Capital Structure and SMEs Operational and Financial Performance: Evidence from Egyptian SMEs

Abstract

This study investigates the impact of capital structure on the financial and operational performance of small and medium-sized enterprises (SMEs) in Egypt. Using a panel dataset of 103 SMEs observed from 2018 to 2022, the research analyzes the relationships between leverage ratios—specifically, short-term debt to total assets and debt-to-equity ratios—and performance metrics, including return on assets (ROA), return on equity (ROE), and cash conversion cycle (CCC). For financial performance, the findings reveal (i) a significant negative relationship between leverage and ROA, supporting the pecking order theory, and (ii) a significant positive relationship with ROE, consistent with agency cost theory. These results indicate that increased debt can enhance returns to equity holders despite diminishing asset efficiency. Additionally, the findings show that leverage has a significant positive relationship on CCC. This result shows the complexities of working capital management in SMEs. This research contributes to the understanding of capital structure dynamics in a developing market context, addressing a gap in existing literature that predominantly focuses on larger firms in developed economies focusing only on financial performance of firms. The study offers critical insights for policymakers and business leaders seeking to improve financial and operational effectiveness in a challenging economic landscape.