A Group Game

Nanayakkara and Iselin 165
An Exploratory Study of the Performance of

Microfinancing Institutions Using the
Balanced Scorecard Approach
Gemunu Nanayakkara
Department of Accounting, Finance & Economics
Griffith Business School, Griffith University
Brisbane, Qld 4111, Australia
Email: G.Nanayakkara@griffith.edu.au
Errol R Iselin
Faculty of Business, Bond University
Gold Coast, Qld 4229, Australia.
Email: e.iselin@bond.edu.au
ABSTRACT
More than 3,000 microfinancing institutions (MFIs) in developing countries
provide financial assistance to the needy poor who are denied access to
institutional credit from other sources. This studys motivation comes from the
importance of MFIs and the lack of knowledge about them. Adopting the
balanced scorecard (BSC) model, this exploratory study investigates the critical
performance measures that MFIs need to emphasize in their performance
reporting to drive high performance. The study first argues that four dimensions
(sustainability, increasing the outreach, depth of outreach, and portfolio at risk)
are needed to measure the performance of MFIs, and then analyzes the impact of
eight performance-reporting measures on these dimensions using multiple-
regression analysis. Of the eight measures selected, the emphasis on net cash
flow has a significant impact on improving two dimensions of performance:
sustainability, and increasing the outreach. The latter is also affected by the
emphasis placed on the ratio of zero security loans to total loans in
performance reporting. The study also finds that the depth of outreach
performance dimension is predicted by the emphasis placed on the two
performance reporting measures: ratio of operating expenses to number of
loans and the average time to process a loan application.
Keywords: Microfinancing institutions, balanced scorecard, performance
measurement, performance reporting, organizational performance
Volume 7, Number 2, December 2012

166 An Exploratory Study of the Performance of MFIs
Using the Balanced Scorecard Approach
1. INTRODUCTION
Global poverty is a major problem facing both developing and developed
nations in the world today. In the Asia Pacific region alone, 900 million people
live in poverty. This is about one-third of the population in the developing
countries in the region [Asian Development Bank, 2000a]. Other than the well-
understood negative social impacts of poverty such as crime, low literacy rates,
and poor health, it is strongly believed that poverty even breeds terrorism. In the
recent past, there has been a greater effort by developed nations and international
aid agencies to reduce poverty. For example, the Asian Development Bank
(ADB) has adopted poverty alleviation as one of its key objectives. The total
loans approved under its poverty reduction program amount to US$ 3.5 billion
[ADB, 2000b].
Over the last two decades, microfinancing has grown in popularity as an
effective tool in reducing poverty in developing countries. The concept of
microfinancing is basically providing financial services to the poor to improve
their income levels and standard of living. The typical loans are small and have
to be repaid with interest over short periods, but require no collateral. They help
the poor borrow to finance an asset (e.g., a bicycle, sewing machine, a cow) to
become self-employed.
The concept of microfinancing was introduced to the world by Professor
Muhammad Yunus, who concluded that one of the major causes of poverty was
the inability of the poor to get any access to institutional credit. In 1976, Yunus
tested his research findings by lending US$ 27 without any security among 42
poor people. This was the birth of the Grameen Bank (GB), considered by many
to be the first microfinancing institution (MFI). After years of successful
operation under this concept, by 1998, its loan portfolio had grown from US$ 27
to US$ 2.3 billion with a client base of 2.3 million poor people. Its operation
covers 38,551 villages and employs more than 12,000 staff [Jolis, 2001]. The
amazing success of the Grameen Bank was considered revolutionary since it
shattered the popular belief that the poor are not credit worthy. Yunus was
awarded the Nobel Prize in 2006 for his contribution.
The success of the Grameen Bank sparked a growth in the number of MFIs
all over the world. The ADB estimates that, from a few thousand in the 1970s,
the number of borrowers has grown to more than 10 million poor people in the
late 1990s [ADB, 2000a]. A survey in 2007 has found more than 3,000 MFIs
serving 133 million poor people around the world [Microcredit Report, 2007].
The actual figure today can be assumed to be even more than this. MFIs have
International Journal of Business and Information

been growing rapidly (both in numbers and size) over the last two decades and
this will continue into the future. There are two main reasons for this. First, if
operated successfully, they have proven to be very effective in raising the income
levels of the poor. For example, research conducted by Hulme and Mosley
[1996] across a sample of almost 4,000 borrowers from four different countries
over four years (1988-1992) has found that increases in family income of
borrowers of MFIs were three times higher than that of the control groups.
Studies conducted by Khandker et al. [1995, 1996] have revealed that about 21%
of Grameen Bank borrowers, and 11% of the Bangladesh Rural Advancement
Committee (BRAC) borrowers, have come out of poverty within four years.
They have also shown that extreme poverty has declined from 33% to 10% in GB
customers and from 34% to 14% in BRAC customers. Further, a 1988 survey has
shown that customers of Bank Rakyat Indonesia (BRI), another successful MFI,
have raised their income levels by 76% and employment by 84% [ADB 2000a].
In fact, some MFIs have been self-sustaining while expanding their
customer base. Therefore, they have become very popular among governments
and donor agencies in their poverty-reduction programs. A second reason MFIs
have been growing rapidly is that, although there are 900 million poor people in
the Asia Pacific region, only about 133 million are estimated to be served by
MFIs at the moment. Considering this huge gap, and the recent popularity of, and
support for MFIs, their growth in the future is almost certain.
Microfinancing has become a very important tool in the battle against
poverty, and hundreds of millions of dollars have been injected into the sector.
For example, the total loan portfolio outstanding to MFIs of the ADB in 2001
was US$ 398 million. The total World Bank (WB) assistance to the
microfinancing sector by 2009 reached US$ 1.29 billion [WB, 2009]. However,
at the moment, there is very limited knowledge regarding the factors that drive
the performance of MFIs. Therefore any contribution toward improving the
performance of MFIs will have a significant impact on millions of poor people
receiving assistance from MFIs, and the effective use of hundreds of millions of
dollars of aid funds originating from the taxpayers of wealthy countries.
2. THEORY AND RESEARCH QUESTIONS

This section presents a discussion of the balanced scorecard, and research
questions.

2.1. The Balanced Scorecard

The main objective of this study was to get an understanding of the
dimensions of MFIs performance, and to explore the drivers of those
performance dimensions by applying the BSC model.
It is argued that both financial and non-financial performance perspectives
are important in the performance of MFIs. Financial performance is important if
an MFI is to survive. Non-financial performance is also important if donors and
borrowers are to be served well. For example, the satisfaction of donors or an
improvement in living standards of the poor borrowers (e.g., social indicators
such as health and children's education) can be measured only by non-financial
indicators. The balanced scorecard (BSC) developed by Kaplan and Norton
[1992, 1996, 2001, 2004, 2006, 2008] is a model that incorporates financial and
non-financial perspectives of performance. Consequently, this exploratory
research uses the BSC framework to study the key dimensions of MFI
performance and the key performance reporting indicators that drive that
performance.
The BSC emerged as a solution to the weaknesses in traditional
performance measurement systems that relied heavily on financial indicators and
reports such as the profit and loss statement and balance sheet. These latter
financial reports indicate the financial performance or the outcomes at the end of
the reporting period. What is also important for managers is an understanding of
the root causes that really drive the financial performance or the desired
outcomes. For example, what factors help an MFI to become a long-term
sustainable MFI? What processes must MFIs excel at in order to achieve this?
What lead indicators must MFIs emphasize in their performance reporting? It
must be noted that some of these lead indicators can be non-financial (e.g., time
to process a loan application and security cover on the loans).
However, the BSC goes beyond just identifying non-financial lead
indicators that drive performance. It looks at the cause and effect relationship
or links between these indicators and how they relate to achieving the
corresponding strategic goals or objectives. The basic BSC model looks at four
perspectives of the organization.
Financial
Customer
Internal Process
Learning and Growth

The link between these four perspectives can be explained as follows. An

investment in training and information systems (learning and growth perspective)
in an organization will result in improved innovation and other internal processes
in the organization (internal process perspective). This will in turn increase
customer satisfaction (customer perspective), which will lead to an increase in
revenue, and profits that improve the financial perspective.
In the literature, the use of BSC in for-profit organizations is very well
documented [see Kaplan and Norton, 1992, 1996, 2001, 2004, 2006, 2008; Iselin
et al., 2008, 2010; Ittner et al., 2003; Libby et al., 2004]. Further, Malina and
Selto [200], Eldenburg and Wolcott [2005], and Atkinson et al. [2012] refer to
surveys of senior executives in which more than 60% of their organizations were
using the BSC.
The model has also been applied successfully to a number of non-profit and
government organizations in the USA; e.g., Duke Childrens Hospital, University
of California, Montefore Hospital, May Institute (a non-profit organization), and
Charlotte City Council [Kaplan and Norton, 2001]. When the BSC is applied to
government or non-profit organizations, the financial perspective gets replaced
by the mission of the organization. Also, in relation to the customer perspective,
there are two types of customers those who receive the services from the
organization, and those who fund the organization to provide these services. For
example, in a government hospital, the patients are the first type of customers
and the government is the second type. The government pays for the services by
funding the hospital. Application of the BSC theory to non-profit organizations is
shown in Figure 1.
It must be noted that it is not known whether MFIs are emphasizing
profitability or not. Although some may operate as not-for-profit, others may see
profits as another source of funds to help more poor people. Therefore, this
study does not classify MFIs as purely not-for-profit organisations. Instead, it
assumes that MFIs may have different levels of emphasis on profitability.

Figure 1. Adapting the Balanced Scorecard System Framework

to Non-Profit Organizations
(Kaplan & Norton, 2001)
2.2. Research Questions

The fundamental research questions investigated in this study relate to
applying the BSC concept to MFIs, and can be stated as:
Q1. When reporting their performance, do MFIs give emphasis to financial

measures that come under the financial perspective of the balanced
scorecard (BSC)?

Q2. Do MFIs give an approximately equal level of emphasis to

performance-reporting measures across all the four perspectives of the
balanced ccorecard (BSC) or does it differ significantly among the four
perspectives?
Q3. What are the key performance-reporting indicators that need to be
emphasized by MFIs to improve their performance?
3. LITERATURE REVIEW
To find answers to the research questions stated above, what is meant by
performance in relation to MFIs is explored in this literature review. A
definition of performance and four dimensions to measure the defined
performance are suggested. Then, based on the BSC model, a number of
performance-reporting indicators are selected to assess their impact on these four
performance dimensions.
3.1. Performance of MFIs

In the literature, there are no studies that have defined the performance of
MFIs or any instruments developed to measure the performance of MFIs. For
example, Lashley [2004] argues:
"In essence, the nature of this complex problem lies in stakeholders

not defining what is meant by successful microfinance. Unless
governments, donors, and microfinance providers can explicitly and
strategically define the mission of microfinance, the microfinance
movement in the Caribbean will continue to flounder. What does the
term successful microfinance mean? Is it institutional self-
sufficiency, the sustainable rising of incomes above the poverty line,
or a successful microenterprise sector? Indeed it may be all of these
things. However donors, governments, and MFIs need to identify
their primary aim for microfinance. They must identify poverty
alleviation as a primary aim, with the eventual aim of enterprise
development and eventual sustainability."
As argued by Lashley [2004] above, the issue of performance is not

straightforward since MFIs are quite different from other financial organizations

such as banks. For example, financial performance measures such as

profitability, return on investment, and share price are not appropriate to assess
the performance of MFIs, which have fundamentally different objectives that
conflict with commercial interests.
Although there is no standard definition for performance in relation to MFIs
in the literature, a number of studies have implied various aspects of MFIs to be
important in their performance. Studies that looked at the impact of
microfinancing on the poor imply that the level of impact on the poverty level of
the borrowers as the performance of MFIs. These impacts were measured by a
number of different methods. For example, Hulme and Mosley [1996] studied
the average annual change in family income of the borrowers. Khandker et al.
[1995, 1996] assessed the family income. Case studies undertaken by the
Consultative Group to Assist the Poor (CGAP 2002) analyzed the improvement
in various social indicators such as children's education (Uganda), level of
immunization of children (Bolivia), reduction in malnutrition (Bangladesh), and
reduction in food deficit period (Vietnam). Similar studies conducted by the
Foundation for Development Corporation [1992] have adopted increase in
employment and income (India, Bangladesh, and Philippines) and increase in
savings and expenditure on nutritional food (Malaysia). Dunford [2001] assessed
the increase in net non-farm income levels in Ghana.
These studies clearly imply the performance of MFIs as poverty alleviation.
However, there are other studies that have focused on the effective utilization of
resources by the MFIs. These studies were critical about the inefficiencies of
MFIs and implied the operational efficiency as performance of MFIs [Adams,
1998; Yaron, 1992; Mudenda, 2002]. However, none of these studies have
suggested a common yardstick to measure efficiency and effectiveness.
A number of studies have selected various factors to measure performance
of microfinancing institutions. The most common factors are:
1. The outreach or the number of customers assisted by the MFI [Kereta

2007; Lapenu and Zeller, 2001; Lafourcade et al., 2005; Mersland and
Storm, 2009; Hartarska, 2005; Mersland and Storm, 2008; Kyereboah-
Coleman, 2007]
2. Profitability [Kereta 2007; Lafourcade et al., 2005; Mersland and Storm,

2009; Hartarska, 2005; Kyereboah-Coleman, 2007; Ahlin et al., 2011]

3. Quality of the loan portfolio [Lapenu and Zeller, 2001; Ahlin et al.,
2011; Field and Pande , 2008]
4. Cost to clients and number of products offered to clients [Mersland and

Storm, 2008]
5. Staff productivity [Lapenu and Zeller, 2001]
All the factors used in the above-mentioned studies can be considered as

some aspect or dimension of performance of microfinancing institutions.
However, none of the studies specify the justification for using the particular
indicator or the reason for not using other indicators. Hence, there is no common
yardstick or accepted dimensions agreed upon to measure the performance of
MFIs. In other words, the question remains: What is the minimum number of
dimensions/areas that we should consider to measure the overall performance of
an MFI? In our study, we first look at the main objective of microfinancing
organizations, and then develop a framework to develop/select the dimensions of
performance by defining the performance as the extent to which an MFI achieves
its main objective.
It is argued that all MFIs are basically helping the poor to improve their
income and create wealth to reduce their poverty levels. Therefore, it is assumed
that the mission of most MFIs is geared toward the objective of alleviating
poverty. This is considered a reasonable assumption if we look at the underlying
root cause for setting up MFIs in most developing countries.
Adopting this principle of defining performance in terms of the extent of
achieving the desired objectives, we can define the performance of an MFI as
follows:
Performance of an MFI is defined as the extent to which it alleviates
the poverty levels of its existing and potential customers.
This study proposes four critical factors that can be used to operationalize an
MFI's performance. They can also be considered as four dimensions of
performance in line with the above definition. Although the terminology used
below to outline these performance dimensions is commonly used in
microfinancing literature, a brief description is provided in the following
discussion. The four dimensions are:
1. Sustainability
2. Increasing the outreach

3. Depth of outreach
4. Portfolio at risk
"Sustainability" refers to the ability of an MFI to maintain continuity in its

operation. Importantly, if an MFI is not sustainable, it will fail in achieving its
objective of alleviating poverty. Although sustainability and profitability are
directly related in commercial organizations, this is not the case for MFIs. In
order to be sustainable, profitability may remain a major factor for some MFI's,
whereas for others it may depend on external grants and concessional funds from
donors. Obtainment of external funding relies heavily on the transparency and
efficiency of the MFI's internal operations to successfully help the poor in a
pragmatic way. It is evident that both profitability and the acquisition of external
funds play a major role in an MFI's long-term sustainability. As mentioned
before, in the absence of sustainability, it is impossible for an MFI to alleviate
poverty. Therefore, we argue that sustainability is a key dimension of the MFI's
performance.
The next dimension, termed increasing the outreach, refers to growth of
the customer base. If we accept that MFIs customers are poor (which is
discussed below under the next dimension), it can be argued that, as the number
of customers increases, so too does the elimination of poverty, because more
people are offered financial assistance to improve their income. Hence,
increasing the outreach (customer base) is considered a critical dimension to
measure performance or the extent to which an MFI is achieving its main
objective of reducing poverty.
The poverty level of the borrowers is captured by the next dimension
depth of outreach. It is argued that an MFI that serves the poorest of the poor
(higher depth of outreach) is doing more to alleviate poverty than an MFI with a
customer base of not so poor (lower depth of outreach) borrowers. In other
words, the deeper the poverty level of the borrowers, the higher the contribution
made by that MFI to reduce poverty. Notably, in the absence of this criterion, it is
extremely difficult to estimate the level of poverty that is alleviated. Therefore,
this dimension is crucial to assess the performance of an MFI.
Although the criteria above analyze the efforts of the MFI attempting to
alleviate poverty, they do not directly measure the outcome of these efforts. A
still pertinent question is whether the assistance offered by the MFI resulted in
borrowers improving their income and reducing poverty levels. If not, the MFI
has evidently failed in its objective to alleviate poverty. This study relates this

dimension to the "portfolio at risk," or the repayment level of loans. It is assumed

that the borrowers who are prompt in their repayments are on their way to get
past (if not already above) the poverty line. Conversely, the overdue or default
loans indicate unsuccessful borrowers who have regressed into more debt and
remain trapped in poverty.
Many causes may underlie an unsuccessful repayment, including the
inability of the MFI to restructure or reschedule the loan. In fact, overdue
payments reflect more on the MFI in terms of its failure in successfully assessing
a loan. Unlike commercial loans, MFIs do not approve loans concentrating
predominantly on the security cover. In most situations, there is no security
offered. Loan appraisal in MFIs rests mainly on applicant credibility and the
repayment potential of the proposed venture. Some MFIs have special branches
tasked with advising borrowers on prospective ventures for their loan.
A high portfolio at risk" value indicates that a large number of borrowers
are still buried in poverty despite the MFI's assistance. It also indicates a waste of
scarce resources that could have otherwise reduced poverty elsewhere
(opportunity cost). Based on the above argument the portfolio at risk is
included as the fourth dimension to assess the contribution made by the MFI to
alleviate poverty.
Importantly, success in one of the four dimensions may compromise
performance in another. Therefore, it is important to appraise all four dimensions
together to assess the performance of MFIs. For example, an MFI may achieve
sustainability via high profitability. However, this may have been achieved by
catering largely to those above the poverty line who may have even provided
collateral for their loans (very similar to commercial banks). Such MFIs will
score poorly when measured along the "depth of outreach" dimension. In some
instances, an MFI may increase its outreach (customer base) at a rapid rate at the
expense of having a higher proportion of bad loans because the loans may not
have been carefully assessed prior to being granted. This is a highly probable
scenario since the demand for microfinancing is very high (large number of poor
borrowers in developing countries), and the availability of funds for further
disbursement may not be affected by the poor repayment of bad loans because of
the continuous inflow of donor funds. Such MFIs will score higher in the
dimension of increasing the outreach, but will have a lower rating in relation to
the portfolio at risk dimension.

In essence, this study will use the above four dimensions to evaluate MFI
performance as:
1. Individually, they are each essential components of the performance of

an MFI in achieving its primary objective of alleviating poverty.
2. Some of these dimensions can also be achieved at the expense of others.

Therefore, it is important to include all four in order to paint a complete
portrait of the MFI's performance. It would be difficult to argue that an
MFI exceeding in all these four dimensions is not achieving its primary
objective of reducing poverty.
The measurement of performance along these four dimensions (including

the instrument used) is outlined later in Section 4. The four dimensions of
performance are considered the dependent variables in the analysis.
The performance dimensions used in this research are supported by the
Consultative Group to Assist the Poor (CGAP). CGAP is an international
organization set up and funded by major international banks like the World Bank
and the Asian Development Bank to develop the microfinancing sector around
the world. CGAP has recommended to donors five performance areas
(dimensions) to assist in identifying MFIs for funding; namely, financial
sustainability, outreach, depth of outreach, portfolio quality, and efficiency. The
first four of these are the same as this studys four performance dimensions
(CGAP defines portfolio quality in terms of portfolio at risk). This research treats
efficiency as a driver of performance rather than a dimension of performance.
It covers efficiency with the internal processes perspective of the BSC, which
includes two variables that are treated as independent variables (the four
performance variables are dependent variables). Consequently, the dimensions of
performance used in this research are, with one exception, in accord with the
CGAP recommendations.
3.2. Selection of Performance Reporting Measures

At the moment, there is no consensus in the literature or standard that
defines the performance reporting measures suitable for MFIs. The only attempt
in this direction was an ADB-funded project in 2002 that came up with a
document defining 20 performance-reporting measures relating to performance
of MFIs [ADB, 2002]. The document limits itself to defining and standardizing

the terminology commonly used in the microfinancing industry, but does not
extend itself to recommending any particular performance reporting measures. It
states:
"This set of definitions was not meant to be a template for financial

reporting by microfinancing institutions, and should not be used for that
purpose. For the most part indicators were included in this document
because they presented definitional issues, not because they were
necessarily preferred indicators for financial reporting."
Theoretically, it is possible to define a large number of measures that MFIs

can use in their performance reporting. This will result in a large number of
regression equations to test the possible relationships between the selected
variables. Therefore, analyzing all the possible performance-reporting measures
is not practical and the number has to be limited to a feasible level.
This study attempts to analyze the performance reporting of MFIs in the
context of the BSC framework, which defines four perspectives of any
organization. Therefore, the performance-reporting measures were selected to
equally represent the four perspectives of the BSC model. These measures were
based on the existing knowledge regarding the industry and the discussions with
experts working in microfinancing. Two performance-reporting measures from
each of the four perspectives of the BSC were selected resulting in a total of eight
performance-reporting measures.
The list of selected performance-reporting measures from each of the four
perspectives of the BSC is given in Table 1, and the reasons for selecting them
are discussed below.
Profitability is probably the most widely used performance-reporting
measure in commercial enterprises. However, for an MFI, emphasis on
profitability can have conflicting results in achieving its objectives. Obviously,
profitability will improve the sustainability of the MFIs. Moreover, it will enable
the MFIs to improve their service and expand the customer base. However, on
the other hand, profitability can affect the charitable or non-profit objective
of an MFI. This can create a negative impact on both its borrowers and donors.
The grassroots-level customers may feel that they are being exploited, and the
donors may divert their limited funds to other MFIs that may be at break-even or
struggling for survival. Because of this double-edged sword effect, the impact
of higher emphasis on profitability on the performance reporting of MFIs is

subject to argument. Hence, it was considered as an important performance-

reporting variable to be included in the analysis.
Table 1
Selected Performance-Reporting Measures
BSC
Performance-Reporting Measures
Perspective
Profitability
FINANCIAL
Net cash flow
Ratio of loans with zero security cover to total number

of loans
CUSTOMER
Percentage growth in subsidized funding from
existing donors
Ratio of operating expenses to number of loans

INTERNAL PROCESS
Average time to process a loan application
LEARNING AND Ratio of training expenses to total expense

Investment in information systems as a ratio of total
GROWTH
expense
Since most of the loans granted by MFIs are without security, it is possible
to have a large number of bad loans that affect cash flow. Profitability may not
reflect the correct picture if accurate provisions for bad debts are not made in the
records. Moreover, cash flow is important for the smooth operation of any
organization. Therefore, net cash flow was selected as the second performance-
reporting measure under the financial perspective.
Under the customer perspective, non-profit organizations such as MFIs have
two types of customers the borrowers and the donors [see Kaplan and Norton,

2001]. Therefore, it was decided to select one indicator that reflects each of these
customer types. Customer satisfaction is one of the most important and
commonly used performance-reporting measures under the customer perspective
of the BSC. The growth in subsidized funding from donors reflects the level of
satisfaction of the donors who are assisting the operations of MFIs. This measure
may indicate that any monitoring or auditing done by the donors has yielded
satisfactory results, confirming that the funds are utilized efficiently and
effectively for the purpose that they were granted. Negative growth in funding
from existing donors may yield a picture that is quite opposite to this. Therefore,
growth in funding from existing donors was considered as an important
performance-reporting measure reflecting customer satisfaction of the donors
under the customer perspective of the BSC.
In relation to MFI borrowers, the meaning of customer satisfaction is
quite different from that of commercial financial institutions such as banks. The
main reason is that the demand for microfinancing services far exceeds the
supply because of the large number of poor people in developing countries. For
example, it is estimated that, out of about 900 million poor people in the Asia-
Pacific region, only about 10 million were served by MFIs in the late 1990s. The
available funds are limited and disbursed according to the carefully selected
guidelines and assessment criteria developed by the MFIs. Therefore, any poor
person (without access to credit elsewhere) becomes a satisfied person as soon as
he/she becomes a customer of an MFI. For this reason, it is very rare for MFIs to
conduct customer satisfaction surveys like other commercial organizations.
However, although most loans are granted without any collateral, some
MFIs take a certain level of security (in most situations, only a fraction of the
loan offered) to reduce the risk. Sometimes, this is done because of requirements
imposed by donors when granting their credit lines to MFIs. Therefore, it was
assumed that customers who offer some form of security are less satisfied than
those who offer no security at all. Based on this assumption, the ratio of loans
without security cover to the total number of loans was considered as an indicator
that reflected the customer satisfaction of MFI borrowers.
It is reasonable to assume that operational expenses will increase with an
increase in the number of loans. Therefore, the ratio of operating expenses to the
number of loans indicates the overall efficiency of operation, which falls under
the internal process perspective of the BSC.
The average time to process a loan application also is an important indicator
under the internal process perspective. Generally, it is an important indicator in

traditional financial institutions such as commercial banks. However, in MFIs, it

becomes even more critical for grassroots-level borrowers since they are
desperate to obtain the funds as soon as possible. On the other hand, most of
these loans are given without any security, a fact that demands more careful
appraisal of the loan applications. This will tend to lengthen the time of
processing a loan application. Therefore, this indicator can affect the
performance in either direction, which makes it a strong candidate to be explored
in this study.
Under the learning and growth perspective, the training of employees was
considered an important aspect for MFIs. Methods that are used in other financial
institutions such as banks are not applicable to MFIs. Procedures that are used in
traditional financial institutions (formal document-based structured systems)
have failed in MFIs [see Schmidt and Zeitinger, 1994]. Some of the operational
procedures of successful MFIs have been found to be innovative and varying
from country to country. Therefore, employees of these MFIs need to acquire the
appropriate special skills in relation to these innovative procedures for the
respective MFIs to operate successfully. Hence, training of employees to acquire
these skills plays a vital role in improving the performance of MFIs. Therefore,
ratio of training expenses to the total expense was selected as one of the
performance-reporting measures for this study.
Existing literature has indicated the lack of proper accounting and
information systems as one of the major weaknesses of MFIs [Mudenda, 2002;
ADB, 2000a]. Donors especially feel reluctant to lend funds to organizations that
are weak in record keeping and information systems. It is common for MFIs to
operate in geographically widespread areas, a fact that increases their
administration costs. Therefore, achieving efficiency and cost effectiveness
through modern information and communication technology is suggested as an
important aspect for an MFI. For these reasons, investment in information
systems as a ratio of total expense, which indicates the level of investment to
improve the information systems, was selected as the second performance-
reporting variable under the learning and growth perspective of the BSC. It
should also be noted that Kaplan and Norton include information system
capabilities in the learning and growth perspective of the BSC.
The performance-reporting variables discussed above are operationalized
and measured by looking at the emphasis placed by the MFIs on these indicators
in their performance reporting (PR). We argue that a PR indicator will have little
effect if it is given little or no emphasis [Iselin et al., 2008]. The emphasis

concept here is similar to the budget emphasis variable in the budgeting

literature [Covaleski et al., 2003]. In summary, the eight performance reporting
measures used as variables in this research are as follows:
PR 1 Emphasis placed on profitability in performance reporting
PR 2 Emphasis placed on net cash flow in performance reporting
PR 3 Emphasis placed on ratio of loans with zero security cover to total number of
loans in performance reporting
PR 4 Emphasis placed on percentage growth in subsidized funding from existing

donors in performance reporting
PR 5 Emphasis placed on ratio of operating expenses to number of loans in

performance reporting
PR 6 Emphasis placed on average time to process a loan application in performance

reporting
PR 7 Emphasis placed on ratio of training expenses to total expenses in performance

reporting
PR 8 Emphasis placed on investment in information systems as a ratio of total

expenses in performance reporting
The measurement of these variables and the instrument used are discussed
in Section 4. It is acknowledged that some dimensions of the BSC such as quality
and innovation are not covered by the above performance-reporting measures. As
mentioned above, this study is exploratory in nature and has not covered all the
potential performance reporting indicators.
4. METHODOLOGY
This section includes a discussion of the measurement of variables, sample
and data collection used in this study, and an overview of the analysis.

4.1. Measurement of Variables

The instrument used to measure the variables is outlined in Appendix A. It
consists of a questionnaire divided into three parts. The first section covers the
general information relating to the MFI. This includes the name, address, contact
details, number of customers, name of donors, etc. The second part relates to the
performance-reporting variables. Each CEO or chief financial officer (CFO) was
asked to indicate by circling Y (Yes) or N (No) whether the MFI was using
the given performance-reporting measure in evaluating its performance. If the
answer was Yes, he or she was then asked to circle the appropriate number on a
Likert scale (ranging from 1 to 9) indicating the extent to which that particular
performance indicator was emphasized in the organization. Where the answer
was No, the value was taken as 0.
The third section of the instrument was designed to measure the overall
performance of the organization. Each CEO or CFO was asked to indicate his/her
organizations overall performance along each of the four dimensions compared
with those of other MFIs operating in his/her country or region. The scale varied
from 1 (well below average) to 9 (well above average) in a 9-point Likert scale,
while 5 represented about the same, compared with other MFIs (see Appendix
A).
This research uses self-ratings to measure organizational performance. It
concurs with Dunks [1993, 2005, 2007] view that this is appropriate. It could be
suggested that managers might be lenient when rating their performance.
However, a number of past studies have used self-assessment and confirmed the
reliability and validity of using such instruments. For example, the instrument
developed by Mahoney et al. has been widely used in past research [Brownell,
1983; Brownell and McInnes, 1986; Govindarajan, 1986; Gul and Chia, 1994;
Otley, 1978]. Dunk [2007] argues:
"Williams et al. (1990) argued that self-rated performance scores overcame

the unfeasibility of matching data objectively across different departments
in multiple organisations, and avoided halo effects associated with
superiors ratings. Furthermore, even though managers may overrate their
performance (Mabe and West, 1982), or the performance of their areas of
responsibility, Venkatraman and Ramanujan (1987) found that managers
self-ratings are less biased than researches might expect. Abernethy and
Stoelwinder (1991) also found no evidence that managers are consistently
lenient in rating the performance of their departments."

In fact, the data collected in this study supports this view. For example,
some CEOs of MFIs selected for this study have given below-average ratings for
their organizations (see Table 4).
Dunk [1993, 2005, 2007] also argues that if leniency occurs it is a type of
measurement error. Measurement error may be either non-random (systematic
bias) or random [Nunnally, 1981]. Systematic bias would occur if a constant
were added (or subtracted), say because of leniency, to (or from) the true score
for the dependent variable. However, this addition (or subtraction) of a constant
does not change the relationship between the independent and dependent
variables in a multiple regression [Nunnally, 1981]. It merely changes the
intercept, and that is of no interest in this research. If the error is random, it is
added to the error term in the regression model [Neter et al., 1985] and thus
makes it more difficult, rather than easier, to reject the null hypothesis. An
argument in favor of using self-ratings is that they overcome inconsistencies and
earnings management in archival data. Archival data is inconsistent because
different companies might use different accounting methods. The problem of
earnings management is widely recognized. These arguments provide substantial
support for the use of self-rating data in this study.
4.2. Sample and Data Collection

The performance of MFIs can also be affected by environmental factors that
are external to the MFI and beyond its control. Therefore, in order to control for
these external factors, it was decided to select a sample of MFIs that are subject
to similar environmental conditions. To achieve this, the population of 18
microfinancing institutions operating in one country (Sri Lanka) was identified
for data collection. Some basic data relating to Sri Lanka are given in Table 2.
There are some advantages in selecting Sri Lanka for controlling the
external variables. First, it is a country with a small land area of 62,705 sq km.
Therefore, geographically, all the MFIs in the country are located very close to
one another, compared with the situation in large countries like India, Indonesia,
or Bangladesh where MFIs are very popular. Second, there is no significant
difference in the level of infrastructure facilities and the characteristics of the
borrowers within the regional centers where the MFIs are located. Third, the
population density is high and the literacy rate of the country is about 90%.
Consequently, the literacy level of the customers of the MFIs can be considered
to be very similar. MFIs in the sample are also subject to the same level of
regulation and government policy. All of these reasons tend to make the

characteristics of the customers and the environment of the selected MFIs very
similar.
Table 2
Basic Data Pertaining to Sri Lanka
Area 62,705 sq km
Population 19,007,000
GDP (real ) growth rate 4%
GDP per capita US $ 872
Unemployment 9.1%
Population density 307 persons/sq km
Literacy rate 90.1%

*Source Economic Report 2002, Central Bank of Sri Lanka
At the time of data collection, 18 MFIs were identified to be operating in Sri

Lanka. It was decided to obtain data from the complete population of MFIs
operating in the country. The data collection was coordinated by the National
Development Bank (NDB), the largest development bank operating in Sri Lanka.
The questionnaire was first tested by discussing it with officers of the NDB
who had experience in dealing with MFIs in the country.
The survey was conducted by sending the questionnaire to the CEO of each
of the 18 MFIs, along with a cover letter explaining the objective of the study. Of
the 18 MFIs, 13 (72.2%) responded. These 13 have an annual turnover from SL
Rs 810,000 (US$ 8,100) to 251 million (US$ 2.5 million). The number of
employees of the MFIs ranged from 18 to 630 while the number of customers
varied from 7,000 to 560,000. The details relating to MFIs that responded to the
survey are given in Appendix B. Names of the organizations have been withheld
for confidentiality. Two of the responses were incomplete, and these were
omitted from the regression analysis, leaving 11 (61% of the population).

4.3. Overview of the Analysis

The data analysis examines the relationship between the performance-
reporting variables listed in section 3.2 and the performance dimensions
discussed in section 3.1. The performance-reporting variables have been selected
for the reasons mentioned in the previous sections, based on existing knowledge
and discussions held with experts in microfinancing. The selection also took into
consideration the context of the balanced scorecard concept where the
performance-reporting variables represented the four perspectives: financial,
customer, internal process, and learning and growth. The empirical model tested
is shown in Figure 2.
PERFORMANCE PERFORMANCE
REPORTING
(Measured by the four
(Measured by the sub-dimensions given in
independent variables Section 3.1)
given in Section 3.2)
Pi (i=1, 2, 4)
PRi (i=1, 2, 3, 8)
Figure 2. Model of the Regression Analysis
In order to test the relationship, regression analysis was done on each

performance dimension (dependent variable) against two performance-reporting
variables (independent variables) at a time. Each time, the two independent
variables included in the regression equation were taken from the same
perspective of the BSC.
Therefore, each dependent variable relating to performance (P1-4) was tested
four times against two independent variables (PR11-4 and PR21-4) coming under
one perspective of the BSC at a time. Since there are four performance variables

and four perspectives, the analysis contains 16 regression equations (4x4). These
16 regression equations can be shown in a general formula as follows:
P1-4 = b0 + b1PR11-4 + b2PR21-4 + e
where,
P1-4 are the four organizational performance variables listed above.
PR1 & PR2 are the two performance reporting variables in each
perspective (see Table 1).
1-4 in the PR11-4 and PR21-4, are the four BSC perspectives (see
Table 1).
The sample size in this study is 11. Although the size may appear small to
some readers, we argue the sample size is not problematic (see Appendix C).
First, we emphasize that the sample is 61% of the population. Since a high
proportion of the population has been sampled, we consider there should not be
difficulty in applying the findings to the population. Second, we point out that
Tabachnick and Fidell [2001] and Sheriden and Lyndall [2001 suggest the
minimum sample size should be five times the number of predictor variables.
Our study meets this requirement (the sample is 5.5 times the number of
predictor variables). We acknowledge that our study may be able to identify only
strong effects. Large samples are necessary to identify weak effects. We leave it
to future research to study weak effects by studying countries where larger
samples are possible. We also acknowledge that any findings identified in this
research should be further studied in other countries to see whether they apply to
MFIs in different environments.

5. ANALYSIS AND RESULTS

This section presents descriptive statistics and discusses the regression
analysis used in this study.
5.1. Descriptive Statistics

The descriptive statistics relating to the eight performance-reporting
variables and the four dimensions of the performance are given in tables 3 and 4.
Since the sample is a large proportion of the population (61%), the mean values
relating to the variables are used as the basis to assess the relative magnitude of
the variables. (Note: the t statistics that assume a normal distribution in the
population were not used since the population distribution is not known.)
Table 3
Descriptive Statistics of Performance-Reporting Variables
BSC Description Min Max Mean Std.
Perspective Actual variables refer to the Dev
emphasis on the following in
performance reporting:
Financial Profitability 5 9 7.45 1.57
Financial Cash flow 4 9 6.82 1.83
Customer Ratio of zero security loans to 0 9 5 2.93

total loans
Customer Growth in funding from existing 0 9 5.18 3.43

donors
Internal Business Ratio of operating expense to 0 9 5.82 2.92

number of loans
Internal Business Average time to process a loan 0 9 5.73 3.22

application
Learning and Ratio of training expense to total 0 9 5.09 2.91

Growth expense
Learning and Ratio of information systems inv. 1 9 5.45 2.42

Growth to total expense

Table 4
Descriptive Statistics of Performance-Dimension Variables
Description Min Max Mean Std.
Dev
Sustainability 5 9 7.45 1.44
Increasing the outreach 5 9 6.73 1.35
Depth of outreach 3 9 6.09 1.7
Portfolio at risk 5 8 6.27 1.10
The mean values in relation to the emphasis placed by the MFIs on the
performance-reporting variables indicate some interesting results. The figures
given in Table 3 show that MFIs, in their performance reporting, give the most
emphasis to the financial perspective of the BSC; i.e., profitability (7.45) and
cash flow (6.82). Next in ranking is the internal process; i.e., operational
expenses to number of loans (5.82) and average time to process a loan
application (5.73). The internal process is followed by the learning and growth
perspective; i.e., investment in information systems (5.45) and training (5.09).
Performance reporting under the customer perspective had the least emphasis; i.e.,
growth in subsidized funding from donors (5.18) and ratio of zero security loans
to total loans (5.00).
Usually, the customer perspective ranks relatively high in commercial
organizations. With regard to MFIs, however, the above result does not come as a
surprise since the demand for microfinancing services far exceeds the supply in
developing countries, as mentioned in Section 1. In the absence of any
competition for customers, MFIs may be paying the least attention to the
customer satisfaction of the borrowers. Note that the indicator used to measure
the emphasis placed on the satisfaction of borrowers (ratio of zero security loans
to total loans) has the lowest mean score, compared with others.
A surprising result is the comparatively less emphasis given to growth in
subsidized funding from donors. One possible explanation for this could be the
fact that the MFIs in Sri Lanka may be pursuing a strategy of relying more on
internal funds (through profits, etc.) rather than on external funds to achieve
sustainability. This may be the reason they place more emphasis on profitability
and cash flow, as shown in Table 3. It also seems that they are trying to achieve
this by giving more emphasis to internal process and learning and growth

perspectives rather than looking at the customer perspective. Therefore, in

summary, the descriptive statistics indicate that:
MFIs place the highest emphasis on profitability and cash flow (financial
perspective) in their performance reporting.
MFIs place the least emphasis on customer perspective in their

performance reporting, which may be due to the large demand compared
with the supply.
5.2. Regression Analysis

The regression analysis was conducted by considering each performance
dimension as the dependent variable and the emphasis placed on the
performance-reporting measures as the independent variables (Figure 2). All the
models tested comprised two independent variables taken from the same
perspective of the BSC at a time against one performance dimension as the
dependent variable. Since there are four performance dimensions and four
performance-reporting perspectives of the BSC (each perspective having two
performance-reporting variables), the total number of regression models analyzed
amounted to 16 (4x4). The models that were found to be significant and/or
needed further analysis are discussed below. The relevant results are summarized
in tables 5 through 10. The acceptable significance level was taken as less than or
equal to 0.05 (two-tailed). In all the tables, figures inside ( ) show the
significance level.
Table 5
Sustainability vs. Profitability and Net Cash Flow
Beta t
Constant 1.876 (0.098)

Profitability 0.148 0.555 (0.594)
Net Cash Flow 0.727 2.717 (0.026)*
R2 0.700
F 9.335 (0.008)*
* Denotes significant at less than 5% level two-tailed.

Table 6
Increasing Outreach vs. Profitability and Net Cash Flow
Beta t
Constant 1.950 (0.087)

Profitability 0.019 0.051 (0.961)
Net Cash Flow 0.611 1.603 (0.148)
R2 0.391
F 2.565 (0.138)
Table 7
Increasing Outreach vs. Zero Security Loans and Growth in Donor Funding
Beta t
Constant 6.258 (0.000)*

Zero security loans 0.667 2.566 (0.033)*
Growth in donor funding 0.094 0.360 (0.728)
R2 0.475
F 3.615 (0.076)
The model in Table 5 shows net cash flow to be significant, but not
profitability. Regression models tested and shown in tables 6 and 7 relate to the
performance dimension of increasing the outreach with performance-reporting
variables from the financial and customer perspectives of the BSC. They are not
significant. However, the t values indicate that the dependent variable may
vary with the performance-reporting variable net cash flow (not profitability
see Table 6) and also the performance-reporting variable ratio of zero security
loans to total loans (not growth in subsidized funding from donors see Table 7).
Therefore, these models were amended by testing the performance
dimension of increasing the outreach against the performance-reporting variables
of emphasis on net cash flow (Table 8) and ratio of zero security loans to total
loans (Table 9) as the independent variables. The results show these two models
to be significant at less than 5% significant level. Hence, it may be concluded

that the emphasis placed on these two indicators (net cash flow and ratio of zero
security loans to total loans) in performance reporting is a better predictor of the
performance dimension of increasing the outreach.
Table 8
Increasing Outreach vs. Net Cash Flow
Beta t
Constant 2.669 (0.026)*

Net Cash Flow 0.625 2.401 (0.040)*
R2 0.391
F 5.767 (0.040)*
Table 9
Increasing Outreach vs. Zero Security Loans
Beta t
Constant 8.040 (0.000)*

Zero security loans 0.683 2.804 (0.021)*
R2 0.466
F 7.861 (0.021)*
The model in Table 10 indicates that the performance dimension of depth of

outreach is associated with the performance reporting emphasis placed on
average time to process a loan application (a negative relationship) and, the ratio
of operating expenses to the number of loans.
This regression model indicates that, in order to achieve performance in the
depth of outreach dimension, MFIs must focus on their operational expense ratio.
This can be expected since the operational expenses are likely to go up with the
increase in poverty level of the borrowers. For example, the loan applications of
poorer customers need more careful appraisal and hence more time and resources
to be provided by the MFI. The negative coefficient relating to the emphasis on

the time to process a loan application in the performance reporting can be

expected once again because of the increase in time to process loan applications
of poorer customers.
Table 10
Depth of Outreach vs. Operational Expense Ratio and Time to Process a Loan
Beta t
Constant 7.259(0.000)*
Operational Expense Ratio 3.633 3.814(0.005)*
Time to Process a Loan -3.934 -4.130(0.003)*
R2 0.696
F 9.150 (0.009)*
When emphasis is given to this indicator in performance reporting,

employees of an MFI will tend to reject the loan applications of poorer customers
because taking a long time to process a loan reflects poorly on the employees
performance. This will lead to fewer very poor customers getting any assistance,
which in turn will have a negative impact on the depth of outreach. This
performance dimension actually reflects whether MFIs are reaching out to the
really poor or whether they are just assisting customers of marginally below-
average income levels. It is an important performance dimension in relation to
poverty alleviation. Therefore, the results of this model suggest that these two
performance reporting measures (operational expense ratio, and time to process a
loan application) are important for MFIs to achieve their objective of poverty
alleviation.
None of the regression models tested in relation to the performance
dimension of portfolio at risk showed any significant relationship with the
emphasis placed on the eight performance-reporting variables selected in this
study.

6. DISCUSSION AND CONCLUSIONS

This section presents the conclusions of this study, discusses contributions
made by the study, and explores the limitations of the study.
6.1. Conclusions
When reporting performance, MFIs give more emphasis to profitability and
net cash flow (that come under the financial perspective of the BSC), compared
with the other six performance-reporting measures (see Table 4) selected from
the remaining three perspectives of the BSC. Out of these six performance-
reporting measures, the two customer-related measures (under the customer
perspective) get the least emphasis (see Table 3). One of these reporting
measures relates to the satisfaction of borrowers. Since the demand for
microfinancing services far exceeds the supply, this result, which indicates that
less emphasis is given to the borrowers satisfaction, can be expected in the
absence of any competition to attract customers. However, a lower emphasis on
the other measure in relation to the satisfaction of donors (who are the second
type of customer) is surprising to some extent. Donors play a vital role in the
operation of MFIs. A possible explanation for this result may be that the selected
MFIs are depending more on their own funds rather than donor funds to carry out
their operations. There is support for this reasoning, as shown by the high
emphasis given to profitability and net cash flow in their performance reporting
(see Table 3). However, it is quite possible that this result will vary in other
countries. The second highest emphasis is given to the internal process
perspective, followed by the learning and growth perspective of the BSC (see
Table 3).
Regression analysis (tables 5 through 10) was carried out to find any
relationships between the performance-reporting measures (independent
variables) and the four dimensions of performance (dependent variables). The
performance dimension of sustainability has a positive relationship with the
emphasis placed on net cash flow by MFIs in their performance reporting. This is
expected since cash flow is vital for the continuous operation of any organization.
The increasing the outreach (number of customers) performance
dimension has a positive relationship with the emphasis placed on net cash flow
(see Table 8), and the ratio of zero security loans to total loans (see Table 9)
indicators in the performance reporting. This may be expected since net cash
flow leads to having more funds available for lending, which will increase the
customer base. The emphasis on the ratio of zero security loans to total loans will

result in MFIs trying to reduce the level of security requested from the customers
to offer loan facilities. Obviously, this will qualify more poor customers to obtain
financial assistance from the MFIs, which in turn will increase the customer base.
Performance measured along the dimension of depth of outreach (poverty
levels of the customers served by the MFIs) can be predicted by the emphasis
placed by MFIs on the average time to process a loan application and the ratio of
operating expenses to total number of loans in their performance reporting. Both
these reporting measures come under the internal process perspective of the BSC.
Operating expenses to total number of loans indicate the operational efficiency of
the MFI. It is reasonable to assume that the operational expenses will increase as
efforts are made to reach the customers who are the poorest of the poor. For
example, as the poverty level gets deeper, the loan application needs more careful
appraisal and hence more time (as shown below) and resources. Therefore, unless
an MFI excels in operational efficiency, it may be very costly to reach those
customers at the lowest income levels. The emphasis placed on the time to
process a loan application in performance reporting has a negative impact on the
depth of outreach as shown by the corresponding coefficient in the regression
model (see Table 10). This may be explained as follows. When average time to
process a loan application is given emphasis in performance reporting, it is very
likely the loan appraisal staff will give priority to loans that take a short time to
process. This will lead to loan applications of very poor customers (which needs
more time for careful appraisal) getting shelved or rejected. The end result is a
reduction in the number of very poor customers in the MFI, which in turn will
have a negative impact on the depth of outreach performance dimension.
The study did not find any performance reporting measures that had a
significant impact on the performance dimension of portfolio at risk.
6.2. Contribution Made by the Study

This study has made a contribution to enhancing the existing knowledge in
the area of the performance management of MFIs. First, it has suggested a
definition for performance in relation to MFIs and has argued that four
dimensions are needed to measure their performance. In the current literature,
there is no evidence of an instrument to measure MFI performance. Second, the
study has empirically tested the application of the BSC model suggested by
Kaplan and Norton [1992, 1996, 2001, 2004, 2006, 2008] for non-profit
organizations to MFIs. Third, it has found certain performance-reporting
measures that MFIs need to focus on to improve their performance.

The findings of this study in relation to the research questions mentioned

under Section 2 are discussed below.
Q1. When reporting their performance, do MFIs give emphasis to

financial measures that come under the financial perspective of the
balanced scorecard (BSC)?
As shown in the descriptive statistics, MFIs surveyed in this study give a
high emphasis to profitability and net cash flow, both of which come under
the financial perspective of the BSC. The findings indicate that the financial
perspective is important in reporting the performance of MFIs.
Q2. Do MFIs give an approximately equal level of emphasis to

performance reporting measures across all four perspectives of the
balanced scorecard (BSC), or does it differ significantly among the four
perspectives?
As shown in the descriptive statistics results in Table 3, MFIs do not give
approximately equal emphasis to all four perspectives of the BSC. In
performance reporting, highest attention is given to the financial perspective.
Next in ranking are the internal processes, followed by the learning and
growth perspective. The least emphasis is given to the customer perspective,
The unusual feature is the lowest rank given to the customer perspective
when compared with the situation of normal commercial organizations. As
mentioned previously, this is expected when one considers the enormous
demand for microfinancing services compared with the supply provided by
the limited number of MFIs in developing countries.
Q3. What are the performance reporting measures that MFIs need to
emphasize to improve their performance?
The study revealed the following relationships between the performance-
reporting variables and the performance dimensions.

Performance Dimension Performance Reporting

Variable
Sustainability Net cash flow
Increase the outreach Net cash flow
Ratio of zero security loans to total loans
Depth of outreach Ratio of operating expenses to number of loans
Emphasis on average time to process a loan (negative
relationship)
In answer to the above research question, it may be concluded that MFIs need to
focus on the above performance reporting variables in order to improve their
performance in alleviating poverty.
6.3. Limitations of the Study

Like all research, this study has a number of limitations and six will be
considered. First, this study looked at only eight performance-reporting variables.
There may be other performance-reporting variables that were not selected in this
study that are of critical importance to improve performance. It must be noted
that this is an exploratory study.
Second, the sample consisted of MFIs operating in Sri Lanka under certain
environmental conditions that are specific to that country. These external
conditions can vary from country to country. Therefore, generalizing the findings
of this study to MFIs operating in other countries has to be done with caution.
Third, the structure and type of ownership (e.g., government, private, non-
government organization may have an impact on the performance of the MFIs.
For example, MFIs owned and controlled by government may be subject to more
political interferences. These variables were not analyzed in this study.
Fourth, there is always a time lag between the emphasis placed on a
particular performance-reporting measure and the improvement in the related
performance dimensions. This being a cross-sectional study, this aspect is not
captured in the data that is collected at one single point in time. In order to
explore this feature, a longitudinal study is necessary.
The fifth limitation is that the study uses particular operationalizations of the
independent and dependent variables. Other operationalizations will be possible,
but the scope of the project prevented the consideration of alternatives.

The sixth limitation is that the variables studied may interact with other
organizational and environmental variables. This too was beyond the scope of the
paper.
The proxies used to measure some variables in this study may not be ideal.
For example, in addition to the satisfaction of donors, the growth in external
funding can also occur because of political and/or other external factors that
influence global financial markets. This is another limitation of this study, but
investigation of the accuracy of selected proxies is beyond the scope of the study.
These limitations open the door for future research in this area.
Notwithstanding these limitations, this study has made a contribution to the
existing knowledge in understanding the performance of MFIs in developing
countries.
APPENDIX A
Outline of Questionnaire for MFIs Operating in Sri Lanka
Questions
Ten questions sought information about the following:
1. Name of the MFI
2. Currency
3. Year commenced
4. Address
5. Telephone, fax, e-mail
6. Type of organization (government, NGO, commercial, etc.)
7. Lending institutions (e.g., ADB, government, World Bank, Aus AID)
8. Number of employees
9. Number of customers
10. Annual turnover
Performance Reporting System

Respondents were asked to indicate by circling either Y (Yes) or N (No) if each of the
following indicators was currently used in evaluating their organizations
performance. If they responded Yes, they were asked to indicate by circling the
appropriate number on the 9-point scale provided, the extent to which the performance
indicator was emphasized (1 = low emphasis, 9 = high emphasis).
Then followed the following 9 items, with each having N/Y, 1-9 scales.
1 Profitability
2 Net cash flow
3 Ratio of loans with zero security cover to total number of loans
4 Growth in subsidized funding from existing donors
5 Ratio of operating expenses to number of loans

6 Average time to process a loan application

7 Ratio of training expenses to total expense
8 Investment in information systems as a ratio of total expense
Performance
Respondents were asked to indicate their organizations overall performance in the
following areas, relative to that of other MFIs operating in their country or region
on a scale from 1(below average) to 9 (above average), (5 = about the same).
1 Sustainability
2 Increasing the outreach
3 Depth of outreach
4 Portfolio at risk
APPENDIX B
Basic Data for MFIs Participating in This Study
Name/ Year Type of Number of Number of Turnover

Code Commenced Ownership Employees Customers (SL Rs
Millions)
A 1986 NGO 630 561,321 56
B 1999 GOVT 311 333,323 109
C 1999 GOVT 328 123,408 128
D 1999 GOVT 153 129,473 152
E na na na na na
F 2002 PVT 225 66,000 200
G 1972 CO-OP 13 7,000 0.72
H 1997 na 163 76,915 279.5
I 1000 PVT 42 30,000 0.81
J 1990 GOVT 18 18,998 6.74
K 1939 GOVT na na na
na Not available. Although the survey questionnaire (see Appendix A) was completed, this
information was not provided by the MFI .

APPENDIX C
Sample Size
The sample size in this study is 11. Although this may appear insufficient to
give enough power to the test, it does not render the significant results found in
this study invalid. The reasoning for this is as follows.
There is no theory or mathematical formula that precisely dictates the
minimum sample size for a given number of predictor variables in a regression.
The foundation for this is that all statistical tests are based on a theory of
probabilities, and adequate sample sizes are influenced by factors other than the
number of predictor variables. Therefore, in current literature, there are a number
of 'rules of thumb' specified by researchers in an attempt to simplify this complex
relationship. For example, Tabachnick and Fidell [1989] and Sheriden and
Lyndall [2001] suggest the minimum sample size to be five times the number of
predictor variables (met by our study). Others have proposed various other
guidelines [see Green (1991) for a comparison of these guidelines] that are based
on the power of a given statistical test. Power is defined as the probability
that the test will yield statistically significant results and it depends on the
following [Cohen, 1988; Green, 1991]:
N - The sample size
- The significance level, which is generally set at 0.05 before the test
f2 - The effect size, which is the extent to which the relationship exists in
the population (for regressions this is defined as R2/1-R2)
An increase in any of the above variables results in an increase in the power
or probability of finding a significant result in the test (if it exists) and vice versa.
Cohen [1988] developed tables (for = 0.05 and 0.1) to compute the probability
or power of a test for given values of N, , and f2. Based on N and f2 a variable' '
is calculated to refer to the power values in the tables. Taking an alternative
approach, Green [1991] developed a variable' L', similar to '', to illustrate the
relationship among these four variables (power, N, f2 and ).
The minimum R2 found in this study was approximately 0.4 (see tables 6 to
11). This gave an effect size of 0.66. For the sample size of 11 and =0.05,
Cohen's tables estimate the power of the test to be around 63%. This is an
acceptable probability (more than 50%), but falls short of the 80% that is
generally considered desirable. It must be noted that this only denotes the
probability of finding a significant relationship. Importantly, it does not make

any significant relationships (set at =0.05) found in this study to be invalid.

Howell [2002] explains:
". . .[M]uch has been said about sample size without putting it in the context of
power. For example, there is a long-standing, and most likely incorrect, rule of
thumb that says that you need at least 10 observations per variable. This appears to
be saying that your multiple regression will be invalid if you don't meet that rule,
but really it is a rule about power. It is really saying that you don't have much of a
chance of finding a significant relationship unless your n is that large, which is quite
different from saying that your regression won't be legitimate." (p. 8)
and continues to reiterate:
"What are these rules of thumb all about? They are the rules of thumb about
POWER. They are not rules of thumb about something else. So if you run a
multiple regression solution with a small sample size, you are foolish. BUT, if an
editor sends you a letter rejecting your paper because the significant result that you
found was based on too small a sample, he or she is foolish." (p. 12)
In addition to the above, it must be noted that the sample represents 60% of
the population. The objective is to predict the relationships present in 18 MFIs
(population) from the data relating to 11 MFIs.
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ABOUT THE AUTHORS
Gemunu Nanayakkara received his Ph.D. from Griffith University, Australia, where he
is currently a lecturer in Management Accounting. His research interests include
performance of microfinancing institutions and other not-for-profit organizations.
Errol R. Iselin is a professor in accounting at Bond University, Australia. He received

his Ph.D. from the University of Queensland, Australia. His research interests include
performance and organizational behavior of both profit and not-for-profit organizations.

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Nanayakkara and Iselin 165

An Exploratory Study of the Performance of

Volume 7, Number 2, December 2012

International Journal of Business and Information

2. THEORY AND RESEARCH QUESTIONS

Volume 7, Number 2, December 2012

2.1. The Balanced Scorecard

International Journal of Business and Information

The link between these four perspectives can be explained as follows. An

Volume 7, Number 2, December 2012

Figure 1. Adapting the Balanced Scorecard System Framework

2.2. Research Questions

Q1. When reporting their performance, do MFIs give emphasis to financial

International Journal of Business and Information

Q2. Do MFIs give an approximately equal level of emphasis to

3.1. Performance of MFIs

"In essence, the nature of this complex problem lies in stakeholders

As argued by Lashley [2004] above, the issue of performance is not

Volume 7, Number 2, December 2012

such as banks. For example, financial performance measures such as

1. The outreach or the number of customers assisted by the MFI [Kereta

2. Profitability [Kereta 2007; Lafourcade et al., 2005; Mersland and Storm,

International Journal of Business and Information

4. Cost to clients and number of products offered to clients [Mersland and

5. Staff productivity [Lapenu and Zeller, 2001]

All the factors used in the above-mentioned studies can be considered as

Volume 7, Number 2, December 2012

"Sustainability" refers to the ability of an MFI to maintain continuity in its

International Journal of Business and Information

dimension to the "portfolio at risk," or the repayment level of loans. It is assumed

Volume 7, Number 2, December 2012

1. Individually, they are each essential components of the performance of

2. Some of these dimensions can also be achieved at the expense of others.

The measurement of performance along these four dimensions (including

3.2. Selection of Performance Reporting Measures

International Journal of Business and Information

"This set of definitions was not meant to be a template for financial

Theoretically, it is possible to define a large number of measures that MFIs

Volume 7, Number 2, December 2012

subject to argument. Hence, it was considered as an important performance-

Ratio of loans with zero security cover to total number

Ratio of operating expenses to number of loans

LEARNING AND Ratio of training expenses to total expense

International Journal of Business and Information

Volume 7, Number 2, December 2012

traditional financial institutions such as commercial banks. However, in MFIs, it

International Journal of Business and Information

concept here is similar to the budget emphasis variable in the budgeting

PR 1 Emphasis placed on profitability in performance reporting

PR 2 Emphasis placed on net cash flow in performance reporting

PR 4 Emphasis placed on percentage growth in subsidized funding from existing

PR 5 Emphasis placed on ratio of operating expenses to number of loans in

PR 6 Emphasis placed on average time to process a loan application in performance

PR 7 Emphasis placed on ratio of training expenses to total expenses in performance

PR 8 Emphasis placed on investment in information systems as a ratio of total

Volume 7, Number 2, December 2012

4.1. Measurement of Variables

"Williams et al. (1990) argued that self-rated performance scores overcame

International Journal of Business and Information