The effect of Capital Structure on Profitability of Small and Medium Enterprise: in werabe city Administration, ETHIOPIA

ABSTRACT The study was conducted to find out how capital structure effects on financial profitability of SMEs in Werabe city administration . The intention of the study was to effects of; equity capital, and debt capital on financial profitability of SMEs. To conduct the survey the researcher used both qualitative and quantitative methods were employed. All 385 SMEs in Werabe city administration were the target population. A sample of 96 (25%) was selected from the target population by the use of random sampling techniques. The secondary data which has been collected from annual financial reports of the sampled SMEs were employed. The primary data questionnaires were administered to the sampled respondents. For a detailed examination of quantitative data Statistical Package for Social Sciences (SPSS version 21) data software was applied. Regression analysis was done and gave different results on the four independent variables (equity capital, debt capital, size and sales growth). The study findings established that equity capital and debt capital have a significant and protective effect on financial profitability of SMEs due to a p-value of 0.00. The study established that equity capital had greatest proportion in capital structure; this was enhanced by its advantages like owner enjoying profit alone and independence in management. On debt capital the study found, it’s a source of capital that can enhances financial profitability of a business, however it’s very risky if not well managed. The study finds that Debt ratio and Equity ratio have a p-value, less than (0.05). DR and ER were a significant, positive and negative effect on financial Profitability. On sales growth, the study found it has no significance effect on financial profitability of SMEs due to difficulties of raise and maintaining it. The research suggests lending institutions should enhance their lending policies and develop tailor made programs that will see debt capital a less risky source of finance. The study concluded that combined sources of finance will enhance a sound financial profitability.