IMPACT OF DEBT FINANCING ON THE GROWTH OF MANUFACTURING FIRMS IN NIGERIA

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IMPACT OF DEBT FINANCING ON THE GROWTH OF MANUFACTURING FIRMS IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND TO THE STUDY

Manufacturing firms are considered important in both developed and developing countries. They are producer of 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 and their operations are often crippled by lack of adequate financing from financial institutions. The main purpose of this research is to examine the impact of debt financing on the growth of manufacturing firms in Nigeria. A manufacturing firm can finance its operations either through equity or debt.

Debt financing is cash borrowed from a lender at a fixed rate of interest and with a predetermined maturity date. The principal must be paid back in full by the maturity date, but periodic repayments of principal may be part of the loan arrangement. Debt may take the form of a loan or the sale of bonds; the form itself does not change the principle of the transaction: the lender retains a right to the money lent and may demand it back under conditions specified in the borrowing arrangement.

Lending to a manufacturing firm is thus at least in theory safer, but the amount the lender can realize in return is fixed to the principal and to the interest charged. Investment is more risky, but if the manufacturing company is very successful, the upward potential for the investor may be very attractive; the downside is total loss of the investment. Manufacturing firms can obtain debt financing from a number of different sources. Private sources of debt financing include friends and relatives, banks, credit unions, consumer finance companies, commercial finance companies, trade credit, insurance companies, factor companies, and leasing companies. Public sources of debt financing include a number of loan programs provided by the state and federal governments to support manufacturing firms. Manufacturing firms need capital in their operations. They can finance their operations using internal funds, debt and equity.

Debt finance is raised by borrowing from financial institutions. A lot of research has been carried out focusing on the impact of debt financing on growth of firms. The results from these studies are inconsistent. 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 decline in growth of the firm. Rainhart and Rogoff (2009) argued that when debt impacted positively to the growth of a firm only when it is within certain levels. When the ratio goes beyond certain levels financial crisis is very likely. The argument is also supported by Stern Stewart and Company which argues that a high level of debt increases the probability of a firm facing financial distress.

Over borrowing can lead to bankruptcy and financial ruin (Ceccetti et al., 2011). High levels of debt will constrain the firm from undertaking project that are likely to be profitable because of the inability to attract more debt from financial institutions. The nature of debt is an important determinant of the growth of a manufacturing firm. Jaramillo and Schiantarelli (1996) stated that the availability of long-term finance allows manufacturing firms to improve their productivity. If a firm has access to long-term debt finance, it can invest in new capital and equipment which helps to increase productivity.

According to Marcouse (2003), by investing in more modern and sophisticated machines, productivity per worker increases. Ventire et al. (2004) adds that modern know-how fuels greater output per unit of effort. The manufacturing firm can also invest in new technologies which are more productive. The inability to access long-term finance can force manufacturing firms to use short-term debt to finance long-term projects. This will create mismatches of assets and liabilities and depletes working capital. Depletion of working capital will negatively affect firm operations. It is crucial that the primary source of loan repayments should be cash flows from the project.

1.2 STATEMENT OF THE PROBLEM

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.

1.4 RESEARCH QUESTIONS

1. What is the impact of debt financing on the growth of manufacturing firms in Nigeria?

2. What are the sources of Finance for manufacturing firms in Nigeria?

3. What is the level of growth in the Nigerian manufacturing firms?

1.5 HYPOTHESIS

HO: Debt financing has no effect on the growth of manufacturing firms in Nigeria.

HA: Debt financing has effect on the growth of manufacturing firms in Nigeria.

1.6 SIGNIFICANCE OF THE STUDY

The following are the significance of this study:

1. The results from this study will be a useful guide for manufacturing companies in Nigeria on debt management using the information obtained from the relationship between debt financing and the growth of manufacturing companies in Nigeria.

2. This research will also serve as a resource base to other scholars and researchers interested in carrying out further research in this field subsequently, if applied will go to an extent to provide new explanation to the topic.

1.7 SCOPE/LIMITATIONS OF THE STUDY

This study on the impact of debt financing on the growth of manufacturing firms in Nigeria will cover all the sources of funds e.g. loans to the manufacturing firms in Nigeria. It will also cover the effect of debt financing on the profitability of manufacturing firms in Nigeria.

LIMITATION OF STUDY

Financial constraint- Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

Time constraint- The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.

REFERENCES

Cecchetti, G. S., Mohanty, M.S. and Zampolly, F.,2011. The real Effects of Debt.

Jaramillo, F. and Schiantarelli, F., 1996. Access to Long-term Debt and Effects on Firm’s Performance: Lessons from Ecuador.

Marcouse F, (2003). The Cost of capital, Corporation Finance and the Theory of investment. Am. Econ. Rev. 48(3):261-295.

Ventire F, Miller MH (2004). Corporate income Taxes and the cost of Capital: Correction. Am. Econ. Rev. 53(3): 433-444.

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