Capital Structure and Financial Performance of Small and Medium Enterprises in Embu County, Kenya

Financial decisions affect the financial performance of Small and Medium Enterprises but vary from one firm to another. This is due to the limited access to finances and ability of the manager to fully utilize the resources available. Despite their importance Small and Medium Enterprises are characterized by slow growth rate and three out of five Small and Medium Enterprises fail in their first three years of operation. The continued poor performances have led to decline in growth and eventually death of the Small and Medium Enterprises. The growth of the Small and Medium Enterprises highly depends on the investment decisions made by the entrepreneurs and lack of access to external finances has created a financial gap that has fueled the challenges that Small and Medium Enterprises face. The objectives of the study were to determine the effect of equity finance, short term debt finance and long term debt finance on financial performance of the small and medium enterprise in Embu County. The study adopted a descriptive research design and simple random sampling technique. The target population of study was 300 Small and Medium Enterprises from which a sample size of 60 Small and Medium Enterprises was drawn. Pretest of the research instrument was done to determine the reliability of the questionnaire by use of cronbach alpha coefficient. Content validity of the questionnaire was determined to ensure that the questionnaire answered the research questions. The primary data was collected using self-administered questionnaire while secondary data was obtained from audited financial statements and analyzed by use of statistical package for social sciences. Data analyzed capture descriptive statistic which included mean, standard deviation and variance. Inferential statistic included Pearson’s correlation and multiple regression. The study revealed that Small and Medium Enterprises had greater preference for contribution from friends and ploughing back profit as a source of equity finance. Angel investors as a form of equity financing has not gained acceptance as a source of finance. From the study it was evident that equity finance had a positive relationship to financial performance of the Small and Medium Enterprises. Equity offered a lifelong financing option with no or minimal cash outflow inform of interest. The overdraft agreements and trade credits were also found to affect business operations. This was because the short term debt finance adapted easily to the firm’s financial need, they required no collateral in order to obtain the funds and they were repaid over a short period thus no or minimal interest rate was charged. The correlation between the short term debt and financial performance was found to be positive and statistically significant. The study further showed that use of bank loans had increased while lease agreement, mortgage and factoring did not play a significant role in the financial performance of the Small and Medium Enterprises. The relationship between long term debt and financial performance was found to be positively correlated and statistically significant. The study also noted that the performance of the Small and Medium Enterprises was largely affected by the source of finance and the liquidity position of the business. The study therefore recommends that Small and medium Enterprises should embrace angel investors as equity financiers since they provide the start-up capital to the Small and Medium Enterprises. Angel investors also provide managerial and book keeping skills to the entrepreneurs thus enhancing the accountability and efficient use of the financial resources at hand. The financial institutions need to create awareness and educate the entrepreneurs on other products available to finance the Small and Medium Enterprises. Reduction on loan processing time and cost of borrowing will encourage entrepreneurs from accessing long term loans, mortgage and lease.