The relationship between leverage and financial performance of top 100 small and medium enterprises in Kenya

Abstract

Small and medium scale enterprises are considered important in both developed and developing countries. They produce goods and services which help to increase economic growth and contribute significantly to employment creation. Leverage reflects the extent of borrowed funds in the company’s funding mix. Small and Medium Sized Enterprises (SMEs) are currently the largest employment creators and they contribute significantly to the country’s Gross Domestic Product (GDP).The objective of the study is to determine the relationship between leverage and financial performance of top 100 SMEs in Kenya. The study used descriptive cross sectional research design. The target population for this study was the top 100 SMEs (2013) in Kenya. The study used a sample of 30 SMEs randomly selected from the population of the study. The study collected secondary data which included the financial statements such as the profit and loss account. The study made use of SPSS (V.20.0) to aid in the analysis. The study found that for the year 2009 liquidity had a greater effect to financial performance followed by leverage while firm size had a minimal impact on financial performance of SMEs. The study also found out that for 2012 leverage, liquidity and firm size explained 62.4% of changes in the financial performance of the SMEs. The study concluded that leverage had a significant influence on the financial performance; the study also concluded that there was a positive relationship between leverage (debt equity ratio) and financial performance of small and medium enterprises in Kenya. The study recommended that for SMEs to effectively determine the funding mix to employ and to maintain a good debt equity ratio, there is need for capacity building of SMEs in areas of business management. The study also recommended that banks should charge low interest rates to encourage SMEs to invest since high interest rates deter investors from using bank financing.