AN ANALYSIS OF THE EFFECTS OF CAPITAL STRUCTURE OF SMALL AND MEDIUM ENTERPRISES ON THEIR FINANCIAL PERFORMANCE: A CASE OF NAKURU TOWN

Abstract

Small and Medium Enterprises (SMEs) use different sources of financing. Some of them emerging to be a challenge to the performance of the SME since most SME owners’ lack necessary knowledge on which sources of finance enhances financial performance. Despite SMEs using different sources of financing some of them are still not growing and others are collapsing, majority of SME owners do not have ideas on how debts and internal sources of finance influences their financial performance. Therefore, this study aimed at analyzing the effect of SME capital structure on financial performance. Specifically, this study assessed effects of SMEs capital structure on their profitability, effects of SME capital structure on their liquidity and effects of SME capital structure on their sales growth. The study was informed by pecking order theory. The study targeted 295 SMEs which are registered as companies in Nakuru town. Stratified sampling was applied for allocating samples in different strata. The sample size selected under proportional allocation was 170. Secondary data was collected from financial records of SMEs. Documentary guide aided in data collection. Descriptive statistics such as mean and standard deviation and inferential statistic such as Pearson correlation and multiple regression model was used in analyzing data. The findings revealed that capital structure had negative effect on firm profitability. However, capital structure had positive and significant effect on firm liquidity. Similarly, capital structure indicated a positive effect on sales growth. Based on the study findings, under increased capital structure firm profitability decreases. On the other hand, under increased capital structure, liquidity and growth in sales increases. Thus, SMEs owners should utilize funding from investors by providing insights, resources, accountability and updating sales accounting data. Moreover, firms should avoid situations where they are highly leveraged since this may lead to bankruptcy if they are unable to make payment on their debt and SME owners should also make good investment decisions in order to increase profitability.