THE EFFECT OF DEBT FINANCING ON FINANCIAL PERFORMANCE OF MANUFACTURING FIRMS IN WESTERN NIGERIA
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Debt Financing
Borrowing of loans from other banks, companies or financial institutions so as to support the operations of a business is referred to as debt financing. An interest expense is paid before the maturity period of the debt, with the loan principal being repaid at a future time (Harelimana, 2017). Debt financing is a financing option that is structured to improve the owners’ rate of return on investments by producing a rate of return that is higher than the overall cost of the borrowed funds (Saad et al., 2015). Leverage financing entails the purchase of interest bearing instruments that are protected by the asset-based security and they have term structures (Githaigo & Kabiru, 2015). Debt financing comprises of the main sources of external funding for most business firms. It provides a mechanism of filling financing deficits for firms that have insufficient financial resources (Onchong’a, Muturi & Atambo, 2016). The core of debt is that the borrower will have to repay the borrowed funds which are accompanied with service charges such as loan origination fees and interest charges (Harelimana, 2017). Debt financing offers a means of satisfying financing deficits of businesses that have insufficient internal resources to finance their operational activities and investments (Onchong’a, Muturi & Atambo, 2016). In the capital structure of a company, debt capital entails the long-term bond that the company uses during the financing of its investment decisions since the company has a period of repaying the loan amount, whereas the payment interest is only limited with the present time. The healthiness of a firm’s balance sheet is a key determinant of the cost of debt capital in the structure of capital of a firm (Lambe, 2014). Leverage financing can lower the firm’s costs of financing due to the availability of liabilities tax shields task and thus improving the value of the firm (Xu, Ou & Chen, 2016).
Leverage financing choice carry the form of trade credit from bank loans and other financial institutions, suppliers, loans from individuals and the governments (Obuya, 2017). Though debt financing is less costly because of the tax exemption, it subjects firms to some constraints as well as default risk of repaying the principle and interest amount (Liaqat et al., 2017). The measure of debt in this study was done using debt ratios that compare the firm's total debt to its total asset. A low percentage will mean that the firm is less reliant on debt i.e., funds obtained from others or that is owed to others. The lesser the percentage of debt ratio, the lower the firm is using debt finance and the stronger its equity state is (Makanga, 2015). Debt ratio (DR) indicates the fraction of money that financed the total assets by use of an outside source of funds. A higher ratio shows that most of the firm’s assets are offered by creditors relative to the owners (Harelimana, 2017).
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Financial Performance
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This implies the level in which the financial goals of a firm are being or have been attained. Financial performance is a method of ascertaining impacts of company's policies and the operations in a monetary language (Harelimana, 2017). This shows the situation of an organization at a moment in time as presented in the balance sheet or it may show a series of actions over a stipulated time period as it is revealed by the statement of comprehensive income (Makanga, 2015). Financial performance is an indicator of the firm's general financial condition in a stipulated time period and can also be employed to contrast related companies in the same business or to contrast sectors or businesses in aggregate (Harelimana, 2017).
Financial performance gives a proper gauge on the use of a firms’ resources for maximization of wealth and profits. The fiscal financial functions are conducted occasionally from the accounts office, balance sheets or the profit and loss statements of the firms so as to evaluate the degree of success in the business (Obuya, 2017). Financial performance is a biased gauge of how effectively a firm can make good exploitation of its assets from its key business objective conduct and the successive revenue generation (Ikapel & Kajirwa, 2017). To appraise a firm’s performance, business entities normally apply financial ratios since they provide a simplified description of the entities current financial state in contrast to previous accounting period and they provides clues on how a firm’s management can improve performance (Tauseef, Lohano & Khan, 2013).
Financial performance can be measured in many different ways, but all these ways should be aggregated. The traditional accounting Key Performance Indicators (KPIs) that include Operating Profit margin, Sales growth, Return on Assets, Economic Value Added or Earnings before Interest and Tax are often used in the calculation of financial performance (Abshir & Nigib, 2016). However, the traditional performance measurement approach by objective rational model may not ably serve the measurement of performance in manufacturing firms. Performance measurement in firms should be by the feature of academic performance and performance of the management based on sub- dimensions, which include quality of education, finance and human resources. To determine the financial performance of public firms this study will use the Surplus or Deficit as % of total income ratio.
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Statement of Problem
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For a manufacturing firm to grow, there need for the firm to operate efficiently in production. This can be achieved when the firm has enough funds for investment in productive new technologies. Manufacturing firm can invest using internal funds, debt or equity. Nigerian manufacturing firms emerged from a severe economic-downturn which resulted in dilapidated infrastructure. There is need for massive investment in machinery and latest technologies in order to raise the operations of the manufacturing firms. Many manufacturing companies are closing down operations although financial institutions have been financing them. However, the examiner seeks to examine the impact of debt financing on the growth of manufacturing firms in Nigeria.
1.3 Objectives of the study
The following are the objectives of this study:
1. To examine the impact of debt financing on the growth of manufacturing firms in Nigeria.
2. To identify the sources of Finance for manufacturing firms in Nigeria.
3. To ascertain the level of growth in the Nigerian manufacturing firms.
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