Abstract

SMEs are the backbone of many economies around the world, since they create jobs and contribute positively to their local economies. In Africa and Cameroon in particular, there ha e been few studies carried out on the link between capital structure and financial performance of large-scale businesses. Very few studies focus on SMEs, yet no studies have been conducted in Buea Municipality on the link between capital structure and financial performance of SMEs.

The objectives of the study were to examined the link between capital structure components such as equity capital, debt capital and retained earnings and how they affect the financial performance of SMEs in the Buea Municipality. The study adopted a descriptive research design to sample 100 correspondents from different categories of SMEs in the Buea Municipality using a structure questionnaire.

The study findings revealed that equity capital., debt capital and retained earnings all have a significant relationship on the financial performance of SMEs. The study concluded that collectively, capital structure has a significant effect on the performance of SMEs in Buea. It was suggested that lending institutions could improve their lending criteria and implement tailored programs, according to the researcher, to make debt capital a less dangerous source of finance.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Small and medium enterprises are crucial to Africa’s growth contributing more than 45% to employment and 30% to gross domestic product (GDP). In high-income countries, SMEs contribute nearly 64% to the gross domestic product and 62% to employment (CMA, 2010).

Despite the role played by SMEs, the World Bank Report (2010) suggests that one of the major causes of SMEs failure is limited access to external finances. Business organizations aim to improve their products and operations efficiency and to increase their profit margin. Several factors may influence the efficiency and effectiveness of business operations including capital structure.

For the success of any new or old business, funds are a prerequisite as they act as a lifeline of any business operation. This funding is required for expanding the business cope as well as to carry out daily operations smoothly. The funds are termed as Capital representing the foundation of any business. This capital comes to the firm as an investment from other people expecting and demanding reasonable returns against the usage of their investment (Javed et al., 2018).

There are two foremost bases to acquire the funds i.e. internal and external. For a generation of funds from an internal source, a board of directors, top executives and owners are requested. To generate funds from external sources, investors and shareholders are sought.

External financing is a term used for the generation of funds other than earnings from operational activities. In the case of external funding, co-owners of the firm increase as shareholders who are legally authorized to receive their share from the profits as dividends. In the case of external borrowing, the credit due on the firm increases and the firm is liable to pay a fixed amount as interest against the amount borrowed.

Capital structure and its influence on the firm financial performance and overall value have remained an issue of great attention amongst financial scholars since the decisive research of (Modigliani & Miller, 2003) arguing that under a perfect market setting capital structure does‟t influence in valuing the firm. This proposition explains that the value of the firm is measured by real assets not, the mode they are financed.

Eldomiaty and Azim (2008) argue that there is a positive relationship between capital structure and financial performance. (Hadlock and James (2002) also support the argument. Fama and French (2008) reported that there is a negative relationship. Capital structure is said to be closely linked to financial performance (Zeitun and Tian, 2007). Jensen and Meckling (2006) posited that high leverage may initiate clashes between managers and shareholders due to the selection of investment either equity, debt or hybrid (Myers, 2007).The risk they want to take (Jensen and Meckling, 2006, Williams, 2007), circumstances due to which the firm might be liquidated (Harris and Raviv, 2010), and the dividend policy (Stulz, 2010).

Verifiable predictions of such types of models are that the rise in leverage should decline agency costs of ownership and debt holders thus improving business performance, everything else remained the same as before. However, when the leverage is relatively high to a certain limit, leads to an increase in debt and it will increase the cost of debt, including an increased cost of bankruptcy or financial distress due to conflicts between equity holders and bondholders. To make a distinction between these two sources of agency costs empirically is very difficult.

 1.2 Statement of the Problem

Capital structure is an important factor by which a business can increase its performance at its optimum level if the SME uses it effectively and efficiently. Capital structure is related to the ability of the business to meet the needs of its stakeholders (Boodhoo, 2009). The past decade or so has witnessed significant transformations in the capital structures of businesses (Gomez, 2005).

Establishing the optimum capital structure in financial management is an important assignment (Pandey, 2009). Decisions on capital structure are made while taking into account factors that include financial performance, liquidity and control. The debt, equity and financial performance relationship is investigated and efforts are made to know how they interrelate. Capital structure is associated with the business can meet the requisites of investors (Boodhoo, 2009). The prior decade or so has attested substantial transformations in the capital structures of businesses (Gomez, 2005). SMEs in the commercial sector are vital to nearly all economies in the world, particularly to those in evolving countries whose that their main challenges are employment and income distribution (Omore et al, 2012).

Concurring with Elimuti and Kathawala (2009), SMEs promote the output and creation of “decent” jobs; looking at the dynamic front, they act as a start-up for the larger firms of the future, are the following (and critical) step up for expanding micro-enterprises, they provide absolutely and often significantly to total savings and investment, and they play part in the development of appropriate technology.

In Africa, there are a few studies on the relationship between capital structure and SME performance. While Abor (2005) looked at the effect of capital structure on the profitability of listed firms in Nigeria, Kamau (2013) carried out a study to investigate the relationship between capital structure and financial performance of errand service SMEs in Nairobi County. Boateng (2004) looked at the determinants of capital structure in international joint ventures.

However, literature revealed that several studies have been carried out to investigate the relationship that exists between capital structure and performance of previous studies have been conflicting. While some researchers reported a positive relationship between capital structure and performance. In Cameroon, no such studies have ever been carried out that examined the effect of capital structure on the financial performance of SMEs. Conducted studies on capital structure in Cameroon focused on MFIs (Kum, 2017). This constitutes a knowledge gap in the SMEs sector that this study sought to address.

1.3 Objectives of the Study

1.3.1 Main Objective

The main objective of the study would be to find out the effect of capital structure on the financial performance of SMEs in Cameroon using Buea Municipality as a case study.

1.3.2 Specific Objectives

Specifically, the specific objectives of the study would be;

1. To establish the effect of equity capital on the financial performance of SMEs in the Buea Municipality.
2. To establish the effect of debt capital on the financial performance of SMEs in the Buea Municipality.
3. To determine the effect of retained earnings on the financial performance of SMEs in the Buea Municipality.

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