Determinants of Cost of Debt and Their Effect on the Financial Performance of Small and Medium Enterprises in Kenya

Abstract

The purpose of this study was to investigate how determinants of cost of finance, particularly debt financing, affect the performance of small and medium enterprises in Kenya. The research addressed six research questions: How does inflation rate affect the performance of SMEs in Kenya? How does transaction cost affect the performance of SMEs in Kenya? How does default risk affect the performance of SMEs in Kenya? How does recordkeeping affect the performance of SMEs in Kenya? How does tax rate affect the performance of SMEs in Kenya? And to what extent does insecurity moderate the effect of determinants of cost of finance on the performance of SMEs in Kenya? The study applied quantity theory of money; transaction cost theory, Loan pricing theory, and Performance Measurement Theory, and adopted positivist research philosophy. A descriptive correlational research design was used to conduct the study. The study population consisted of 1.56m registered SME managers. A sample size of 260 was drawn using random sampling technique, and data was collected using self-administered questionnaires, while secondary data was obtained from the financial statements of the businesses. The data was then analyzed using descriptive statistics of frequency, distribution, mean, and standard deviation. Furthermore, inferential data analysis methods of Pearson‘s correlation, ANOVA, and multiple linear regressions were used to test the hypotheses. Statistical Package for Social Sciences (SPSS) software was used as a tool for data analysis. Results were then presented in tables and figures. Regarding the effect of high inflation rate on SME performance, the results of the multiple regression analysis showed that market value explained 35.9% of the variance (R2=0.359), f(6, 200)=1.422, p > .05, while sales growth predicted 27.9% of the variance, (R2=0.279), f(6, 193)=1.007, p > .05. ROA explained 18.3% (R2=0.183), f(6, 197)=3.284, p < .05. It was found that high inflation rate was not significant in predicting market value and sales growth, but predicted ROA, and the null hypotheses was accepted. In relation to the effect of high transaction cost on SME performance, the result of regression indicated that transaction cost explained 22.8% of variations in market value (R2=0.228), f(6, 205)=2.181,p <.05, ROA explained 18.0%, (R2=0.180), F(6, 204) = 2.904, p< .05, while sales growth explained 14.7% (R2=0.147), F(6, 206) = 1.471, p =>. 05. It was found that high transaction cost was significant in predicting market value and ROA, and the null hypothesis was rejected. Default risk was found to be significant in predicting market value, ROA, and sales growth,  = -.218, t (207) = -3.121, p < .05,  = -.095, t(204) = -1.346, p < .05,  = -.131, t (208) =- .440, p < .05 respectively. This led to the rejection of the null hypotheses. On the other hand, market value and ROA was not significant in predicting recordkeeping, but sales growth was significant in predicting recordkeeping,  = .064, t (213) = -1.070, p >.05, ROA,  = .011, t(6, 213) = .163, p >.05, and  = .264, t(212) = 4.195, p < .05 respectively, and this result led to accepting the null hypotheses. The results of the regression indicated that tax rate significantly predicted Market value,  = .119, t(208) = .647, p <.05, ROA,  = -.158, t (208) = -.433, p < .05, and sales growth,  = -3.612, t(209) = .948, p < .05. It was also found that market value explained 21.1% (R2= .211), f(6, 208) = 12.984, p < .05, while ROA explained 46.3%, (R2=0.463), f (6, 208) = 16.519, p < .05. Sales growth explained 22.9%, (R2=0.463), f(6, 209) = 8.108, p > .05. This led to rejection of the null hypotheses. The regression results revealed that security significantly predicted market value,  = -.181, t(214) = -.462, p < .05, ROA,  = -.300, t (207) = -2.667, p <.05; and sales growth,  = -.381, t(207) = .251, p < .05. It was also found that security explained 37.4%, (R2=0.374), f(3, 209) = 61.931, p < .05, while ROA, explained 19.1%, (R2=0.191), f(6, 207) = 7.783, p < .05, and sales growth explained 16.3%, (R2=0.163), f(3, 207) = 20.160, p <.05. The results showed that security significantly moderated the relationship between the cost of finance and SME performance. The study concluded that inflation rate and recordkeeping did not significantly affect the performance of SMEs in Kenya, while transaction cost, default rate, and tax rate significantly affected the performance of SME. Security had a significant moderating role on independent and dependent variables. The study recommended that the government should keep inflation rate below the positive point by avoiding inflation rate above 5%. Transaction cost should be kept low by adopting and developing online access of finances for SMEs. Also the government should applaud and implement easy recovery process of loans to reduce default rate and consequently reduce cost of finance. SMEs should have proper recordkeeping in order to circumvent fund misuse by business stakeholders and high interest rates from the lenders. In addition, the government should charge commensurate tax rate on lenders so that they decrease interest rate on SMEs. The government should also create conducive environment for SMEs by improving security in the country. SMEs should avoid interest rate above 8%, which is the mean profit rate for SMEs. This study further recommends the inclusion of micro and large corporation businesses managers as respondents for future research.