 2015).

Unlike conventional banks, saving and credit cooperatives (SACCOs) provide diverse financial services as well as non-financial services to the rural and poor people with reasonable rates of interest and conditions that favour themselves, to improve the livelihoods of the poor who cannot afford a collateral requirement of other formal financial institutions and are excluded from basic financial service for a long time (Mmari and Lebitso 2019). Ahimbisibwe (2007) noted that without SACCOs and other types of MFIs, the poor would permanently remain poor.

The savings and credit cooperative societies also known as a credit union are financial institutions that are owned and controlled by its members to meet the common economic and social needs of the members through savings mobilisation, loans and financial advisory services (Auka and Mwangi 2013; Mmari and Lebitso 2019). Delivering financial services to the members is the key function of SACCOs. In this sense, they are suitable for low-income households that find it difficult to access credit from banks. They enhance economic growth and development by providing funds to members, to engage in viable business ventures (Odhiambo 2018). To adequately do this, they ought to perform effectively and need to be financially sustainable to effectively serve the poor (Melesse 2019). According to Armstrong (2006), financial performance is a subjective measure of how well a firm can undertake its primary mode of business using the available resources and generate revenue. This term is also used as a general measure of a firm’s general financial health and sustainability over a given period.

According to Kiama (2014), good performance in SACCOs indicates that SACCOs are efficient and effective in their resource utilisation. This also implies the proper management of transaction costs. Scholars who studied on the same issue as Muriu (2011) and Jorgensen (2012) argue that profitable SACCOs reach the larger poor as well as build a sustainable institution with their resources rather than with subsidies from external donors. The focus on profitability is attributed to their conformity to the perspective that only independent, financially sustainable institutions will be able to achieve the highest level of impact on their target population (Yonas 2012). Profitable SACCOs reinvest their excess earnings back into the funding pool or distribute them to their members in the form of dividends (Mazure 2011; WOCCU 2005).

Profitability is a means for achieving the long-term viability and sustainability of the finance sector. In other words, profitability is a stepping stone to financial sustainability and has also been widely used as a measure of the same (Armendáriz and Morduch 2007; Cull et al. 2007). Furthermore, profitability is a precondition for an organisation’s long-term survival and success (Yazdanfar 2013). Financial sustainability means the smooth operation of financial institutions with the necessary profitability, having adequate liquidity to overcome any challenges of bankruptcy. In other words, financial sustainability means that the SACCO can cover all its operating and other costs from generated revenue and generate a margin to finance its growth (Ayayi and Sene 2010), and this is the same as profitability in the long run (Filene 2011; Marwa and Aziakpono 2015). It is an indicator showing how the SACCOs can run independent/free of subsidies on their own feet financially (Melkamu 2012; Siwar and Talib 2001; Woolcock 1999). Hence, heavy reliance on grants and subsidy harms the sustainability of SACCOs due to the lack of competitive pressure associated with attracting market funding. Thus, the motive behind this study is to investigate how SACCOs perform and whether they are financially sustainable. Understanding the performance and sustainability of these institutions is important for institutional longevity and lasting services to the poor, and it is an important barometer for researchers, policy makers, regulators and shareholders in guiding the industry in the desired direction. Therefore, the objective of this study is to identify the determinants that affect the financial performance of SACCOs in Eastern Ethiopia. Hence, this study provides an answer to the following questions:

Is the cooperative model of financing the poor profitable and financially sustainable?

What are the major determinants that affect the profitability and financial sustainability of SACCOs?

Literature Review

Concepts of SACCOs

According to Were (2009), SACCOs are ‘user-owned financial intermediaries owned and controlled by members in which members are identical in some aspects such as community or location’. They exist to provide a safe, convenient place for members to save money and to get loans and other financial services at reasonable rates. SACCO members regularly pool their savings and subsequently obtain loans, which creates the opportunity for members to take responsibility for their cooperatives and encourage them to take control of their financial affairs (Oigo 2015). SACCOs have the capability and opportunity to reach clients in areas unattractive to banks such as rural or poor areas; the aim of SACCO has always been to mobilise savings from middle- and low-income groups and supply credit to the member at an affordable interest rate (Ondieki et al. 2012). SACCOs have solid bases of small saving accounts constituting a stable and relatively low-cost source of funding, which directly or indirectly plays a major role in the financial performance of SACCOs, thus deeply entrenching themselves in the financial sectors of many countries (Owino and Ng’ang’a 2019).

Financial Performance of SACCOs

According to Busenitz and Barney (1997), as quoted by Sangali (2013), performance has been the most important issue for every organisation regardless of whether it is a profit or non-profit one, and it is very important for managers to know which factors influence an organisation’s performance for them to take appropriate steps to initiate them. Financial performance is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenue. It can be used as a general measure of a firm’s general financial health/strength and also acts as an appraisal of the firm’s financial capabilities over a given time (Kiaritha 2015) and can also be used for financial comparison purposes for firms within the industry or sectors in aggregation (Armstrong 2006; Ene and Bello 2016).

In evaluating the financial performance of SACCOs, an important question is whether the traditional corporate goal of profit maximisation holds. Profitability is not the primary concern for credit unions. However, WOCCU (2005) report looked at the profitability of credit unions from a different perspective. It stated that credit unions sought to generate profits to directly benefit the owners as they (members) serve as both the owners of the credit union and the recipients of the credit union services. Thus, when credit unions maximise their profits, they used excess earnings to offer members more affordable loans, a higher return on savings, dividend to members, lower fees or new products and services, cover all costs (cost of fund, operation costs, administration cost and cost of provision), paying competitive salary to its employee and contribution to increasing capital as vital to growth and success (Bauer 2008). Birchall (2005) and Fried et al. (1993) argued that the fundamental objective of credit unions is ‘to maximise the benefit that the member users can obtain from their commercial transactions with the cooperative’. They define benefits as the saving and loan services a credit union offers. However, they acknowledge that it is not appropriate to ignore the services offered by other financial intermediaries when developing a behavioural model for credit unions since they compete in many of the same markets. Thus, applying the profit maximisation approach to modelling financial performance in SACCOs would not negate the principle of maximising member’s benefits.

Determinants of Financial Performance

Various empirical studies have been conducted to identify the determinant factors affecting the financial performance (in line with profitability as well as financial sustainability) of financial institutions. Ndonga (2016) undertook a study on factors affecting the financial performance of SACCOs’ employees at Pesa and k-Rep Welfare Association. The result showed that the amount of loan desired and saving mobilisation had a positive relationship with the financial performance of SACCOs and recommended to make effective improvements on those factors. Ndonga (2016) argued that good loan volume was granted to members by SACCOs leading to high profits for the SACCOs as it generates interest income.

Kathuri (2014) found that age, size, growth rate and liquidity have a positive effect on SACCO’s profitability in Nairobi; however, the leverage ratio had a negative effect. The empirical result on the relationship between leverage and firm’s profitability is inconsistent. A study by Berger and Bonaccorsi di Patti (2006) provided empirical evidence supporting a positive relationship between leverage and a firm’s performance or profitability, while Booth et al. (2001) and Fama and French (2002) established a negative relationship between debt level and a firm’s performance or profitability.

Atsango (2018) examined the effect of firm characteristics on the profitability of deposit-taking SACCOs in Kenya and found that firm size, asset quality and operational efficiency (OE) had a negative and significant effect on profitability. Ochingo and Muturi (2018) examined the effect of firm characteristics on the financial performance of SACCOs in Kenya and revealed that capital adequacy, asset quality, OE and liquidity had a positive and statistically significant effect on the financial performance of SACCOs. Barus et al. (2017) found an inverse relationship between OE and financial performance of SACCOs considering SACCOs operating in Kenya from the period 2011–2015. However, the result was against the finding of Fujo and Ali (2016) and Hesborn et al. (2016), who reported a positive and significant relationship between operating efficiency and financial performance.

Yitayaw (2017) investigated determinants of the financial performance of SACCOs: evidence from selected three zones of Amhara regional state, Ethiopia and found that OE, management efficiency (ME), capital adequacy, gearing ratio and loan-to-deposit ratio (LDR) have a positive and statistically significant impact on profitability. Loans are the most important indicators of performance and primary activity of financial institutions. For that, a positive relationship between the LDR and profitability is expected. However, if increasing loans lead to higher funding requirements, a negative impact of the LDR on the bank’s profitability may accrue (Alexiou and Sofoklis 2009; Kundid et al. 2011). Oigo (2015) identified factors affecting the financial performance of deposit-taking SACCOs in Kisii County, Kenya, and revealed that capital adequacy, asset quality, management capability and earning quality significantly influence financial performance. However, Barus et al. (2017) concluded that ME has no significant effect on the financial performance of SACCOs in Kenya.

Melesse (2019) examined the financial sustainability and outreach performance of SACCOs in Eastern Ethiopia and found that return on asset (ROA) and OE has a positive effect on financial sustainability, while debt-to-equity ratio, donation, deposit mobilisation (DMO) and size has a significant negative effect on the financial sustainability of SACCOs. Findings by Marwa and Aziakpono (2015) showed that ROA, DMO, cost per loan, technical efficiency and loan size had a significant influence on the sustainability of SACCOs. Additionally, Abate et al. (2013) identified that the OE of the firm, ROA, loan size, gross loan portfolio, yield and donation over loan have a significant effect on the sustainability of microfinance. A study by Nyamsogoro (2010), Bogan (2008) and Cull et al. (2008) established a relationship between size and MFIs’ sustainability and showed that size is positively and significantly related to financial performance reflecting the cost advantages associated with size (economies of scale).

Nthaga (2018) analysed the profitability and sustainability of SACCOs in Botswana and revealed that ROAs and the capital structure were significantly and positively related to operational sustainability, while size and liquidity were found to be statistically insignificant determinants of profitability and sustainability. Nyamsogoro (2010) concluded that efficiency affects financial sustainability positively through two channels: cost reduction and revenue increase where more efficient financial institutions tend to have relatively lower expenditure and higher revenue generated per unit. Kinde (2012), Bogan (2012) and Nyamsogoro (2010) argued that SACCOs with high leverage ratios are relatively less sustainable because of the increased cost of capital and the likelihood of ex-post moral hazard.

Zergaw (2015) studied the determinants of profitability of Microfinance in Ethiopia and found that breadth of outreach and age has a positive and significant effect on profitability, while OE (lower cost) has a negative and significant effect on profitability. Jorgensen (2012) studied the determinants of profitability in connection with the yield on gross profit by taking a sample of 879 MFIs all over the world. The finding of his study depicted that the number of active borrowers (NAB), deposit, cost per borrower and legal status have a negative significant relationship with profitability. Sima (2013) studied the determinants of profitability of Ethiopian MFIs and found that OE and portfolio quality have a negative significant effect on profitability, while age has a positive significant effect. Ngumo and Collins (2017) examined the determinants of the financial performance of Microfinance Banks in Kenya. The study found a positive and statistically significant relationship among OE, capital adequacy, firm size and financial performance of microfinance. Ashenafi and Cherinet (2018) studied factors affecting the profitability of MFIs (a study of MFIs in southern nation nationalities people’s regional state) and found a negative relationship between profitability and operating efficiency and size.

Tehulu (2013) investigated the determinants of financial sustainability of 23 MFIs in East Africa using unbalanced panel data from the period 2004–2009, and the result revealed that financial sustainability correlated positively with the level of leverage and liquidity, while management inefficiency and portfolio at risk have a negative and significant impact on financial sustainability. However, the breadths of outreach and DMO are not important determinants of financial sustainability. Regarding breadth of outreach, Kinde (2012), Zerai and Rani (2012), Harmes et al. (2008), De Crombrugghe et al. (2008) and Mersland and Strøm (2009) found that a larger number of borrowers is the biggest sustainability factor and a positive relationship between the active number of borrowers and the sustainability of MFIs. On the other hand, Rahman and Mazlan (2014) and Nyamsogoro (2010) reported a negative and significant relationship between the number of borrowers and financial sustainability because there could be increased inefficiency as a result of an increased number of borrowers.

Khan et al. (2017) identified the factors affecting the financial self-sufficiency (FSS) of MFIs in Pakistan, India and Bangladesh, and their result showed that the size of MFI and loan portfolio to total assets have a positive impact and portfolio at risk, breadth of outreach, management inefficiency and operating cost ratio has a negative effect on FSS.

Ayele (2012) investigated determinants of private commercial banks’ profitability in Ethiopia and found that capital adequacy, managerial efficiency and size have a positive effect on the profitability of private commercial banks in Ethiopia. Ongore and Gemechu (2013) estimated the determinants of the financial performance of commercial banks in Kenya. Their finding reveals that specific factors such as capital adequacy and ME have a positive relationship with the performance of Kenyan commercial banks, and for asset quality, the relationship was negative. Tesfaye (2013) empirically explored the bank-specific, industry-specific and macroeconomic determinants of Ethiopian commercial banks’ performance using unbalanced 10 years (2003–2012) of 16 banks, and he found that size and capital adequacy have a positive effect and OE and LDR have a negative effect on the profitability of Ethiopian commercial banks. Kundid et al. (2011) also found a negative influence of increased LDR on bank profitability in Croatia.

In summary, several studies have been conducted to identify determinants of financial performance (profitability as well as financial sustainability) using data from large and well-developed financial institutions reported in a mixed market. This study extends this literature by adding empirical evidence on SACCOs, which are not normally reported in the major database like mix market, most of which are organised in the rural area where poverty and access to financial service are serious problems and are less exposed in empirical studies, while the cooperative sector in Ethiopia is relatively promising. Thus, the current study will add to the limited empirical literature in this area by exploring the profitability and financial sustainability of SACCOs and its determinants.

Materials and Methods

This study attempted to investigate the determinants that affect the profitability and financial sustainably of SACCOs in Eastern Ethiopia. It is a densely populated and drought-prone part of the country, wherein the majority of the people are poor (Melesse 2019). To this effect, many SACCOs are organised with the support of NGOs and the government to break the poverty cycle.

In light of the research objective, the hypotheses developed and the quantitative nature of the data, this study employed a quantitative approach to identify the determinants that affect SACCO’s profitability and financial sustainability. Accordingly, this study adopted an explanatory research design to examine the cause and effect relationships between profitability and financial sustainability and their determinant variables.

The total population of SACCOs organised and operating in the study area, Eastern Ethiopia, is 395. However, the majority of them are not audited and running without an appropriate account keeping system due to the absence of employees (like accountants) to prepare the necessary documents for the annual audit. Besides, the limited capacities of the supervisory body also contributed to the fact that the majority of them remain unaudited, even though they have proper accounting documents. Since there is no regular audit, most SACCOs are audited once in two to three years. As a result, the study considered only SACCOs operating five years and above and reported at least two years of audited financial statements from 2015 to 2019, which result in having 43 SACCOs as a sample in the study period.

This condition implies that the study used a purposive sampling technique when selecting only SACCOs that are active and complete five years of operation and reported two to three audited financial statements over the study period.

Types and Sources of Data

The study used secondary data collected from annual audited financial statements of sampled SACCOs, which have been collected from government bodies (East Hararghe Zone and Dire Dawa City Administration cooperative promotion office) through document review to increase the reliability of the data. The data were unbalanced panel type, which captured both cross-sectional and time-series behaviours simultaneously.

Methods of Data Analysis

The study used both descriptive statistics and econometric tools to analyse the data. The former includes simple descriptive methods such as mean, maximum, minimum, standard deviations and others that enable us to better understand the existing situation and analyse the general trends of the data. The study substantiated the descriptive analysis through manipulating econometric models to examine causation between the explanatory and dependent variables. In this regard, the study employed a robust random effect model to identify determinants that significantly affect the profitability and financial sustainability of SACCOs.

Definition and Measurements of Variables

Dependent Variables

The dependent variables in this study were the profitability and financial sustainability of SACCOs, which were measured by ROA and FSS, respectively. ROA is an indicator of ‘profitability’ and is intended to measure a SACCO’s efficiency in using its assets (WOCCU 2009). It is known as a profitability or productivity ratio, which provides information about how management is efficient in using its assets to generate earnings and to measure their progress against predetermined internal goals, a certain competitor, or the overall industry (Nyamsogoro 2010). ROA is also used by investors and business analysts to assess a company’s use of resources and financial strength (Brealey et al. 2006). ROA is calculated as the ratio of the net income to the average total assets

R O A = \frac{N e t I n c o m e}{A v e r a g e T o t a l A s s e t} .

The FSS measures the ability of an organisation, a project or a program to maintain broader sources of funding to provide standard services to its clients over time and how well a firm can cover its costs, taking into account some adjustments to operating revenues and expenses (Marwa 2015; Rahman and Mazlan 2014). The FSS is measured as the ratio of adjusted operating income to adjusted operating expenses, which is the sum of financial, operating and loan loss provision expense. The adjustment was crucial to show the true financial picture of an institution on an unsubsidised basis, where funds would be raised on the commercial market, rather than through donor grants or subsidised capital (Marwa 2015). For this study, financial sustainability means that the SACCOs collect their savings and cover all their costs to continue serving its poor clients and increasing numbers of clients, even after they are no longer getting grants or soft loans from donors or government (Chundu 2014; Dunford 2003).

In short, the FSS ratio can be computed as follows:

F S S = \frac{A d j u s t e d F i n a n c i a l R e v e n u e}{A d j u s t e d (F i n a n c i a l + O p e r a t i n g + L o a n l o s s p r o v i s i o n) E x p e n s e s}

(2)

Independent Variables

Depending on the research questions, the explanatory variables used to determine the profitability and financial sustainability of SACCOs in Eastern Ethiopia are DMO, OE, leverage ratio, managerial efficiency, LDR, breadth of outreach (measured as active borrowers) and size of SACCOs. Those variables are used and reported significant by various studies as determinants that affect profitability as well as financial sustainability of SACCOs and MFI with different combinations of variables (Atsango 2018; Melesse 2019; Nthaga 2018; Harelimana 2017; Khan et al. 2017; Osazefua 2019; Yitayaw 2017). Marwa (2015) also measured the sustainability of financial cooperatives in Tanzania using the ROA, OE, loan size, DMO and cost per loan portfolio and concluded that financial cooperatives are operating at a satisfactory level. Table A.1 presents the summary of variables and their expected effect on the ROA and FSS. Some of the variables were computed to their log form for compatibility of the regression.

To identify the effect of determinant variables on the profitability and financial sustainability of SACCOs, this research formulated the following econometric models:

R O A = α + β_{1} {(D M O)}_{i t} + β_{2} {(O E)}_{i t} + β_{3} {(L D R)}_{i t} + β_{4} {(L V R)}_{i t} + β_{5} {(M E)}_{i t} + β_{6} {(S i z e)}_{i t} + ε_{i t}

(3)

{F S S}_{i t} = α + θ_{1} {(D M O)}_{i t} + θ_{2} {(O E)}_{i t} + θ_{3} {(L V R)}_{i t} + θ_{4} {(N A B)}_{i t} + θ_{5} {(S i z e)}_{i t} + ε_{i t}

(4)

where FSS is the financial sustainability, ROA is the return on asset, DMO is the deposit mobilisation, DER is the debt-to-equity ratio, OE is operational efficiency, LDR is the loan-to-deposit ratio, ME is the management efficiency, LVR is the leverage ratio and Size is the size of SACCOs, i is the ith SACCOs, t is the time, β₁, β₂, β₃, β₄, β₅, β₆ and θ_1, θ_2, θ_3, θ₄, θ₅ are the coefficients for each explanatory variables in the model and Ξ_it is the error term.

Results and Discussion

Descriptive Result

Profitability (ROA) is a ratio of net income and average total assets, which measures the amount of profit generated per birr of investment in assets. As shown in Table A.2a, the average value of profitability is 0.08 (8%), which indicated that sampled SACCOs in Eastern Ethiopia generated a profit of 8% of their total assets during the study period. According to WOCCU (2011), the ratio of net income to average total assets equal to 10% and above indicates that SACCOs are profitable and can build institutional capital. Based on this benchmark, SACCOs in the study area are close to the minimum threshold on average in terms of profitability.

Financial sustainability (FSS) measures how well a SACCO can cover its costs, taking into account some adjustments to operating revenues and expenses (Rahman and Mazlan 2014). The value greater than 105% for FSS indicates that the SACCOs are financially self-sufficient, and the value below this point indicated that they are not (WOCCU 2011). The average value of the FSS is 1.11 (111%), which is above the breakeven/threshold of 105% to be financially sustainable. The results portrayed that the sample SACCOs in Eastern Ethiopia were financially sustainable.

DMO is the ratio of the total deposit to the gross loan portfolio. The higher this value, the more it implies that the institutions are mobilising deposits that will be used for satisfying loan demands (Melesse 2019). As indicated in Table A.2b, the average value of DMO is 0.59 (59%), which indicates that on average sampled SACCOs financed 59% of their gross loan portfolio from deposit mobilised internally. Leverage (LVR) is the ratio of the total debt to the total asset. The higher this value is, the more the SACCOs are leveraged than financed through equity capital. The average value of this variable is 0.55 (55%), which indicates that sampled SACCOs were leveraged 55% of their total asset, and the rest 45% was financed through equity financing. OE is used as an indicator of management’s ability to control costs and is expected to have a negative relation with profits since improved management of these expenses will increase efficiency and therefore raise profits (Abdi 2010). The higher this value, the more the SACCOs incurred costs to generate income. The average value of this variable is 0.95 (95%), which implies that, on average, sampled SACCOs were incurred 0.95 cents cost to generate one birr income during the study period. The LDR is the ratio of the total outstanding loan to funds available for loans. The higher value implies that SACCOs offered more loans to their members from the available funds. The average value of this variable is 1.22 (120%), which signifies that sampled SACCOs offered a loan to their members 20% more than the funds available for loans during the study period, which may be covered from an external source. ME is the ratio of operating expense to operating income and measures the ability of management to control its cost. The average value of this variable is 0.07 (7%), which shows that, on average, the sampled SACCOs were incurred 0.07 cents operating expense to generate one birr operating income during the study period. The NAB as a proxy of the breadth of outreach measures the extent of providing financial services to low-income or underserved clients. The average value of this variable is 4.16, which indicates that, on average, sampled SACCOs served 14635.2 borrowers in their real value during the study period. Size is measured as the log of the total asset of the institutions, which indicates that they are efficient and maintain their market position through economies of scale. The average value of this variable is 12.78 in its natural logarithm value; this implies that SACCOs included in this study on average have total assets of 6081350012787.2 Ethiopian birr.

Regression Result

Model Results for Profitability (ROA)

As shown in Table A.3a, multiple regression results identified the effect of explanatory variables on the profitability of SACCOs in Eastern Ethiopia. The variables included in the model explained about 74% of the total variation of profitability scores, which is reasonably a good fit. This implies that the explanatory variables (such as DMO, OE, LDR, leverage ratio, managerial efficiency and size) jointly explained about 74% of the total variation in the profitability.

The model result of the study indicates that DMO, LDR and managerial efficiency has a positive and statistically significant effect on the profitability of SACCOs. On the other hand, OE has a negative and statistically significant effect on the profitability of SACCOs at 10 significant levels as to the model result (see Table A.3a).

The model result shows that DMO has a positive and statistically significant effect on the profitability of SACCOs. The DMO is one of the usual activities of them, and theoretically, it is expected that high DMO will lead to a lower cost of capital and translate to profit maximisation. The result is in line with the theory of asset transformation, and the findings of Ndonga (2016) affirm that SACCOs’ overreliance on savings as a source of finance reduces costs and leads to profit maximisation, while it is against the result of Melesse (2019), Nthaga (2018) and Jorgensen (2012), who argued that this could be due to varying income demographics, memberships size and the result of less net borrowers than savers.

Loans are the most important indicators of SACCO’s performance, which reflects their conventional activity. The model result shows that LDR has a positive and statistically significant effect on the profitability of SACCOs, and that an increase in LDR leads to an increased ROA. Thus, to be profitable, SACCOs should transfer their deposit to a loan rather than holding the money in their custody to generate more interest on loans. The result is in line with the findings of Yitayaw (2017) and Ndonga (2016), who found a positive and statistically significant result as determinants of financial performance, but against the findings of Tesfaye (2013), Kundid et al. (2011) and Alexiou and Sofoklis (2009), who conclude that increasing loans leads to higher funding requirements; as a result, a negative impact on the firm’s profitability may accrue.

A managerial efficiency ratio is a financial ratio designed to measure the efficiency of management in using its assets (working capital or other resources) and managing its liabilities effectively in the short term. The model result indicates that managerial efficiency has a positive and statistically significant effect on the profitability of SACCOs. It is expected that, when a firm has improved managerial efficiency (low operating expense), the firm is either getting more operating income with a determined level of resources or incurring less operating expenses that, in turn, leads to improved profitability of SACCOs (Atsango 2018). The lower ratio of this variable leads to profitability, while the ratio is high (0.74), which implies that SACCO’s managements are less efficient to manage their resources in the study area. The result substantiated with the findings of Yitayaw (2017), Oigo (2015), Ongore and Gemechu (2013) and Ayele (2012) found a significant and positive relationship between ME and profitability. However, Barus et al. (2017) found that managerial efficiency has no significant effect on profitability.

Conversely, the model result depicted that OE has a negative and statistically significant effect on the profitability of SACCOs. OE is a performance measure used as an indicator of a firm’s ability to control the cost and is expected to have a negative relation with profits since improved management of these expenses will increase efficiency and, therefore, raise profits (Abdi 2010). The result of the model is as per the prior expectation and in line with x-efficiency theory, which says efficient firms (lower cost) tend to earn higher profit. The result is consistent with the findings of Atsango (2018), Ashenafi and Cherinet (2018), Barus et al. (2017) and Zergaw (2015), who found that OE has a negative and statistically significant effect on profitability, but against the finding of Ochingo and Muturi (2018), Ngumo and Collins (2017), Fujo and Ali (2016) and Hesborn et al. (2016), who found that OE has a positive and significant effect on profitability; perhaps, this can be attributed to external factors, which are responsible for such variations.

Model Results for Financial Sustainability (FSS)

As presented in Table A.3b, the multiple regression results identified the effect of explanatory variables on the financial sustainability of SACCOs in Eastern Ethiopia. The variables included in the model explained about 70% of the total variation of financial sustainability scores, which is reasonably a good fit. This implies that the explanatory variables (such as OE, leverage ratio, NAB and size) jointly explained about 70% of the total variation in the financial sustainability of SACCOs.

The model result of the study indicates that the leverage ratio and the NAB have a positive and statistically significant effect on the SACCOs’ financial sustainability. On the other hand, OE and size had a negative and statistically significant effect on the financial sustainability of SACCOs as to the model result (see Table A.3b).

The model result shows that the leverage ratio has a positive and statistically significant effect on the financial sustainability of SACCOs. The expected relationship between leverage and financial sustainability is inconsistent. Some studies identified a negative relationship (Anthony 2012; Wafula 2016) and a positive relationship (Berger and Bonaccorsi di Patti 2006; Muriu 2011) between the leverage ratio and firm financial sustainability. The model result of this study is in line with the findings of Khan et al. (2017), Tehulu (2013) and Cull et al. (2007), who found that leverage has a positive effect on financial sustainability. However, the result is against the findings of Kathuri (2014), Kinde (2012), Bogan (2012) and Nyamsogoro (2010). Those findings argued that simply putting a high proportion of leverage to equity would imply that the firm is highly indebted and risks of insolvency increase. The model result indicates that an increase in the leverage ratio increases the financial sustainability of SACCOs by enjoying scale economies until it reaches the threshold that is 70%–80% of the total asset established by WOCCU (2011).

The NAB is a proxy of the breadth of outreach, which measures the extent of providing financial services to low-income or underserved clients. This variable has a positive and statistically significant effect on the financial sustainability of SACCOs. The result portrayed that the larger the number of borrowers, the better the sustainability, since it increased the volume of sell that is one means to maximise profitability, which leads to financial sustainability. This model result is in line with the findings of Zerai and Rani (2012), Kinde (2012), Harmes et al. (2008) and De Crombrugghe et al. (2008), who found a positive relationship between the NAB and financial sustainability. However, it is against the findings of Khan et al. (2017), Rahman and Mazlan (2014) and Nyamsogoro (2010), who reported a negative relationship between the number of borrowers and financial sustainability.

As to the model result shown in Table A.3b, OE has a negative and statistically significant effect on the financial sustainability of SACCOs. OE is a performance measure used as an indicator of a firm’s ability to control the cost. The model result is as per the prior expectation and in line with x-efficiency theory, which states that efficient firms (lower cost) tend to earn higher profit, which could result in financial sustainability. The result is consistent with the findings of Atsango (2018), Ashenafi and Cherinet (2018), Barus et al. (2017) and Zergaw (2015), who found that OE has a negative effect on financial performance. However, the model result is opposite to the finding of Melesse (2019), Abate et al. (2013) and Nyamsogoro (2010), who found that OE has a positive effect on financial sustainability.

Moreover, the model result revealed that the size of SACCOs has a negative and statistically significant effect on the financial sustainability of SACCOs in Eastern Ethiopia. One would expect that the impact of firm size on financial sustainability was positive and statistically significant. However, the result of this study shows that size has a negative effect on financial sustainability; it may be due to bureaucratic and other reasons for managing large SACCOs. The model result is consistent with the findings of Melesse (2019) and Ashenafi and Cherinet (2018), who found that diseconomies of scale for large firms due to possible bureaucratic bottlenecks and managerial inefficiencies but contradicts the scale-efficiency hypothesis of efficiency theory, which suggests that larger firms can obtain lower unit cost and higher profits through economies of scale, and the findings of Nyamsogoro (2010), Bogan (2008) and Cull et al. (2008), who found economies of scale for large firms.

Conclusions and Recommendations

Conclusions

Based on the findings from the descriptive analysis, SACCOs in Eastern Ethiopia were not profitable but financially self-sufficient during the study period. This implies that SACCOs are using their resources for the benefit of society at large than generating profit. As per the model result, it is easy to conclude that the profitability and financial sustainability of SACCOs are best explained by the explanatory variables included in the model.

The findings demonstrate that DMO, LDR and managerial efficiency had a statistically significant and positive effect on the profitability, which indicates that an increase in those variables results in better profitability. However, OE has a statistically significant and negative effect on the profitability of SACCOs in Eastern Ethiopia. Besides, it can be concluded that the leverage ratio and the NAB have a significant positive effect on financial sustainability, while OE and size of SACCOs has a significant negative effect on the financial sustainability of SACCOs in Eastern Ethiopia.

Furthermore, this study also concludes that the profitability and financial sustainability of SACCOs are complimentary, since sustainable business practice assists in improving the financial performance of the SACCOs. Thus, SACCOs should work to be financially sustainable than on their short-term focus, which is profitability.

Recommendations

Based on the findings, the study forwarded the following operational and policy recommendations.

It is recommended that SACCOs keep watch over firm characteristics such as operational and managerial efficiency, firm size, leverage ratio and DMO to ensure that SACCOs remain financially sustainable to reduce their subsidy dependence and ensure survival and growth in the future.

SACCOs have to maximise DMO to improve their capacity to disburse more loans to get more interest income (one of their conventional activity) through providing training and information to their members to save and paying reasonable interest on member’s deposits.

SACCOs have to balance their capital structure through selling additional shares, increasing the number of new members joining their cooperatives, and have to ensure operational and managerial efficiency by providing continuous training and information to management committee members and hiring high-calibre managers in the field to bring good governance and better financial management to remain competitive and sustainable.

Finally, all the government bodies in charge of cooperative at various levels should pay great attention through continuously supervising, inspecting, auditing and developing regulatory environment to make them financially prudent and enhance the development of infrastructures in different areas where difficulties are being faced on the way to provide financial services.

Appendix A

Table A.1.

Summary of Variables and Their Expected Relationship.

Category	Variable Name	Measurement/Proxies/Used	Expected Effect
Dependent variables	Return on asset (ROA)	Net income/average total asset
Dependent variables	Financial sustainability (FSS)	Adjusted operating income to adjusted operating expenses
Independent variable	Deposit mobilisation (DMO)	Total deposit/total loan portfolio	+
	Operational efficiency (OE)	Expense/revenue	–
	Leverage ratio (LVR)	Total debt/total asset	–
	Managerial efficiency (ME)	Operating expense/operating income	+
	Loan-to-deposit ratio (LDR)	Total outstanding loan/funds available for loan	+
	The breadth of outreach (NAB)	Log of active borrowers	+
	Size of SACCO (size)	Log of total assets	+

Source: Developed based on the literature.

Table A.2a.

Descriptive Statistics for the Dependent Variables.

Variables	Obs = 119	Mean	Std. Dev.	Min	Max
ROA		0.0813	0.0432	0.004	0.2511
FSS		1.1137	0.3778	0.5841	4.0876

Source: Own computation, 2020.

Table A.2b.

Descriptive Statistics for the Independent Variables.

Variable	Obs	Mean	Std. Dev.	Min	Max
DMO	115	0.599	0.979	0.0647	10.1187
LVR	119	0.5596	0.2247	0.132	0.9653
OE	119	0.9526	0.1984	0.2446	1.7119
LDR	118	1.2268	0.6897	0	3.5887
ME	118	0.0778	0.0472	0.0039	0.3086
NAB	118	4.1655	0.7133	2.9957	7.0901
Size	119	12.7844	1.1658	10.7674	16.8897

Source: Own computation, 2020.

Table A.3a.

Random Effect Model for Identifying Determinants of ROA.

Explanatory Variables	Robust Coefficient	Std. Err.	Z-Value
DMO	0.0035^***	0.0014	2.55
OE	–0.0268^*	0.0148	–1.81
LDR	0.0445^***	0.0018	25.18
LVR	–0.0134	0.0149	–0.94
ME	0.7488^***	0.0642	11.67
Size	0.0045	0.0032	1.39
_cons	–0.0564	0.0269	–2.10
R² within	0.7462	sigma_u	0.00
R² between	0.8405	sigma_e	0.0223
R ² Overall	0.7483

Source: Own computation, 2020.

Notes: ^*** and ^** imply significance at 1% and 5% level of significance, respectively.

Table A.3b.

Random Effect Model for Identifying Determinants of FSS.

Explanatory Variables	Robust Coefficient	Std. Err.	Z-Value
DMO	0.0195	0.0231	0.84
OE	–1.5394^***	0.3714	4.14
LVR	0.2926^***	0.1466	2.00
NAB	0.0809^***	0.0313	2.59
Size	–0.1276^***	0.0457	2.79
_cons	3.6997	0.742	4.99
R² within	0.7035	sigma_u	0.00
R² between	0.5991	sigma_e	0.2089
R ² overall	0.7016

Source: Own computation, 2020.

Notes: ^*** and ^** imply significance at 1% and 5% level of significance, respectively.

Appendix B

Multicollinearity test for ROA

Variable	VIF	1/VIF
LVR	2.60	0.384093
Size	2.54	0.393298
LDR	1.48	0.677406
DMO	1.46	0.685889
OE	1.10	0.905423
ME	1.10	0.912614
Mean VIF	1.71

Multi-collinearity test for FSS

Variable	VIF	1/VIF
Size	4.21	0.237656
NAB	3.20	0.312631
LVR	2.39	0.418270
DMO	1.22	0.819616
OE	1.01	0.988342
Mean VIF	2.41

Footnotes

Acknowledgement

I am gratefully indebted to all those who have contributed to the success of this study. First and foremost I recognise and praise the name of Almighty Lord whose power has made me come this far. My sincere gratitude goes to Dr Arega Shumetie, sharing his scholarly experience heartily and Dire Dawa City Administration and East Hararghe Zone cooperative promotion office for their cooperation in providing all the necessary data required for this study. Once again, I thank you all. You will always remain treasured in my heart.

Declaration of Conflicting Interests

Funding

The author received no financial support for the research, authorship and/or publication of this article.

ORCID iD

Mekonnen Kumlachew Yitayaw

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