RESEARCH play a crucial role in economic growth and


The Impact of Debt Financing on SME’S: Evidence from

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MBA (1.5) B




                                  Department of Management Sciences

-I-Azam University Islamabad




The Impact of Debt Financing
on SME’S: Evidence from Pakistan




Table of Contents
     Data Collection. 10
     Study Population. 10
     Sample of the study. 10
     Statistical Analysis. 10








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. Although
they play a crucial role in economic growth and employment their operations are
often crippled by lack of adequate financing from financial institutions.

SMEs Sector is
a back bone of Pakistani economy.  The
SMEs sector in Pakistan plays a vital role in economy and considered as a
survival tool in worse economical condition. Pakistan is an SME economy and it
heavily relies on SMEs for jobs, exports, earnings, industrial productivity,
foreign investments, and its overall economic prosperity (Habib 2010). The
statistics indicate that 99 % (3 million) enterprises in Pakistan are SMEs. Out
of these 3 million SMEs, 96 % are solely owned. In Pakistan, the SME sector
employs 78 % (State Bank of Pakistan 2010) of
industrial labor force and it is therefore responsible for skills development,
training of unskilled labor, and fostering an entrepreneurial culture that
eventually translates into cost cutting innovations. SME sector is known to
contribute 30 % (Herani and Qureshi 2011) to the gross domestic product (GDP)
in developing nations like Pakistan and about 50 % in developed nation.

A number of
theoretical and empirical studies have been conducted to explore the impact of
debt financing on the corporate financial performance. Majumdar & Chhibber
(1999) and Mahakud & Misra (2009), studies conducted in India, found that
corporate debt has a negative impact on the firm’s financial performance
because of high interest burden and agency costs.


This indicates
that SMEs Mostly rely on other sources like informal sources of finance or
utilize their internal funds or Savings. Although the banking infrastructure is
developed in Pakistan, there are number of reasons why SMEs mostly rely on
sources like informal finance. It involves lengthy documentation, borrowing
costs, collateral and other requirements. From an SME perspective, a small
business loan from commercial banks involves an average of 27 steps and 9
client meetings (World Bank 2009) which makes them a time-consuming process.

For making
strategies, their implementation and for providing assistance to SMEs the
Government has restructured the key support institution such as Small and
Medium Enterprise Development Authority (SMEDA).

In order to
design strategies for this sector, a comprehensive definition is required. But
un-fortunately, there is no uniform definition of SMEs application across the
board in Pakistan. mainly because of the wide diversity of businesses Different
departments and originations define SMEs in accordance with their functional
ease rather than market situation. Some Define SMEs according to their turnover
and some department define SMEs according to the number of Employees. Reason is
that it recognized that it may be more appropriate to define size by the number
of employees in some sectors but more appropriate to use turnover in others.
Across Government, it is most usual to measure size according to numbers of
full-time employees or their equivalent.







Recent years
have seen a major resurgence of small business throughout the developed world.
The countries like divided Russia and Eastern Europe are prizing such skills
very high. The first piece of writing about the small business discovered was
of about more than 4000 years ago. This writing is about loaning from a Bank
for a small business with terms and conditions. Since then, the small business
people have been the backbone of most economies providing products and services
to the consumers.

  The challenges faced by SMEs in Subcontinent
are; Lack of technical knowledge and skills, most managers of SMEs lack
adequate education, they are not well informed in terms of managerial knowledge
and skills, lack of managerial training More often than not small and medium
enterprises establish managerial strategies through trial and error mechanism.
Their managerial techniques only focus on operational plans rather than
strategic plans of their organization Moreover small and medium enterprises are
not able to adequately handle challenges. like Rapid technology changes,
Technology change poses a big challenge to the growth of small and medium
enterprises. On the other Side Lack of adequate finance, many small and medium
enterprises do not have access to finance and credit especially from financial
institutions such as commercial banks and NBFC’s.

Small business
flourished in almost all ancient cultures. In the undivided subcontinent if we
look back at beginnings of the known history of small business, the cottage
industries thrived through the period when society was organized more or less
into self-sufficient and self- contained units. The sub-Continent industry,
whether small or large scale, suffered a serious setback during British rule.




The impact of
debt financing on growth, Profitability, operations, capital structure and
productivity of small and medium enterprises.




What are the
Advantages of debt financing?

What are the
disadvantages of debt financing?

Does debt
financing play a role in reducing profitability to small and medium

What is the
relationship between debt financing and Growth of SME’s?




 The main
purpose of this research is to investigate the impact of debt financing on the growth,
Profitability, operations, and productivity of SMEs in Pakistan.




The objectives
of the study are to determine the effects of long-term loans and short-term
loans on SMEs financial performance Some of the main objectives are: –

the type of debt financing offered by financial institutions.

the impact of debt financing on the levels of investment by SMEs.

the effects of debt financing on the productivity of SMEs.

if SMEs are adequately funded by financial institutions.

the sources of Finance available to SME’s (Formal sources like banks and NBFC’s
and informal sources like Creditors, Friends, Family members etc

 Assess the impact of interest rates on the
operations of SMEs

the impact of debt financing on the growth, Profitability, operations, and
productivity of SMEs.




Brich (1979)
argues that small firms are playing crucial role in job creation. Many small
firms are more important in capital structuring than large firms practicing in
same industry.  Wizarat and Zafar (1990)
this study finds a problem that small firms provide job to skilled and
semi-skilled labor, that’s why labor productivity of small firms are lower than
that of large firms. Jaramillo and Schiantarelli (1996) argued long term debt
finacing provides firm a platform for better productivity by achieving capital
and equipment. SMEs face
common problems in respect of their survival or to take competitive advantage.
According to the available resources more than 50% of SMEs are collapse within
first five years of operation (Reiss, 2006; Ahmad and Seet, 2009).

There are
numbers of evidence that shows that SMEs face more financing problems as
compared to larger corporations (Berger and Udell 1998) and therefore these
firms fulfill a smaller share of their financial requirements from formal
sources like NBFC’s or banks. A study conducted by Becket al. (2008) reflects
on the financing patterns employed by SMEs in developing nations. Less than 10
% small firms finance their investment from banks compared to 20 % by larger
firms. Larger firms hold the same advantage when soliciting trade credit and
development finance (Beck 2007). Two studies that signify the role of
subsidized credit on SME growth of sales in India and Pakistan were conducted
by Banerjee and Duflo (2004), Zia (2007), respectively. Both confirm that
credit constrained firms have reduced or improved sales once their application
for subsidized credit is rejected or approved, respectively. This means that
post entry growth of an SME can be stalled in the absence of external finance,
eventually affecting the life of the enterprise (Philippe et al. 2007).

 Nishat (2000) by this study, it is declared
that small and medium firms providing job opportunities and capital development
in countries such like Pakistan. Shah and Hiijazi (2006) and Ilyas (2008)   These studies have also focused on
identifying the elements of capital structure for the non-financial firms in
Pakistan. However, these studies have not investigated how the capital structure
affects the firm’s financial performance. Since the firm has a choice of using
debt or equity for financing its assets, there is a need to explore how the
company’s financing mix influences its financial performance.

Kashif and
Abidullah (2006) This research is done in Faisalabad region in order to analyze
the financing of SMEs. The result revealed that lack of adequate capital
security and misuse of credit facilities are basic hurdles for growth in Small
and medium enterprises. Abour (2007) through this research the relationship of
debt policy and financial performance among small & medium enterprises in Ghana
and south Africa is analyzed. Findings revealed that there is negative relation
between debt policy and financial performance.  
Leitao and Franco (2008) inspect the influence of organizational capital
and human capital on the performance of SMEs in Portugal. Their finding reveals
that non-economic indicators of human capital is passion at work and
non-economic indicators of organization capital are efficient organizational
structure, participative management, dialogues, workgroup frequent meetings and
incentive.  Robb and Robinson (2008)
states that debt financing is most important source for every type of firms, on
the other hand retained earnings are insufficient or not available. Rainhart
and Rogoff (2009) argued that when debt effected positively to the growth of a
firm only when it is within confident levels. When the ratio goes beyond
certain levels financial crisis is very likely. 

Ebaid (2009)
concluded that there was insignificant relationship between total debt, short
term debt and long- term debt and financial performance measured by gross
profit margin and ROE. Sun (2010) according to this study debt financing is
comparatively better than equity financing because it is proved that debt
financing is moderately cheaper than equity financing.  Cecchetti et al. (2011) studied the effects
of debt on firms and concluded that moderate debt level improves welfare and
enhances growth but high levels can lead to a weakening in growth of the
firm.       S. Azra & salyha (2011) according to
this study the performance and structure of the small and medium scale
manufacturing sector of Pakistan in terms of employment and productivity should
enhanced by making policies in order to favour labour. Ashraf, Imran et. al.,
(2012) this study is done in order to find financial issues of cotton ginning
of SMEs in Faisalabad, Pakistan. The result is drawan that government policies,
high interest etc are major financial issues but they can overcome by joint

Maritala (2012)
examined the ideal level of capital structure which empowered a firm to
increase its financial performance. The study found that there was a negative
relationship between the firm’s debt ratio and financial performance measured
by return on assets and return on equity. Ahmad, Abdullar and Roslan (2012)
carried a study in Malaysia which sought to investigate the impact of capital
structure on firm performance by analysing the relationship between short-term
debt and total debt. The study established that short-term debt and long-term
debt had! significant relationship with ROA. It was also established that ROE
had significant relationship with short term debt, long-term debt and total
debt. Hlupeko dube (2013) the main determination of this research was to
investigate the impact of debt financing of SMEs of Masvingo. The result shown
from the study that debt financing has positive impact on productivity of SMEs.  The result concluded that a reasonable level
of firms to borrow adequate amount of required finance investment. S. Kamran
Sherazi et. Al (2013) through this study obstacles of small and medium
enterprises is analyzed. Many obstacles are find especially financial
conditions are ranked first. Tauseef et. Al (2015) examines the effect of debt
financing in firm’s financial performance measured as return on equity. Results
derived as sales growth has positive and significant impact on return on equity
whereas the firm size has no significant impact on it. Peter and Charles (2015)
studies properties of debt financing on financial performance pf SMEs in Kenya.
The study has to determine the long-term loans and short-term debt loans on
SMEs financial act. The discoveries from this study is that short term loans decrease
performance of SMEs.



After overview
of literature the gaps are revealed Work has been done only on problems faces
by SME’s and sources of finance available to SME’s and very less or no work has
been done on the impact of debt financing on SMEs, especially in Pakistan. This
research will be done in order to fill this gap by interviewing owners of SMEs
in Pakistan. And also by analyzing the impact of debt financing on SME’s.




Methodology describes the methods techniques
and Design which can be used in this research study.



Data Collection


The study used
primary and secondary data. Primary data were collected by means of interviews.
Secondary data on changes in output, interest rates, debt ratio and new
investment were collected from these Sources:


Chamber of Commerce Pakistan

Related published materials

Company Records

Study Population


The population which was
selected included all SME’s present in major cities of Pakistan.


Sample of the study


. A sample of the study made up
of 20 SME’s was randomly selected from this population


Statistical Analysis


Descriptive statistics will be used
for this study. Correlation and Regression will also be calculated for the purpose
to know about impact of debt financing on firm’s profitability and the
association between firm profitability and Growth of the Firm.




This study will
be a correlational research. A qualitative research will be conducted in order
to get different aspects of debt financing and SME’s



Ethical issues
regarding confidentiality will be considered and the data provided by the
respondent would be kept secret. Participation will strictly be voluntary and
respondents may refuse to participate at any time. As it will be self-administered
interview’s questions for data collection therefore I will be counseling while
getting data and will provide additional information if needed.



Debt financing
can be divided into two categories

term debt financing

term debt financing

Expected result
is that long term debt financing will have negative impact on the
profitability, growth and financial performance of SME’s due to high interest
and difficult repayment plan of Pakistani banks’ SME’s which are not often
financially stronger came under the debt trap. While short term debt financing has
positive impact on the financial performance of SME’s because mostly SME’s are
facing liquidity problem so they required short term loans for meeting their
working capital requirements which is essential for regular routine running of
their businesses.





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Questionaries’ (if any)