Effects Of Debt Financing On Financial Performance Of Small And Medium Enterprises In Nairobi Central Business District

Abstract

There exists quite a lot of literature, empirical studies and theories on the optimal debt and equity mix on what is known as capital structure. There are studies that support use of more debt than equity, use of more equity than debt or use of a balance of the two in obtaining an optimal capital structure that would maximize the value of shareholders’ wealth. The study objective was to investigate the effects of debt financing on financial performance of SMEs in Nairobi Business District in Kenya. The study employed random sampling and used a sample 85 SMEs around the Nairobi Business District (CBD). Data was collected by use of both secondary and primary data collection methods as information was obtained from financial reports published on websites of some of the SMEs; other SMEs had to fill a data collection form with data relevant for the analysis and making findings and conclusion for this study. There were a total of 72 respondents that duly provided information required for the analysis which represented 85% response rate. Data was analyzed by the use of SPSS software version 20 and output presented in form of graphs and tables. The study discovered a negative but statistically insignificant relationship between debt financing and financial performance of SMEs in Nairobi Central Business District. The regression model summary showed a coefficient of determination (R squared) of 0.042. The p value obtained was higher than alpha value of 0.05 and the F calculated was lower than critical F value, which enabled the study to accept the null hypothesis because there is no relationship. The study also showed that SMEs in Nairobi mostly financed their operations through equity and less of debt. The debt financing obtained was mostly short term debt which is considered more expensive. It is recommended that owners and managers of SMEs should not shy away from investing in projects with positive NPV by use of debt, since the correlation between debt financing and financial performance is insignificant. This would mean that increase of debt financing would only adversely affect financial performance by a percentage of 4%.