EFFECTS OF FINANCIAL LEVERAGE ON COMPANY PERFORMANCE

OF SMALL AND MEDIUM ENTERPRISE

IN SILANG, CAVITE

Undergraduate Thesis
Submitted to the Faculty of the
Department of Management
Cavite State University
Silang, Cavite

In partial fulfillment
of the requirements for the degree
Bachelor of Science in Business Management

Kristine Caguiat
Erica Pangan
Everly Kaye Poblete
June 2022
DOM R&E Form No.2
Republic of the Philippines
CAVITE STATE UNIVERSITY
Silang Campus
Biga 1, Silang, Cavite

DEPARTMENT OF MANAGEMENT

TITLE APPROVAL SHEET

AUTHOR’S : KRISTINE CAGUIAT, ERICA D. PANGAN, EVERLY KAYE B.

POBLETE

TITLE: EFFECTS OF FINANCIAL LEVERAGE ON COMPANY PERFORMANCE

OF SMALL AND MEDIUM ENTERPRISE IN SILANG, CAVITE

A P P R O V E D:

WENDY SADANG ________ HERMILINA A. MENDOZA, DBA __________

Adviser Date Technical Critic Date

HERMILINA A. MENDOZA, DBA _______ HAZIEL T. ALVAREZ, MBA ______

Dept. Research Coordinator Date Department Chairperson Date

HERMILINA A. MENDOZA, DBA _______ JOCELYN L. REYES, Ph.D. ________

Campus Research Coordinator Date Campus Administrator Date
 EFFECTS OF FINANCIAL LEVERAGE ON COMPANY PERFORMANCE
OF SMALL AND MEDIUM ENTERPRISE IN SILANG, CAVITE

Kristine Caguiat
Erica Pangan
Everly Kaye Poblete

An undergraduate thesis submitted to the faculty of the Cavite State University-Silang

Campus, Silang, Cavite in partial fulfillment of the requirements for the degree Bachelor of
Science in Business Management major in Financial Management with contribution No.
___________. Prepared under the supervision of Ms. Wendy Sadang.

INTRODUCTION

Both investors and businesses employ financial and operational leverage to gain larger

returns on their assets. When acquiring new assets, a corporation must always make the best

selection possible. The corporation has three financing choices when purchasing an asset. There's

stock, debt, and leasing to consider. Finance is critical in any type of business, whether it is new

or established. Financial and non-financial institutions both require capital to carry out daily

operations.

Financial leverage is the use of borrowing (debt) to fund the purchase of an asset in the

hope that income or capital gains from the new asset will exceed the cost of borrowing. As

stated by Iqbal (2018), Financial Leverage shows that businesses need finance to purchase a new

asset, and enhance their production or operational activities. Financial leverage is one of the best

ways to achieve organizational goals and maximize the value of its shareholders. As stated by
Al-Slehat (2019), The financial leverage and size of the company most impacts financial

managers as it is due to the tremendous development facing financial markets and the

technological development of the use of financial resources that has made it possible to achieve

it. It has been regarded as an important issue. Financial leverage is a critical issue because it

directly affects a company's performance; therefore, financial managers should exercise

prudence when deciding on the debt-equity balance.

Financial leverage decisions are extremely important for a company's existence and

performance. Quoted firms should consequently maintain an adequate debt-to-equity ratio in

order to maintain a constant return on equity. One of the ways to measure financial leverage is to

use the debt-to-equity ratio. It helps to find out the amount of financial leverage of a corporation

and shows the symmetry of debt to the company’s equity. This helps management, lenders,

shareholders, and other corporate stakeholders understand the level of risk in a company's capital

structure.

Because financial leverage may be used to discipline management, it can have a

favorable impact on a company's performance. However, it is not always relevant to companies

with excessive debt. Because excessive debt levels can lead to considerable financial constraints,

which can have a negative impact on a company's performance.

The relationship between profitability and borrowing costs has a significant negative

impact. This means that financial activity is included, and if the company is profitable, it will not

increase borrowing costs (Muspyta and Ruslim, 2021).

This study aims to know the impact of Financial leverage on investors as well as to

determine the significance of Financial leverage on the company's performance. Every

individual, business, and parastatal must pay close attention to the most significant
considerations about the level of financial burden, associated cost of capital, and their impact on

firm performance. The researchers want to determine if firms should use more long-term debt to

total assets since it increases returns on equity, which is important to both potential and

prospective shareholders. Corporate leverage increases profit growth, there is indeed a constant

need for short-term debt to total asset improvement for improved company performance.

Statement of the Problem

The focus of this research is on the effect of financial leverage on the company

performance of small and medium enterprises. To gather the necessary knowledge, data, and

information, the study attempted to answer the following questions:

1. What is the demographic profile of the Small and Medium enterprises in terms of:

1.1 Age of the company

1.2 Number of employees?

2. What are the effects of financial leverage in terms of:

2.1 Retained Earnings

2.2 Debt to Asset

2.3 Debt to Equity?

3. What are the significant effects of Financial leverage on companies' performance in

terms of:

3.1 Clarity

3.2 Challenge

3.3 Commitment

3.4 Task-Complexity
 3.5 Feedback

4. What are the external factors and Internal factors that affect Financial leverage in terms

of:

2.1 Retained Earnings

2.2 Debt to Asset

2.3 Debt to Equity?

5. Does the company remain profitable while having financial leverage?

Objectives of the Study

In general, this research aims to determine the effect of financial leverage on the small

and medium enterprises in Silang, Cavite.

The objectives of this research are as follows:

1. To determine the demographic profile of the Small and Medium Enterprise in terms of:

1.1 Age of the company

1.2 Number of employees.

2. To investigate the effects of financial leverage in terms of:

2.1 Retained Earnings

2.2 Debt to Asset

2.3 Debt to Equity

3. To determine the significant effects of Financial leverage on companies' performance in terms

of:

3.1 Clarity

3.2 Challenge

3.3 Commitment
 3.4 Task-Complexity

3.5 Feedback

4. To assess the external factors and Internal factors that affect Financial leverage in terms of:

4.1 Retained Earnings

4.2 Debt to Asset

4.3 Debt to Equity.

5. To investigate if the company remains profitable while having financial leverage.

Significance of the study

● Future researchers – this study would help them to have background knowledge about

the financial leverage of a company or business. The ideas presented may be used as

reference data in conducting new research and testing the validity of other related

findings.

● Entrepreneur – it would be a big help for the entrepreneur to know the value of financial

leverage of a company's performance. Accurately, for the entrepreneur who has a

business or company or wants to have someday. And the result will be used to encourage

others to do a good performance.

● SMEs Owner - They can gain information that may help them about the effects of

financial leverage on company performance that they can use so that they can have more

knowledge in financing.

Time and Place of the Study

 This study was conducted from March 2022 until May 2022. For the given time frame,

the researchers made sure that all the needed efforts to suffice the study were managed properly,

effectively, and efficiently. The researchers endeavored to seek the most available and

convenient Small and Medium Enterprises (SMEs) in Silang, Cavite where the gathering of data,

information, and knowledge took place through the use of survey questionnaires. Based on the

location of researchers, the SMEs in Silang, Cavite are the most appropriate location for the

study with less use of resources in time and effort.

Scope and Limitation of the Study

This study mainly focused on the effects of financial leverage on the company

performance of Small and Medium Enterprises (SMEs) in times of pandemic. It aims to

determine the financial decision as well as the choices towards the enhancement of operational

activities. The data collection was conducted on fifty (50) selected Small and Medium Enterprise

which will represent the participants of the study. Each of the respondents was given the same

questionnaires to answer concisely about their experiences.

Definition of Terms

For clarification, the important terms of this study have been defined.

The following terms are:

Assets. It is a resource with economic value that an individual, corporation, or country

owns or controls with the expectation that it will provide a future benefit.
 Company performance. It is a combination of an organization's financial and non-

financial components. These factors may be used to determine how successfully a firm is

implementing its business plan and to find opportunities for improvement.

Debt to Asset. Creditors frequently use this method to assess a firm's debt, capacity to

repay its debt, and if future loans will be provided to the organization.

Debt to Equity. This ratio is used to measure a company's total liabilities to its

shareholder equity and may be used to determine how much leverage it has.

Financial Leverage. Refers to investment strategy using borrowed money or debt

(Hayes,2022).

Income. The money received, especially on a regular basis, for work or through

investments.

Retained Earnings. It is the amount of profit left over after all direct and indirect costs,

income taxes, and dividends to shareholders have been paid. This is the percentage of the

company's equity that may be utilized to invest in new equipment, research and development,

and marketing, for example.

Small and Medium Enterprises (SME’s). It is a company that keeps its sales, assets, or

personnel count below a specified level.

Clarity. It refers to a specific and measurable goal that can be met within a specific time

frame and goal setting (Locke, 1968).

Challenge. It refers to goals that can be achieved with a reasonable level of difficulty,

motivating individuals and organizations to strive for positive goal achievement (Locke, 1968).

Commitment. It motivates individuals or organizations to make concerted efforts to

achieve their objectives. Furthermore, it aids in making goals more attainable (Locke, 1968).
 Task-Complexity. It facilitates goal attainment by establishing processes and steps. Goal

setting can be accomplished by strictly applying all of the principles and ensuring that all goals

account for the principles (Locke, 1968).

Feedback. It provides information on how well goals are being met. Individuals and

organizations can adjust their goal-setting based on feedback (Locke, 1968).

Theoretical Framework of the Study

Pecking order theory

Figure 1. Pecking Order Theory by Myers and Majluf (1984).

This study used the Pecking order theory that was designed and developed by Myers and

Majluf in 1984. The theory identified the 3 steps that help a company in its financial decision-

making.
 The first stage was identified as Internal financing which states that a company should

finance itself first internally through its retained earnings. The second stage was External

Financing: Debt which stated that if the company’s source of financing is unavailable, a

company should then finance itself through debt. Lastly, the third stage was External Financing:

Equity. It serves as a company's last resort where a company should finance itself through the

issuing of new equity.

From the theory, the researcher employed three sub-variables under financial leverage

which are retained earnings, debt, and equity.

Goal Setting Theory

Figure 2. Goal setting theory by Edwin Locke (1968).

Another theory to support the dependent variable is the Goal Setting Theory of

Performance Management System with the sub variables such as clarity, challenge, commitment,

task-complexity, and feedback. When a company wants to enhance or improve the performance

of an individual or organization, that company will set goals for the future to become in the top
management or distinct to everyone. Edwin Locke proposes Goal Setting theory. He stated that

when organizations set more good goals, they will perform even better than before. This theory

considers the most effective and relevant approach to company performance; hence, for a

company to achieve what they want.

According to Shaiza and Giri (2016), Setting goals will aid in creating an action plan

intended to direct individuals and organizations. It contributes to its prominence in the literature

on human development and management. Additionally, many researchers have noted a link

between better organizational and corporate outcomes and goal-setting. It is for all facets of

effectively creating organizations that can cover the goal-setting theory. Goal Setting Theory

supports the study's variables to see the effectiveness of the bank whose businesses depend on

lending, funding and paying off deposits' interest. As we all know, financial leverage results

from borrowed capital as a source of funds when investing in expanding the firm's assets and

generating the return on risk capital (as cited in Locke & Latham (2006), Spaulding & Simon

1994, and Koppes 2014).

Conceptual Framework of the Study

 Financial Leverage Company performance
Clarity
Retained Earnings Challenge
Debt to Asset Commitment
Debt to equity Task-Complexity
Feedback

Figure 3. The conceptual framework of the study

This conceptual framework shows the effects of two variables which are Financial

leverage and the Company’s Performance. The independent variable of this study is the financial

leverage comprising retained earnings, debt to asset, and debt to equity ratio as sub-variables. On

the other hand, the dependent variable is the company performance with the sub-variables of

clarity, challenge, commitment, task complexity, and feedback. This illustrates the endeavor of

the study in determining the effects of financial leverage on a company's performance of small

and medium enterprises in Silang, Cavite.