La Consolacion University Philippines

City of Malolos, Bulacan

College Department
(A.Y. 2018-2019)

Debt Control: An Analysis of Debt Management

Practices of Micro-Entrepreneurs in the Vicinity
of Capitol View Park Malolos, Bulacan

Bondoc, Kristian Eldric P.

Cabatic, Shane Ann
Cheung, Joanne
Cruz, Loy Marcy
Domingo, Arianne Shae
Flores, Ellyza Mae
Reyes, Katrina M.

Submitted to:
Alexander Villaluz, LPT, ToCarm

May 18 2019
 La Consolacion University Philippines
City of Malolos, Bulacan
College Department
(A.Y. 2018-2019)

Chapter 1

This chapter includes the introduction, theoretical framework, statement of the problem,
hypothesis, scope and limitation, conceptual framework, significance of the study and the
definition of terms used.

1.1 Introduction
Debt is a financial obligation by one party from another. It is used by many corporation,
entrepreneur and even individuals as a method to acquire large amount of products that they
could not afford. Debt arrangement gives an opportunity to one party to borrow money under the
condition that it is to be paid back at a later date, and usually has an interest. One of the common
forms of debt is loans, it is used by entrepreneur to start their business. The borrower is required
to repay the balance of the loan by a certain date. The amount of interest is depend on the term
used if it is paid annually or monthly. In order to limit the interest expense the entrepreneur or
the borrower must repay the loan quickly.

Debt management help company, entrepreneur and individual to control their debt. Debt
is quite stressful and it can lead to serious problem like health problem and even death. The
company or entrepreneur must know how to handle debt for the better result of their business.
Company that experience bankruptcy experience loss in their business due to payment of loan
and its interest. The debtor must know when to pay their debt and how debt affect their business.
The short term payment of loan the lower interest that the company may pay. But long term
payment of loan leads to higher interest expense. The debt management help the entrepreneur to
settle their debt properly, entrepreneur who manage loan properly will not experience bankruptcy
or loss.

Malolos City is one of the industrialized city and province many entrepreneur put up their
business especially in food industry. Around Malolos City Capitol there is a lot of restaurant, fast
food chain and even street vendors who sell street foods. Street foods are one of the popular,
many student and individual patronized it because of cheap price. Due to high demand of street
 La Consolacion University Philippines
City of Malolos, Bulacan
College Department
(A.Y. 2018-2019)

foods, vendors need to purchase large amount of their product to meet the demand of their
customer. But the problem is the vendor doesn’t have sufficient money to acquire large amount
of product so they borrow money from a creditor and pay it within the agreement of vendor and
creditor.

Financial management is important especially when they have an obligation to settle.

Even small business or micro entrepreneur need to know financial management especially in
handling debt from creditor. Many small businesses experience loss and bankruptcy because they
cannot handle their finances properly. Putting up a business is very risky, the owner should have
enough knowledge how to circulate the business in a way that they can pay obligation and at the
same time they have income. Small business are prone in losses because of small capital and
some of the owners doesn’t have enough knowledge to how to manage their business. This study
aims to give awareness in debt management especially in the street vendors of Malolos City

1.2 Background of the Study

In every part of the Philippines you can see a lot of businesses. In a city like Malolos,
there are lots of businesses whether big or small. Starting a business requires a huge amount of
money. A person who wants to establish a business might not have enough money. So they are
taking loans to add to their capital. With that, they will have a debt to settle. Different lenders
have different conditions, rules and policies on how and when you should pay your debts to
them.
It is a must that entrepreneurs know how to properly manage their debts. Improper debt
management will have different consequences to the entrepreneurs. At the end, it will not bring
any good effect on their business. Especially if they have small scale businesses. This study will
analyze the debt management practices of micro-entrepreneurs around Capitol Viewpark
Malolos City.

1.2 Theoretical Framework

This study followed the concept of the theory of Financial. Financial Management theory
focus on explaining how and why decisions are made and the importance of financial
 La Consolacion University Philippines
City of Malolos, Bulacan
College Department
(A.Y. 2018-2019)

management in the business (J. Fred Weston). Under this theory it explained the importance of
debt management and the effect of financial obligation to the business. This theory explain that
the longer time maturity of debt the bigger interest expense will be paid. Using this theory, the
researcher can assume that every business need to know how to manage their finances specially
their debt. This theory can help the researcher to align their focus on the factors that stated
above, in such way, they can tackle the problem more easily using the theory as their guide in
formulating their question and assumptions.

1.3 Statement of the Problem

The general problem of the study is to analyze how micro-scale entrepreneurs manage
their debts and determine the factors that lead to debt growth. Specifically, it aims to answer the
following questions:

1. What is the personal profile of the following respondents in terms of:

 Gender
 Age of their business
 Economic Status
2. What are the possible factors that pushes a micro-scale entrepreneurs to have debts?
3. Do micro-scale entrepreneurs use money from loans to serve as their capital?
4. Do their net income sufficient to pay their indebtedness?
5. What are the possible solutions to avoid indebtedness?

1.4 Research Objectives

After identifying the research problem, the researchers formulate objectives of the study:
1. To know how micro-scale entrepreneurs manage their business finance
2. To know how micro scale entrepreneurs/businessmen handle their debts
3. To determine factors that lead to using of debt as capital of the business
4. To assess the allotment of micro-scale entrepreneurs’ net income as addition to their
capital
5. To provide simple financial strategies on how capital and debts should be manage
 La Consolacion University Philippines
City of Malolos, Bulacan
College Department
(A.Y. 2018-2019)

1.5 Significance of the Study

The study may enable business enterprises and micro-entrepreneurs to appreciate the
importance of debtors’ management. This review will also help to determine some of the factors
that are constraining the operations of Micro and small enterprises. The review will also help
micro-entrepreneurs to analyze their sources of funds that are likely to enhance micro-
entrepreneurs financial performance, sustainability, and survival. The various governments can
use this research paper to design policies that are meant to enhance access to credit by MSEs so
that they can contribute significantly to their performance that would result in economic
development of said city.

1.6 Scope and Limitation

The scope of this research involves the time and money that were used by the researchers,
the materials used in making this research happen, the knowledge’s that were used in order to
make this research possible and successful. Thus, limited time in doing this research was used
properly allowing the researchers to gather more information. The researchers managed to gather
information’s and were analyzed and evaluated in order to give correct and accurate details
preventing the readers in misunderstanding data’s that were involved in this research. The
limitation of this was to focus only on some areas of the Capitol View Park in the city of
Malolos, Bulacan due to limited time and resources.

2.4 Assumptions
 Insufficient accounting practices, unrealistic budgeting and pricing, and low sales over
high expenses are the possible factors that urge the growth of the debt of a micro-scale
entrepreneurs.
 Micro-entrepreneurs use money from loans to serve as their capital in every time they
faces under comings with their expenses and insufficiency with their net income.
 Micro-entrepreneurs must not create more debt, must manage their expenses to eliminate
and reduce the higher possibility of debt growth and should communicate with the
creditors for smaller interest rate.
 La Consolacion University Philippines
City of Malolos, Bulacan
College Department
(A.Y. 2018-2019)

CHAPTER 2
This chapter presents the related literature and studies after the thorough and in-depth
search done by the researchers. This will also present the synthesis of the art, theoretical and
conceptual framework to fully understand the research to be done and lastly the definition
of terms for better comprehension of the study.

2.1 Review of Related Theories

In section 2.1 is the review of theories, theoretical relationship, measure of variables and
section summary
 Optimal Capital Structure Theory
Optimal capital structure refers to the best combination of debt and equity that
can minimize finance cost, and maximizes a firm value (Roshanak Heshemi, 2013;
Bradley, Jarrel, & Kim, 1984). Optimal capital structure theories therefore, are those
theories that suggest how enterprises can maximize their value with a particular
percentage of debt.

 The Static Tradeoff Theory

The static tradeoff theory equates the returns and the cost of debt, whereby the
equilibrium point is referred to as the optimal capital structure (Heshemi, 2013).
According to the static tradeoff theory, firms select the supreme financial structure by
matching the tax benefits of debt, to finance cost including agency and bankruptcy
costs (Modigliani & Miller, 1963). So optimal leverage minimizes cost of capital and
maximizes firm value. This infers that profitable enterprises rely on debt financing
option because of tax advantage. Remember that interest on debt is deducted from
income before tax in the income statement, leading to tremendous tax saving resulting
in increased profits (Myers, 2001).

Despite MSEs having advance defined optimal capital structures; there are some
constraints that hinder them to get there, such as dearer transaction costs and
 La Consolacion University Philippines
City of Malolos, Bulacan
College Department
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negligence on the side of the managers to implement the capital structure as advocated
by static tradeoff theory (Shyam-Sunder & Myers, 1999; López-Gracia & Sogorb-
Mira, 2008).
If the relationship between profitability and leverage is negative, then such a
relationship defeats the static tradeoff theory argument of equating cost of debt to
benefits of using it, such as tax advantage at the corporate level is cancelled by tax
disadvantage at the personal level (Fama & French, 2002; Heshemi, 2013). The static
tradeoff theory is also criticized because the corporate tax gain championed by tradeoff
model is insignificant compared with financial distress cost (Miller, 1977).

 The Pecking Order Theory

Myers and Majluf (1984) developed the pecking order theory which suggests
that firms have a particular preference order of raising capital, starting with less risky
retained earnings, then safe debt and finally equity. This order is dictated by
asymmetric information, released onto the market by each financing category that
business managers analyze to make a prudent decision of cost effective source of
financing regardless of debt-equity ratio target (Myers & Majluf, 1984). This suggests
that, for firms to improve on their cash flows and increase profits, they need to follow
a certain hierarchical fashion of financing their operations starting with least cost
source of retained earnings, safe debt and lastly equity.

 Debt financing, Financial Performance and Age of Business Relationship Theory

As much as theoretical relationship between debt financing option and
financial performance seeks to equate costs of debt and benefits derived from its use,
age of the business on the other hand modifies their original relationship either
positively or negatively. Negatively, financial performance may decline if knowledge,
abilities, and skills become outdated with age forcing some MSEs to shut down their
businesses while others are merged or acquired whereas positively, older MSEs get
highly skilled personnel, customer royalty among other competitive advantages that
encourage superior performance and highly promising relationship between the age of
a business and its financial performance (Loderer et al., 2009; Agarwal & Gort, 2002;
Sorensen & Stuart, 2000; Liargovas& Skandalis, 2008)
 La Consolacion University Philippines
City of Malolos, Bulacan
College Department
(A.Y. 2018-2019)

2.2 Review of Related Literatures

 Sources Of Small Business Capital: There's More To Growth Than Debt And
Equity

Debt as a Source of Capital. While you may have cash for operations, your
financial position looks no better and you likely won’t qualify to assume other loans or
debt. This is a critical distinction to Hodgson. Having the cash you need for today’s
operations doesn’t help you secure the financing you need for tomorrow’s operations. I
don’t know any entrepreneur in business to run a revenue flat operation they want to
grow. It takes capital to grow and so a funding solution that only enables you to acquire
the capital you need to stay where you are today is not a growth solution. M. Vetter.
(2016)

 Think Twice Before Lending Money To Family

Takes stocks with your Goals. The key is to make sure any request for money is
backed by a reasonable business plan and the skills needed to make it succeed. For
example, consider whether a loan for graduate school will open the door to a good job,
rather than just postpone the need to figure out the next career move. Remember, too, that
ultimately we all need to find our own way in life. If you fulfill every need, your child
may never learn self-sufficiency.

 Mental Budgeting and the Financial Management of Small and Medium

Entrepreneur

Savings and loans from relatives are the major sources of the business capital with
micro-credit coming in the second place. The earnings from existing business were
mostly used to meet family expenditures. The results also show that Mental Budgeting
(MB) and its determinants like other sources of income over existing business, never
spending more than a fixed amount, having an overview of checking balance, long-term
future orientation and financial product knowledge have significant influences on the
financial management of SMEs.
 La Consolacion University Philippines
City of Malolos, Bulacan
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 Ways to Reduce Small Business Debt. Communicate with Creditors and Lenders

Communicate with creditors and lenders. If you find yourself falling behind on
payments, prioritize debt payments to determine which creditors and suppliers must be
paid first. Your cash flow statement should be particularly helpful for identifying
delinquent accounts and missed payments. Once you’ve figured out the amount of money
you can allocate towards outstanding debts, contact creditors to see if they’re open to
arranging agreeable payment terms. Ask your lenders about available loan-consolidation
programs, which can group multiple loans into a single monthly payment. (B. Austin.
2019)

 Dealing with Small Business Debt

Save the business. Obviously, the first option in trying to save a business while
managing its debt is taking money out of your own pocket and putting it into your
business. This is a calculated risk that probably has failed as many times as it has
succeeded, and should only be done if you can justify it as a short-term tactic that
promises the likelihood of a long-term payoff. (B. Fayy. 2019)

 Joint Effects of Debt Financing Option, Risk and Age of Business on Financial
Performance

The impact of debt financing option on financial performance is conflicting in a

way that positive, negative, and non-relationships are depicted in literatures reviewed
(Amirkhani & Fard, 2009; Myers & Majluf, 1984; Ebaid, 2013). Risk has a negative
impact on financial performance, and its management is essential to allow financial
performance to prosper well without interference as agitated by Saunders & Cornett
(2006) in his study. Age has either negative or positive effects on financial performance
of MSEs, because the argument is that financial performance may decline or prosper with
age (Lodereret al., 2009; Agarwal & Gort, 2002; Sorensen & Stuart, 2000; Liargovas &
Skandalis, 2008).
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 Debt financing option, Financial Performance and Risk

Whereas theoretical emphasis on debt financing and financial performance

concentrates on the cost /benefit of debt, systematic and non-systematic risks on the other
hand, influence this relationship negatively by sweeping out the benefits of debt forcing
Saunders and Cornett (2006) to advise enterprise managers to come up with strategies of
mitigating these risks. Financial distress cost as well as agency cost and other intervening
variables may distort both theoretical and practical relationship between debt financing
option and financial performance of MSEs that results in poor financial performance
(Heshemi, 2013; Jensen & Meckling, 1976; Myers, 1977).

 Debt financing Option and Financial Performance

The major emphasis on theoretical relationship between debt financing option and
financial performance is the cost of debt implication and the benefit derived thereafter
from its use (Heshemi, 2013). The static tradeoff theory emphasizes on the cost/benefit of
debt, where the benefits should overweigh its cost so that the revenue generated must be
adequate to cover the operational cost, pay interest on debt itself and meet the business
owners’ investment returns (Heshemi, 2013). Interest on debt is tax deductible resulting
in tax savings that contribute to higher profitability, indicating a clear theoretical
relationship between debt financing option and financial performance (Modigliani &
Miller 1963). Therefore, accordingly, debt usage is advantageous because of tax
deductibility of its interest on income to arrive at net taxable income, its low-cost nature
and facilitation of planning because its interest cost is fixed and known in advance,
resulting in better returns to the business owners (Damodran, 1999; Bernstein, 1999)

2.3 Review of Related Studies

 Debt Financing Option And Financial Performance Of Micro And Small

Enterprises: A Critical Literature Review

According to the study of Obuya, David (2017), trade credit is linked with firms’
liquidation and default payment hence has a negative effect on financial performance.
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City of Malolos, Bulacan
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The study shows that there is a negative relationship between short term loans on
enterprise financial performance measured by return on assets. If enterprises depend more
on long-term debt, they are likely to increase their cost of capital and finally collapse.
Total debt is a predictor of non-performance on MSEs because it impacts negatively both
on return on assets and gross profit margin.

On the other hand, Trade credit decreases costs of transactions. Enterprises that
increase short-term loan hold more cash that improves their cash flows. Long-term loan
has a positive effect on financial performance, measured by return on asset. Total debt
has a positive effect on financial performance measured by gross profit margin. The study
concludes that Micro and Small Enterprises should finance their operations with trade
credit and long-term loan and ensure proper utilization of external finances.

 Small and Micro Enterprise Owners’ Characteristics and their Impact on Capital
Structure
According to the study of Kapkiyai, C. & Kimitei, E. (2016), overconfidence has
a significant effect on capital structure. There is need for SME owners to avoid being
overconfident in order for entrepreneurs to assume unnecessary risks that threaten the
survival of their firms. Hence, there is need for SME owners’ to be confident of
confronting obstacles especially in times of crisis and when venturing in business
activities whose outcomes are uncertain.

 Micro Financing: Accountability and Financial Management Practices of Micro

Entrepreneurs
According to the study of Ahmad Nadzri, F.A, Omar, N. and Rahman, R.A.
(2017), poverty incidence may be reduced by encouraging the poor to involve in
entrepreneurship. However, due to the factors that they have no collateral and proper
business records to support their loan applications in the formal financial institutions, it is
a big challenge for the poor to finance their micro businesses, though introduction of the
concept of microfinance seen as an opportunity for the poor to have access to credit and
 La Consolacion University Philippines
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other financial services. The study also found out that micro entrepreneurs in general are
not practicing a good record keeping. They are also prone into ridding indebtedness since
these micro entrepreneurs were recording their business transactions in a notebook
without proper accounting format.

 The Financial Literacy of Micro Entrepreneurs

According to the study of Fatoki, Olawale (2014), the failure rate of new micro
enterprises is very high in South Africa. Financial literacy impacts positively on the
ability to make good financial decisions and household well-being and business
survival.The objective of the study is to measure the level of financial literacy of the
owners of new micro enterprises.

The results indicated that most of the micro enterprises’ owners do not engage in
formal financial planning, budgeting and control and only keep some books of
account. Most of the respondents understand commercial banks as a source of finance
but do not understand the sources of equity finance and the requirements to obtain a
loan. The results suggest a low level of financial literacy by the owners of new micro
enterprises.

 The Role of Micro Finance in the Growth of Small and Medium Size Industries

According to Hulme et al (1996), microfinance schemes often are of paramount

importance when the targeted problem is in its initial stage and not when it has
emanated. Microfinance is only a portion of what is needed to boost an enterprise
activity in the rural areas and who are incapable of getting the necessary assistance
from a commercial bank. It develops new markets, increases income, creates and
accumulates assets and promotes a culture of entrepreneurship. Besides infrastructural
development, MFI’s needs information from the poor micro entrepreneur about market
trends and skills so as to create a favorable financial environment for them.
 La Consolacion University Philippines
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 Joint Effect of Debt Financing Option, Risk and Age of Business on Financial
Performance

Unlike risk which has a definite negative relationship with financial performance,
debt financing option and business age have mixed effects on financial performance
(Saunders & Cornett, 2006; Matarirano, 2007; Agarwal & Gort, 2002; Sorensen & Stuart,
2000; Liargovas & Skandalis, 2008). Financial performance when measured by gross
profit margin, return on assets and current ratio depicts positive relationship with
moderate debt financing usage (Abor, 2005; Modigliani & Miller, 1963; Cecchetti,
Mohanty, &Zampolly, 2011; Rainhart&Rogoff, 2009). However, in certain cases, when
excess debt financing is used, ceteris paribus,financial performance indicates negative
relationship with debt financing option that may, to a certain extent induce bankruptcy
cost (Al-Timimi&Alsaadi,2014; Cecchetti, Mohanty, & Zampolly, 2011). As mentioned
earlier, financial performance measured by gross profit margin has insignificant
relationship with debt financing (Ebaid, 2013).

2.4 Summary of Review of Related Literatures

The literature on small firms’ financial management is very broad and it draws upon
different aspects of firm’s life. The initial interest of research in SMEs bankruptcies and default
risk has widen to studies investigating capital budgeting, development and growth models of
small business and relationship between default behaviors of SMEs and the credit facets of their
owners. Another interesting point of investigation were the financing patterns and capital
structure and working capital management. Myers (2001) argues that capital structure theory
choice is not standardized. However the best combination of equity and debt known as optimal
capital structure is the one that minimizes the financing cost, and maximizes the value to the
firms by giving the best balance between tax benefits and distress cost (Roshanak Heshemi,
2013; Bradley, Jarrel, & Kim, 1984). The static Tradeoff Theory equates the benefits and the
cost of using debt where the optimal capital structure occurs when the benefit and cost are
optimal (Heshemi, 2013). Myers and Majluf (1984) developed the pecking order theory which
suggests that firms have a particular preference order for raising capital.
 La Consolacion University Philippines
City of Malolos, Bulacan
College Department
(A.Y. 2018-2019)

2.5 Definition of Terms

La Consolacion University Philippines
City of Malolos, Bulacan
College Department
(A.Y. 2018-2019)

CHAPTER 3