IMPACT OF DEBT FINANCING ON THE GROWTH OF MANUFACTURING FIRMS IN NIGERIA. A RESEARCH PROJECT MATERIAL ON BANKING AND FINANCE
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.