Capital Structure Decisions and Profitability of Small and Medium Enterprises in Enugu Metropolis

The choice of capital structure, specifically the mix of debt and equity used to finance business operations, is one of the most consequential financial decisions facing small and medium enterprise owners in emerging markets, where access to diverse financing options remains limited. This study examines the relationship between capital structure decisions and the profitability of SMEs in Enugu Metropolis. The research is anchored on Modigliani and Miller's Capital Structure Theory, alongside the Trade-Off Theory, which argues that optimal capital structure balances the tax benefits of debt against the costs of financial distress. A quantitative survey research design was employed. The population comprised 312 SMEs registered with the Small and Medium Enterprises Development Agency of Nigeria (SMEDAN) in Enugu State. Using random sampling, a sample of 175 respondents was drawn. Data were collected through structured questionnaires directed at business owners and finance managers, complemented by analysis of three-year financial records. Data were analysed using panel regression and Pearson correlation. Findings reveal that excessive debt reliance significantly reduces profitability margins, particularly for SMEs in the services and retail sectors, while equity-financed SMEs demonstrate more stable profit trajectories. The study further finds that financial leverage moderates the relationship between asset size and profitability, with leveraged firms recording better returns on equity only when debt is channelled towards income-generating investments. It is concluded that SMEs must adopt balanced capital structures that avoid over-dependence on costly short-term debt instruments. The study recommends that SME owners in Enugu prioritise retained earnings and explore venture capital and cooperative financing as cost-effective equity alternatives.

Keywords: Capital structure, profitability, SMEs, Trade-Off Theory, Enugu