The Role of Return on Equity (ROE) in SMEs’ Credit Decisions in the United Kingdom

Abstract

The present study was conducted to investigate the role of Return on Equity of Small and Medium-sized Enterprises in credit decisions in the United Kingdom. A sample of 270 SMEs was derived from several industries across the UK. The most common industries from which the sample was obtained were the finance sector, telecommunications, property construction, motor dealerships, advertising, communication and networking, and legal services. The research was based on the assertion that the role of profitability in determining firms’ credit decisions stems from the influence of debt financing on the efficiency of organisations. The research also examined the relationship between debt financing and the capital structure of the sample companies, which are major factors that determine the firms’ ability to take on debt to finance their operations. Besides, the research was based on the fact that most SMEs in the UK rely heavily on credit financing, which affects their profitability and debt to equity ratio. The study used a quantitative research strategy and a deductive approach. The statistical techniques applied to test the hypotheses included correlation and regression analysis. The correlation analysis was conducted to determine the strength of the association between the variables, and the regression analysis was conducted to develop models to predict variables in the research. Because the research was based on secondary information, the data were obtained mainly from the Thomson Reuters database, which has updated information about SMEs across the UK. The findings of the study demonstrated a positive association between the Return on Equity and revenue of the SMEs. The findings also showed a weak negative relationship between net profit and total debt. The relationship between working capital and current assets was positive and significant. However, the correlation between current liabilities and working capital was not significant but positive. Also, the findings showed that the relationship between total debt and leverage ratio was negative. Based on these findings, it was concluded that the SMEs’ profitability and performance were associated with their credit decisions. The findings suggested that the model developed to estimate net profit was appropriate for decision making regarding companies’ credit and financing. Therefore, the aim of this research was achieved because a connection was demonstrated between profitability and credit decisions.