Abstract:
Debt ratios in large firms have been examined by a number of researchers while smaller firms have attracted less attention. The financial policies of large listed companies often differ from smaller firms because they raise funds by issuing debt or equity into capital markets. As such this study sought to investigate the effects of debt financing on the financial performance of SMEs. The objectives of the study were to determine the effects of long-term loans and short-term loans on SMEs financial performance. The study was guided by optimal capital structure theories. The study target 4122 SMEs in Eldoret town. Stratified sampling technique was used to select a sample size of 50 SME firms in Eldoret Town. The study collected quantitative secondary data from SMEs’ financial statements for three consecutive years (2011-2013). The reliability and validity of the data collection instrument was done using Cronbach Alpha. Multiple Regression analysis was used to test study hypothesis. The results revealed that short term loansβ=-0.304, and long term loans β=-0.155 had negative impact on financial performance of SMEs. The study concluded that long term and short term loans reduce financial performance of SMEs. The study recommends that SME should utilize loans, diversify for sustainability of revenue, keep proper books of accounts, offer clients sales contracts and lay down payment modes for trade credits, clearly stipulate the payment schedules, in order to deter poor credit and loan control policies and train their staff regularly while employing experienced internal and external auditors to improve on the internal control systems and book keeping.