The Effect of Internal Controls on the Financial Performance of Manufacturing Firms in Kenya

Abstract

The overall objective of this study was to establish the effects of internal controls on the financial performance of manufacturing firms in Nairobi Kenya. This was achieved by looking at the effect of control environment, risk assessment, information and communication, control activities and monitoring on the return on asset of manufacturing firms in Kenya. Descriptive statistics and inferential analysis of the data were carried out using measures of central tendency and Pearson correlation analysis. Secondary data collected from the manufacturing firm’s annual reports for the period 2013 to 2014 was used in this study. The data collected from the annual report was analyzed using the multiple regression analysis, which was obtained using statistical package for social sciences. In the model, the dependent variable return on asset was used as an indicator of financial performance while the independent variables (control environment, risk assessment, information and communication, control activities and monitoring) were used as internal control indicators. The findings of the study showed that there is a significant relationship between internal controls and financial performance. The dependent and the independent variables in the study indicated a relationship with control environment, risk assessment, information and communication and control activities showing a positive relationship with the return on asset while monitoring showed a negative relationship with return on asset. The study concluded that control environment, risk assessment, information & communication, and control activities have a significant relationship with the return on asset of manufacturing firms in Kenya. The study suggests that all manufacturing firms in Kenya should implement internal control system. Manufacturing firms that had invested on effective internal control systems had more improved financial performance as compared to those manufacturing firms that had a weak internal control system. The study further recommends that the governing body, possibly supported by the audit committee, should ensure that the internal control system is periodically monitored and evaluated. The limitation of this study is that the study focused on 35 manufacturing firms only while we have more than 500 manufacturing firms in Kenya, therefore these findings may not be used for generalizations on all manufacturing firms in Kenya. It is therefore important for a study to be conducted using wider scope and coverage then, the findings can be compared and conclusions drawn.