1 Title page

CAPITAL STRUCTURE AND FINANCIAL PERFORMANCE

Investigation of Manufacturing Industry

By

P K M T KUMARI

MF/ 2011/ 3188

Department of Accounting and Finance

July 2016

Dissertation Presented to the Faculty of Management and Finance

of University of Ruhuna

in Partial Fulfillment of the Requirements for the Degree of

Bachelor of Business Administration

i
 Acknowledgement

In this opportunity I would like to thanks specially for my supervisor, lecturer Mr.
G.K.C Jeewantha for the grate contribution on behalf of the dissertation prepared
by me. Also I would like to thanks Mr. H.V.D.I Abeywicrama , head of the
department of Accountancy and finance and the dean of the Faculty of
management and finance for given support in various situations.

P.K.M.T KUMARI

ii
 Dedication

I dedicate this study for my

Loving

Mother

iii
 Table of content

Acknowledgement……………………………………………………………….ii

Dedication……………………………………………………………………….iii

Table of content…………………………………………………………………iv

List of Tables……………………………………………………………………vii

List of Figures…………………………………………………………………..viii

List of Acronyms………………………………………………………………...ix

Declaration……………………………………………………………………….x

Certification……………………………………………………………………...xi

Abstract………………………………………………………………………….xii

CHAPTER 1 ..........................................................................................................1.

Introduction.....................................................................................................1

1.1 Introduction ...............................................................................................1

1.2 Background of the study ...........................................................................1

1.3 Research problem ......................................................................................3

1.4 Research Questions and Objectives ..........................................................3

1.4.1 Research Questions ............................................................................3

1.4.2 Research Objectives ...........................................................................3

1.5 Research Methodology..............................................................................4

iv
 1.5.1 Data and Data Collection ...................................................................4

1.5.2 Data analysis ......................................................................................4

1.6 Significance of the study ...........................................................................4

1.7 Limitations of the study.............................................................................5

1.8 Chapter Summary......................................................................................5

1.9 Chapter organization .................................................................................5

CHAPTER II

2 LITERATURE REVIEW ..............................................................................7

2.1 Introduction ...............................................................................................7

2.2 Capital Structure........................................................................................7

2.3 Capital Structure Theories.........................................................................8

2.3.1 Modigliani and Miller Theory ...........................................................8

2.3.2 Trade-off theory .................................................................................9

2.3.3 Pecking order theory ..........................................................................9

2.4 Financial performance ...............................................................................9

2.5 Capital structure and financial performance ...........................................10

CHAPTER III

3 METHODOLOGY OF THE STUDY.........................................................12

3.1 Chapter introduction................................................................................12

3.2 Sample and Sample Selection .................................................................12

3.3 Data and Data Collection ........................................................................13

3.4 Variables..................................................................................................13

3.4.1 EPS...................................................................................................13

v
 3.4.2 ROE..................................................................................................14

3.4.3 ROA .................................................................................................14

3.4.4 Debt to equity ratio ..........................................................................14

3.5 Debt to Asset Ratio .................................................................................15

3.6 Method of Data Analysis.........................................................................15

3.6.1 Descriptive statics ............................................................................15

3.6.2 Correlation analysis..........................................................................15

3.6.3 Regression Analysis .........................................................................16

3.7 Conceptual Framework ...........................................................................16

3.8 Hypotheses Development........................................................................17

3.9 Summary .................................................................................................18

CHAPTER IV

4 DATA ANALYSIS AND DISCUSSIONS ..................................................19

4.1 Introduction .............................................................................................19

4.2 Descriptive Analysis ...............................................................................19

4.3 Correlation Analysis................................................................................20

4.3.1 Relationship between independent variables and ROE ...................20

4.3.2 Relationship between independent variables and EPS ....................21

4.4 Regression Analysis ................................................................................22

4.4.1 Regression Analysis of ROE ...........................................................23

4.5 Table: Results of ROE in regression analysis .........................................23

4.5.1 Regression Analysis of EPS.............................................................24

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 4.5.2 Regression Analysis of ROA ...........................................................24

4.6 Discussion ...............................................................................................25

4.7 Chapter summary ....................................................................................27

CHAPTER V

5 Conclusion, Limitations and Furthe r Research.........................................28

5.1 Conclusion...............................................................................................28

5.2 Implications .............................................................................................28

5.3 Limitations ..............................................................................................29

5.4 Further Research .....................................................................................29

References………………………………………………………………………xii

Appendix………………………………………………………………………..xvii

vii
 List of Tables

Table 4.1 Descriptive statistics of debt to equity ratio and debt asset ratio 22
Table 4.2 Correlation analysis of ROE 23
Table 4.3 Correlation analysis of EPS 23
Table 4.4 Correlation analysis of ROA 24
Table 4.5 Results of ROE in regression analysis 25
Table 4.6 Results of EPS in regression analysis 25
Table 4.7 Results of ROA in regression analysis 26
Table 4.8 The Results of Hypothesis Testing 27

viii
 List of Figures

Figure 3.1 18

ix
 List of Acronyms

ROE - Return on Equity

ROA - Return on Assets

DE - Debt to Equity Ratio

DA - Debt Asset Ratio

EPS - Earning Per Share

x
 Declaration

I hereby declare that this dissertation is my own work and effort and that, to the

best of my knowledge and belief, it contains no material previously published or

written by another person nor material which has been accepted for the award of

any other degree or diploma of the university or other institute of higher learning,

except where due acknowledgment has been made in the text.

Signature of the student:

Name of the student: P.K.M.T KUMARI

Registration number of the student: MF/ 2011/3188

Date: 18th July 2016

xi
 Certification

This is to certify that this dissertation submitted by P.K.M.T Kumari

(Mf/2011/3188) in partial fulfillment of the requirement for the Degree of
Bachelor of Business Administration in Accounting at the Faculty of Management
and Finance of the University of Ruhuna is a record of the own work carried out
by the student under my supervision. This dissertation has been submitted with
my approval.

____________________________

Supervisor

Mr. G.K.C Jeewantha

Lecturer

Department of Accounting and Finance

Faculty of management and Finance

University of Ruhuna

____________________________

Head, Department of Accounting and Finance

Faculty of management and Finance

University of Ruhuna

xii
 Abstract

In modern turbulent business environment Capital structure is the most significant

discipline of company‟s operations since it directly impact to enhance the value of
organization by make Suring survival of the business. Though ability of the
organization to carry out their stakeholders need is closely related to the capital
structure still there is no specific opinion regarding the capital structure and
financial performance.

Therefore, this study empirically investigated the relationship between capital

structure and the financial performance of listed manufacturing firms in Sri Lanka
from 2011to 2015. Capital structure were measured by using Debt to Equity ratio
and Debt to assets ratio whereas financial performance have measured by using
Return on Equity, Return on Assets and Earning per Shares. Ten listed
manufacturing firms were selected as sample based on market capitalization. The
data were analyzed and hypotheses were tested through descriptive, correlation
and regression analysis.

The findings revealed that, there was no significant relationship among the
capital structure and financial performance.

Keywords: Capital Structure, Financial performance, Listed Manufacturing

Companies

xiii
 CHAPTER 1

1. Introduction

1.1 Introduction
Through this chapter researcher tries to give understand about the reasons to select
research topic by emphasizing research problem, research objectives and significant
of the study. Influence in capital structure on financia l performance is very debatable
important topic in modern financial management context since it directly impact to
the survival of business. This chapter concern about the establish research questions
and objectives to overcome research problem.

1.2 Background of the study

The ability of companies to carry out their stakeholders‟ needs is tightly related to
capital structure. The Capital structure decision of business organizations is important
because a poor decision can affect to the firm‟s profitability a nd it lead to decrease in
firm‟s value. An optimum capital structure is important to firm for make sure
competitive advantages in complexity business environment. Modigliani and Miller
(1958) argued that an „optimal‟ capital structure exists when the risks of going
bankrupt is offset by the tax savings of debt. Once this optimal capital structure is
than returns obtained from a firm whose capital is made up of equity only (all equity
firm).It established, a firm would be able to maximize returns to its stakeholders and
these returns would be higher can be argued that leverage.

The primary objective of financial decisions is to maximize the wealth of shareholders.

In other words, the objective of a firm‟s financial decisions is to increase the value of
its shares. „good financial decisions increase the market value of the owners‟ equity
and poor financial decisions decrease it‟.(Ross, Westerfield, & Jordan, 2001 ) At the
heart of capital structure decisions is the search for the optimal capital structure whic h
is the level of capital that maximize profitability and shareholders' value. The search
for the optimal capital structure has led to theories like the trade-off, pecking order
and agency theories. To date, there is still no consensus on what the optimal capital
structure should be.

1
Capital structure decision is the selection of organization‟s composition of financing
between debt and equity. It refers to the mix of long term debt and equity financing
(Brealey, Myers, &M arcus,2009) According to Ross,Westerfield & Jordan (2001)
capital structure is a reflection of firm‟s borrowing policy.

Performance can be measured by using variety of dimensions. In modern business

environment performance become as a very important concept in finance management.
This concept can be divided in to two parts as financial performance & non-financial
performance. Financial performance are Return on Investment, Return on Equity
whereas non- financial performance are customer satisfaction, organization growth
etc .According to Green et al., (2002) when organization take finance decision they
concern about variety of policies & matters related to the firm. Decisions taken by
base on that influence to loan term decisions such as capital structure, acquisition etc.
(Leon 2013). With the purpose of enhancing organizational performance a company
can use current liability to finance assets since short term loan cost is low rather than
the long term loan cost. As a result of that Return on Assets & Return on Equity will
increase.

According to the Tian and Zeitun, 2007 there is closed link between capital structure
and corporate performance. Even through there are so many variables to measure
corporate performance such as productivity, profitability, growth, customer
satisfaction, According to the Barbosa & Louri, 2005 financial measurement is one of
main tool which indicate financial strength, weakness, opportunities and threats.
Therefore it is very rational to use financial performance to measure optimum capital
structure related to particular organization. Furthermore it shows relationship between
the capital structure and financial performance of the organization.

2
1.3 Research problem

The survival of a particular organization highly depends on the finance management

decision taken by the management. Among the financial decision capital structure
decision have high prioritize value since it will determine long term profitability of
the company.

Siddiqui and Shoaib (2011) review that high leverage organization associated with
high return. In here company should identify optimum capital structure while
overcoming difficulties connected with the organization policies. To determine
competitive strategies, management should have sound understand regarding the
impact of capital structure decision on financial performance. According to the
Velnampy and Niresh (2012) capital structure decision are utmost important and those
are directly impact to the profitability of company. Decision regarding optimum
capital structure will benefit to the company by minimizing Weighted Average Cost
of Capital (WACC).

Therefore the problem of this study can be stated as “how the capital structure
affects to the financial performance of Listed Companies in Sri Lanka”.

1.4 Research Questions and Objectives

1.4.1 Research Questions

When financing capital structure of organization, management can select proportion

among the debt and equity capital according to the organization policies. Base on that
some company may be livered where as some are unlevered depending on their
management decision. So in here try to identify,

1. What type of capital structure used by companies?

2. What is the impact of capital structure to the financial performance?

There are direct relationship among the capital structure and financial per formance.
Through above questions try to identify impact of capital structure on organizational
performance in related to manufacturing industry.

1.4.2 Research Objectives

To address the questions of the study following objectives are wished to accomplish.

1. To investigate “Types of capital structure” used by organization.

3
 2. To investigate impact of capital structure to the financial performance.

3. To make suggestion to improve firms‟ financial performance based on capital

structure.

1.5 Research Methodology

1.5.1 Data and Data Collection

Researcher uses secondary data from the Annual reports related to financial year
2011 to 2015 in selected PLC companies from manufacturing industry. ROE, ROA
and EPS use as dependent variables related to financial performance, whereas capital
structure treats as independent variable.

1.5.2 Data analysis

 Correlation analysis

Correlation analysis techniques use to analysis data and it explains the relationship
between the dependent variable and independent variable.

 Regression Analysis
Regression analysis is a mathematical method to use measure the impact of
independent variable and dependent variable.

1.6 Significance of the study

Manufacturing industry represents major part of the Sri Lanka economy. Therefore it
is very important to take clear idea regarding impact of capital structure on financial
performance in selected industry. Provide investors, to relevant information rather
than just showing financial statements for their decisions whereas giving good inside
to financial managers regarding capital structure decisions. Existing knowledge
related to previous researches not sufficient to take clear idea about research topic, as

4
well as relationship among capital structure on financial performance debate up to
now.

1.7 Limitations of the study

In here researcher have selected only five listed companies representing

manufacturing industry. In addition to this selected company there are so many
companies represented in selected industry. Therefore our sample does not match with
our population. Researcher consideration limited only for one industry. Here hundred
percent disregard all most all industries except manufacturing industry and therefore
this study will cover only small potion in Sri Lankan economy. Researcher
consideration limited only for Public Listed companies in Colombo stock exchange
and if he could have to consider Small and Medium Size business also in selected
industry this study will be more effective rather than this.

1.8 Chapter Summary

This chapter focuses on the introduction of the study by giving relevant brief
information related to the research. Here identify main reason to do research as a
research problem and it convert in to research questions while establishing research
objectives with the purpose of carry out research successfully. Furthermore this
chapter concern about the research methodology use to find the answers for above
scenarios with discussing limitations, significant and advantages of the studying the
impact of capital structure on financial performance.

1.9 Chapter organization

Second chapter related to literature review. In here try to get clear understanding
about “Impact of capital structure on financial performance” with supportive literature
reviews. Under this separately go through capital structure and financial performance
and after try to understand relationship between them with relevant literature reviews.
Third chapter is the methodology of the study. Here randomly select five listed
companies related to manufacturing industry. To collect data use annual reports as
secondary data and correlation analyze and regression analyze use to analyze data.

5
Under the chapter four, researcher tries to present findings under the collected data
using relevant models. Chapter five is related to conclusion, limitations and future
research. Here try to make sure achieving research objectives while finding the
answers for research questions. At the same time there may be arise new questions.

6
 CHAPTER II

2 LITERATURE REVIEW

2.1 Introduction

The definitions related to capital structure presented initially in this chapter and then it
considers about the capital structure theories. And this chapter is focused to present
the relationships between capital structure and financial performance with the
evidence. The purpose of this chapter is to provide better understand about the
theoretical background of capital structure on financial performance.

2.2 Capital Structure

Capture structure may be defined as the combination of debt and equity to finance a
firm‟s operations. Capital structure includes mixture of debt and equity financing
(Chou and Lee, 2010, Hall et al, 2004, Barral and Boothet al, 2001). Capital structure
topic had been come to the financial management scope with the paper presented by
the Modigliani and Miller (1958). Their first argument was the there is no effect of
capital structure to the firms performance. Further Modigliani and Miller (1963)
argued that “capital structure really does matter in determining the value of a firm”
through modifying their earlier capital structure irrelevance theory since debt offers a
tax shield. The term capital structure according to Kennon (2010) refers to the
percentage of capital (money) at work in a business, forms of capita l either equity
capital or debt capital. Alfred (2007) stated that a firm‟s capital structure implies the
proportion of debt and equity in the total capital structure of the organization.

A company‟s combination of debt and equity issues to relieve potential pressures on

its long-term financing (Tekker, et al, 2009). Yet, the mixture of a variety of long-
term sources of funds and equity shares including reserves and surpluses of an
enterprise is called capital structure (Pratheepkanth, 2011). Pandey (1999)
differentiated between capital structure and financial structure of a firm by affirming
that the various means used to raise funds represent the firm‟s financial structure,
while the capital structure represents the proportionate relationship between long-term
debt and equity. The capital structure of a firm as discussed by Inanga and Ajayi

7
(1999) it does not include short-term assets.credit, whereas compromise of a firm‟s
long-term funds obtained from various sources to finance

In financial management point of view capital structure refers the way of a firm
finance their assets through the combination of equity, debt or hybrid securities (Saad
2010). According to the Ehrhardt and Brigham (2003) existence of optimum capital
structure consist of combination of debt as well as equity and it will lead to increase
firm‟s value. Further he said that firm value can be measure present value of the total
future cash flows arise from the assets when discounted Weighted Average Cost of
Capital (WACC). This was supported by Wet (2006) when he concluded that
optimum capital structure will lead to the lowest WACC.

Asset structure, non-debt tax shields , growth, uniqueness, industry classification, size,
earnings, volatility and profitability are the major determinants of capital structure
(Titman and Wessel 1988) .This was supported by the findings of Alve and Francisco
(2013) when they described these determinants as firm- level variables.

2.3 Capital Structure Theories

2.3.1 Modigliani and Miller Theory

Modigliani and Miller (MM), 1958 illustrates that under certain key assumptions,
firm‟s value is unaffected by its capital structure. That means the value of the firm is
independent of its capital structure. It further describe average cost of capital does not
change in the debt or equity proportion in the capital structure. The theory was based
on the argument that the use of debt offers a tax shield. Brigham and Gapenski
(1996) .The underlying rationale for the Modigliani- Miller theory is that the value of
the firm is determined solely by the left hand side of the balance sheet which reflects
the company‟s investments policy (Drobez and Fix, 2003). In an effort to validate
MM theory in Kenya,Maina and Kondongo (2013) investigated the effect of debt-
equity ratio performance of firms and the study found a significant negative
relationship between capital structure (Debt Equity) and all measures of performance.
This result collaborated with MM theory that indeed capital structure is relevant in
determining the performance of a firm.

8
2.3.2 Trade-off theory

According to this theory an optimal capital structure is achieved when there is a trade-
off between the tax deductible benefits of debt and the risk of bankruptcy or financial
distress. Jensen & Meckling (1976 ) as cited in Melinda & Cristina stated that, „firms
select optimal capital structure by examining the net tax advantage of debt financing
by comparing debt advantages‟. Watson and Head (2006) observed the existence of a
trade-off theory and they concluded that debt financing is a more convenient source
for the finance rather than the equity.

2.3.3 Pecking order theory

According to the pecking order theory there is no well-defined debt equity ratio and
since that firm has freedom to select debt ratio according to the organization financing
policies (Myers (1984). This theory for the emphasize companies use internal fund
firstly and then issue the debt or only issue equity Fama and French (2005) and (Leon,
2013). Managers rank their order of financing in order of internally generated finance,
and then externally generated finance with debt ranking before equity” (Addae et al,
2013)

2.4 Financial performance

According to the Weldeghiorgis (2004) business leaders should have clear understand
about the both financial and non- financial indicators to survival in the business world.
Weldeghiorgis (2004) also quotes Zairi (1996) that “performance measures are the
life blood of organizations, since without them no decisions can be made”. According
to the Brindusa, 2012) Performance can be measured by using variety of dimensions
and in modern business environment performance become as a very important
concept in finance management. Further he explained that Performance can be
divided in to two parts as financial performance & non-financial performance.
Financial performance are Return on Investment (ROI), Return on Equity (ROE)
whereas non- financial performance are customer satisfaction, organization growth etc .
9
According to Green et al., (2002) when organization take finance decision they
concern about variety of policies and matters related to the firm. Decisions taken by
base on that, influence to long term decisions such as capital structure, acquisition etc.
(Leon 2013). With the purpose of enhancing organizational performance a company
can use current liability to finance assets since short term loan cost is low rather than
the long term loan cost. As a result of that, Return of Assets (ROA) & Return on
Equity (ROE) will increase (Mwangi et al., 2014).

According to Levasseur (2002) information on financial performance is useful in

predicting the capacity of the enterprise hence analyzing how well or poorly an
enterprise is doing against its set objectives. The final objective of Wealth
maximization can be achieved by competent use of resources. Analysis of financial
performance helps to make sure survival of the business. “Financial performance
analysis is the process determining the operating and financial characteristics of a firm
from accounting and financial statements” ( Panwala 2009). Rafuse (1996) says that
finance always ignored in financial decision making as involve investment and
financing in short term period. Further a company does not give attention to return on
equity, financial performance hold back (Bhunia et al., 2011).

2.5 Capital structure and financial performance

A study have been done by Abor in year 2005 on the Ghana stock exchange regarding
influence on capital structure on profitability, found that there is positive relationship
among the short term debt and financial performance. Though 85% represent debt
capital out of total capital still there is positive relationship between debt to assets and
Return on Equity. According to the (Sayeed, 2011) there are positive relationship
between capital structure and firm performance, which indicates when the firms
depend on debt as much as firm‟s needs, it will lead to enhance their performance.
The cost of debt is less than equity cost and the tax advantage of debt, which would
therefore, maximize the firm performance (Soumadi a nd Hayajneh, 2013; Arbabiyan
and Safari, 2009).

10
According to the findings of Mujahid and Akhtar (2014 ) there is a positive
relationship among the shareholders wealth and financial performance. To examine
above relationship they used debt equity ratio and reveled that significant level of 5%
debt to equity ratio positively affected with the shareholders wealth. Cespedes et al.
(2010) investigated relationship between capital structure and ownership in Latin
American countries in 1996-2005. They revealed that there is positive relationship
between leverage and ownership as well as growth rate.

A study ( Akintoye, 2008) found that there is significant sensitivity among the capital
structure and organization performance. Velnampy and Niresh (2012) found that
capital structure decision is utmost important decision since it will directly impact to
the financial performance of the organization. Findings of this research emphasized
that there is a negative association between debt to equity and return on equity.

According to the (Alom, 2013) there is an inverse correlation between capital

structure and firm performance since the cost of debt will exceed the return that firm
will obtain it. Consequently, it will lead to increase the bankruptcy risks which effect
inversely on firm Performance. According to the Ebaid, 2009; Singapurwoko and El-
Wahid, 2011 there is no relationship between capital structure and firm performance
since, this scenario supposes that cost of debt is relatively stable and the cost of equity
is not constant. When the debt reaches to certain level, any additional borrowing will
lead to inability of firm to meet its financial obligations .Therefore, owners‟ equity
will be exposed to operating risks and they will require additional compensation. This
might proof that capital structure is not linked to the performance of the firm.

The debt ratio is negatively affected to the financial performance, since high risk
associated with the debt. (Pourghajan et al. 2012) Onaolapo and Kajola (2010) have
investigate regarding financial performance on capital structure using 30 companies
representing Nigerial stock exchange and they found that debt ratio has significant
negative effect on financial performance of the company.

11
 CHAPTER III

3 METHODOLOGY OF THE STUDY

3.1 Chapter introduction

The main purpose of this research is to understand whether or not there exists any
relationship between capital structure and financial performance in related to
manufacturing companies. In order to meet the objectives this chapter is consider the
methodology of the study. Descriptive research design was used for this study, and
sample has been selected based on market capitalization. The data were collected
from secondary sources from Annual reports of the selected companies. Further this
chapter consists with variables, methods of data analysis, conceptual framework and
hypothesis in this study.

3.2 Sample and Sample Selection

According to Jankowicz, (1994) generalization about the population from data

collected using any sample is based on probability. So as to be able to simplify about
the research finding to the population and it is essential to decide enough sample size
(Tharmila and Arulvel, 2013).Similar to Abor‟s study of 2005, our sampled firms also
had fulfill three basic criteria; firstly all of the selected firms should have been listed
on the CSE, none of them should be delisted during the period under investigation and
all five year financial statements must be available for all companies to be included in
the study.

The study focused on the manufacturing sector in Sri Lanka. The population consists
of all the forty (40) manufacturing companies listed on the Colombo Stock Exchange
year 2011 to 2015 and out of that ten (10) companies have been selected based on
market capitalization which are exceed Rs five billion as at the 01st of July 2016. So
we have 50(10 firms * 5years) firm-years for panel data analysis.

12
3.3 Data and Data Collection

Secondary data used for this study with the quantitative approach since quantitative
researches are moved towards find out the results of the study and this approach is
considered to be an appropriate approach for the study (Tharmila and Arulvel, 2013).

The data for all the variables in the study were extracted from published annua l
reports and financial statements of the listed companies in the Colombo Stocks
Exchange (CSE) covering the years 2010 to 2014. The information gathered on key
accounts of the financial statements related to the selected manufacturing
organizations for the five years‟ time period.

3.4 Variables

There are mainly two types of variables called dependent variable and independent
variable. Independent variable is capital structure and Debt to Equity ratio, Debt to
Assets ratio used to measure capital structure whereas Dependent variable is financial
performance and it measure by ROE, ROA, EPS. Those variables were used to
investigate the effect of capital structure to firm‟s financial performance (Mujahid et
al., 2014) The value of the firm is measured using the firms performance determinants,
ROE and ROA will be used as the measure of the firm‟s performance based on the
work of Majumdar and Chhibber (1999) Abor (2005)

3.4.1 EPS

A company‟s earnings per share are generally of interest to the management and to
existing and prospective shareholders. EPS represents the no of rupees earned in
terms of each outstanding ordinary share. It is measured by using following formula.

EPS = Net profit (after tax) - Preference dividend

Number of ordinary shares issued

13
3.4.2 ROE

This ratio shows how much return has been created from the funds invested by
investors and also represent the real cost of use of invested funds (Azarbaijani, K., A.
Soroushyar and S. Yarian, 2011) Return on equity is calculated from proportion o f net
Income after tax on book value of equity.

ROE = Net profit (after tax)

Total shareholders‟ equity

3.4.3 ROA

Return on assets is investment return in assets and represents the amount of profit that
can be made use of corporate assets (Rahnamay Rodposhty, F., 2008). This ratio is
measured from dividing net income after tax by book value of total assets.

ROA = Net profit (after tax)

Total assets

3.4.4 Debt to equity ratio

To measure the firms‟ financial performance, debt to equity ratio is used as

independent variable (Mujahid et al., 2014). Debt to equity ratio measures the
proportion of total debt finance by the shareholders equity. It is measured by dividing
total debt by Total shareholders‟ fund”.

Debt to equity ratio = Total debt

Total shareholders‟ Equity

14
3.5 Debt to Asset Ratio

Financial leverage Similar to previous literature (Abor, 2005, Abor, 2007, Saedi, 2009,
Ebaid, 2009) financial leverage was measured in the study by debt to total assets ratio.
Keeping in line with previous studies, such as those of Saeedi and Mahmoodi (2011)
and Masnoon and Anwar (2012), here also used Debt to Assets ratio.

Debt asset ratio = Total debt

Total assets

3.6 Method of Data Analysis

This section considers the analytical tools which are used to analyze the impact of
capital structure to the financial performance. The data were analyzed by using
descriptive statics, correlation analysis and regression analysis.

3.6.1 Descriptive statics

Descriptive statistics were carried out to obtain sample characteristics. There are
maximum, minimum, mean and standard deviation include in descriptive statics and
also consists of number of sample and variance of each capital structure and financial
performance variables (Nirajini and Priya, 2013).

3.6.2 Correlation analysis

Correlation analysis was carried out to find out the relationship between determinants
of capital structure and the measures of firm performance. Correlation is concern
describing the strength of relationship between two variables. In this study the
correlation co-efficient analysis is under taken to find out the relationship between
capital structure and financial performance. It can be said that what relationship exist

15
among variables. Here, dependent variable financial performance is correlated with
independent variable capital structure.

3.6.3 Regression Analysis

Regression analysis is carried out to test the impact of capital str ucture on financial
performance. Here capital structure is the independent variable and financial
performance is the dependent variable. From these independent and dependent
variables, the following relationships are formulated. Financial performance of the
manufacturing firms is dependent upon the capital structure. It is represented as
follows;

EPS i ,t = а + β1DE i ,t + β2DA i ,t +E i ,t

ROA i ,t = а + β1DE i ,t + β2DA i ,t + E i ,t

ROE i ,t = а + β1DE i ,t + β2DA i ,t + E i ,t

Where,

a = Constant term

β = Coefficients of the explanatory variables

DE= Debt to equity ratio for firm i in time t

DA= Debt asset ratio for firm i in time t

E = Error term for firm i in time t

3.7 Conceptual Framework

With the purpose of find to answers for the research problem following conceptual
framework has been developed. Conceptualization model shows the relationship
between capital structure and Performance of listed manufacturing companies in Sri
Lanka.
.

16
Figure 3.1

 ROE
 Debt to equity ratio  ROA
 Debt to total assets ratio  EPS

3.8 Hypotheses Development

The researches done by (Mujahid et al., 2014) build the following hypothesis to test
relationship between the debt to equity ratio and financial performance.

Hypothesis -1

H1: There is a significant positive relationship between capital structure and financial
performance.

H0: There is a significant negative relationship between capital structure and financial
performance.

Hypotehesis-2

H2: There is a significant positive relationship between capital structure and

shareholders wealth.

H0: There is a significant negative relationship between capital structure and

shareholders wealth.

17
According to research findings H-1 Hypothesis accepted since significant level of
0.05 is greater than the findings of 0.002, related to Debt to equity ratio to ROE and
ROA. Findings of research H-2 Hypothesis also accepted since significant level of
0.05 is greater than the findings of 0.036, related to debt to equity ratio to EPS.

Based on the above research hypothesis and findings, to identify relationship between
capital structure and financial performance this study has been developed following
hypotheses.

H1: There is a positive relationship between debt equity ratio and financial
performance.
H0: There is a negative relationship between debt equity ratio and financial
performance.
H2: There is a positive relationship between debt asset ratio and financial
performance.
H0: There is a negative relationship between debt asset ratio and financial
performance.

3.9 Summary

This chapter described systematically about the way of this study continued. This study
based on a sample of five companies. EP S, ROA and ROE were used to mea sure
financial performance and debt to equity ratio and debt asset ratio were used to measure
capital structure.

18
 CHAPTER IV
4 DATA ANALYSIS AND DISCUSSIONS

4.1 Introduction

This study focus regarding the impact of capital structure on financial perfo rmance of
manufacturing companies listed in Colombo Stock Exchanges. This chapter includes
the findings of this study. The data for the study gathered by the using annual reports
of ten manufacturing companies of financial years from 2011 to 2015 and Debt equity
ratio and debt asset ratio are represents the role of capital structure of this study
whereas EPS, ROE and ROA have used to measure financial performance.
Descriptive analysis, Correlation analysis and regression analysis techniques were
used to capture data for the impact of capital structure to the financial performance.

4.2 Descriptive Analysis

Descriptive statistics were carried out to obtain sample characteristics. Output of the
descriptive statistics is presented in table 4.1 According to the descriptive statistics in
table 4.1 for the independent variables indicate that debt equity ratio and debt assets
ratio in the same level approximately among all the listed manufacturing companies in
Sri Lanka.

Table 4.1 Descriptive statistics of debt to equity ratio and debt asset ratio

Descriptive Statistics
N Minimum Maximum Mean Std. Deviation
Debt to Equity ratio 50 .23 3.60 1.0492 .79628
Debt to Assets ratio 50 .19 .78 .4619 .14959
Valid N 50

The above table shows the values of minimum, maximum, mean and stranded
deviation of variables of Debt to Equity ratio and Debt to Assets ratio. The mean

19
 value of 1.05 in Debt to Equity ratio represents the average amount of Debt to Equity.
Standard deviation related to Debt to Equity ratio is 0.80 and it shows by 80% it can
deviate positively or negatively from the mean value. Furthermore Debt Equity ratio
spread 0.23 to 3.60 between minimum to maximum value.

The research done by Nirajini and Priya (2013) related to the trading companies
reviled that 2.02 as mean value of the Debt Equity ratio. This study done by regarding
the manufacturing companies and mean value of Debt Equity ratio is 1.05. Reason for
this difference may be high debt usage of trading companies than manufacturing
companies. When consider Debt to Assets ratio in 2011 it spread minimum 0.19 to
maximum 0.46. Standard deviation value 0.15 and it means Debt to Assets ratio can
be variance from the mean 0.15.

4.3 Correlation Analysis

This analysis describes the correlation between capital structure and financial
performance variables.

Correlations
Debt to Equity Debt to Assets Return on
ratio
4.3.1 Relationship between independent variables ratio
and ROE Equity
4.2 Table: Pearson
Correlation Correlation
analysis of ROE 1
Debt to Equity
Sig. (2-tailed)
ratio

Pearson Correlation .930** 1

Debt to Assets
Sig. (2-tailed) .000
ratio
50
Pearson Correlation .222 .297* 1
Return on Equity Sig. (2-tailed) .121 .036

**. Correlation is significant at the 0.01 level (2-tailed).

*. Correlation is significant at the 0.05 level (2-tailed).

20
According to the 4.2 table correlation between Debt to Equity Ratio and Return on
Equity is 0.222. There is weakly correlation relationship among the variables and
significant value is 0.121. The correlation between Debt to Assets ratio and Return on
Equity is 0.279 and it represents significant positive relationship between the
variables.

4.3.2 Relationship between independent variables and EPS

4.3 Table: Correlation analysis of EPS

Correlations
Debt to Equity Debt to Assets Earnin
According to the table 4.5 there is weakly positive ratio
relationship between
ratio the DebtgstoPer
Equity ratio and Earning per Share. Correlation between the Debt to Assets ratio andShare
Pearson Correlation 1
Earning
Debt to per Share also weakly positive since when debt increase it help to increase
Sig. (2-tailed)
Equity ratio
residual income of equity share holders up to some extent.
Pearson Correlation .930** 1
Debt to
Sig. (2-tailed) .000
Assets ratio
50
Pearson Correlation -.071 -.040 1
Earnings
Sig. (2-tailed) .623 .784
Per Share

**. Correlation is significant at the 0.01 level (2-tailed).

According to the table 4.3 there is weakly negative relationship between the Debt to
Equity ratio and Earning per Share. Correlation between Debt to Assets ratio and
Earning per Share also represent weakly negative relationship.

21
 4.3.3 The relationship between independent variables and ROA
4.4 Table: Correlation analysis of ROA

Correlations
Debt to Equity Debt to Assets Return on
ratio ratio Assets
Debt to Equity Pearson Correlation 1
ratio Sig. (2-tailed)

Debt to Assets Pearson Correlation .930** 1

ratio Sig. (2-tailed) .000

Return on Assets Pearson Correlation .003 .112 1

Sig. (2-tailed) .982 .440

**. Correlation is significant at the 0.01 level (2-tailed).

According to the table 4.4 correlations between Debt to Equity ratio and Return on
Assets is -0.003. It shows weak positive relationship. The correlation between Debt
Assets ratio to Return on assets is 0.112 and it also implies the weak positive
relationship among the variables.

4.4 Regression Analysis

Regression analysis was used to investigate the relationship between capital structure
and financial performance of selected listed manufacturing companies in Sri Lanka.
This analysis describes the impact of independent variable to dependent variable.
Capital structure is the independent variable and financial performance is dependent
variable.

22
 4.4.1 Regression Analysis of ROE

4.5 Table: Results of ROE in regression analysis

Coefficients a
Model Unstandardized Coefficients Standardize t Sig.
d
Coefficients
B Std. Error Beta
(Constant) -.044 .093 -.476 .636
Debt to Equity
-.062 .059 -.393 -1.051 .299
ratio
Debt to Assets
.561 .317 .661 1.771 .083
ratio
a. Dependent Variable: Return on Equity
R square 0.109

Table 4.5 shows the relationship of Debt to Equity ratio and Debt to Assets ratio on
the return on Equity related to manufacturing sector. The Beta value represents the
percentage of independent variable contribution to determine dependent variable
whereas significant value shows impact of independent variable to dependent variable.
R square shows the percentage of variance of dependent variable.

Beta value is -0.399 and R Sq is 0.109 related to Debt to Equity ratio to Return on
Equity. Significant level is 0.299. Therefore there is no significant relationship
between Debts to Equity ratio to Return on Equity. The significant value of debt asset
ratio to ROE is 0.083. And beta value is 0.661. It shows that there is significant
relationship between of debt asset ratio to Return on Equity in 0.1 significant levels.

23
 Coefficients a
Model Unstandardized Coefficients Standardized t Sig.
Coefficients
B Std. Error Beta
4.5.1 Regression
(Constant) Analysis of EPS 2.521 7.031 .358 .722
4.6 Table:Debt
Results of ratio
to Equity EPS in regression
-2.891 analysis4.507 -.253 -.642 .524
Debt to Assets ratio 11.880 23.989 .195 .495 .623
a. Dependent Variable: Earning Per Share

R square 0.010

According to the table 4.6 significant level is 0.524 and beta value is -0.253 in related
to Debt to Equity ratio to Earning Per share whereas 0.623 significant level and 0.195
value for Beta fore Debt Assets ratio to Earning per share. Therefore there is no
significant relationship in respect of Debt Equity ratio and Debt Asset ratio to Earning
per Share.

4.5.2 Regression Analysis of ROA

4.7 Table: Results of ROA in regression analysis

Coefficients a
Model Unstandardized Standardize t Sig.
Coefficients d
Coefficient
s
B Std. Error Beta
(Constant) -.048 .079 -.614 .542
1 Debt to Equity ratio -.099 .051 -.740 -1.957 .056
Debt to Assets ratio .569 .269 .799 2.114 .040
a. Dependent Variable: Return on Assets
R square 0.087

The significant value is 0.056 of debt to equity to ROA. The beta value is -0.740. It
implies that there is significant relationship in significant level 0.1 of debt to equity
ratio to ROA. The significant value is 0.040 of debt asset ratio to ROA. It shows there
is a significant relationship between debt asset ratio and financial performance.

24
4.6 Discussion

4.8 Tables: The Results of Hypothesis Testing

4.8.1 Table 1

Dependent Independent variable( Debt to equity ratio)

variables Correlation R Significant T value Note
Square value
EPS -0.710 0.010 0.524>0.05 -0.642<1.96 No
significant
ROA 0.003 0.087 0.056>0.05 -1.957<1.96 No
significant
ROE 0.222 0.109 0.299>0.05 -1.051<1.96 No
significant

4.8.2 Table 2

Dependent Independent variable( Debt to assets ratio)

variables Correlatio R Significant T value Note
n Square value
EPS -0.400 0.010 0.623>0.05 0.459<1.96 No significant

ROA 0.112 0.087 0.040<0.05 2.114>1.96 **significant

ROE 0.297 0.109 0.083<0.01 1.771<1.96 ** significant

The findings, however, indicated a negative significant coefficient association

between capital structure and financial performance measured by EPS. This implies
that that one unit increases in Debt capital tends to decrease the EPS by (-0.710), and
an increase in Debt to finance assets position is associated with a decline in EPS by (-
0.784). When consider the ROA and ROE there are positive correlation relationship
among the capital structure since when one unit of debt increase it will enhance the
ROA and ROE.

25
Regression analysis has applied to the data from 2011 to 2015 to identify influence of
capital structure to financial performance. Debt to Equity ratio and Debt to assets ratio
treated as Independent whereas ROE, ROA and EPS used as dependent variable to
measure financial performance. Here decisions taken based on the significance level
and if the significance level is less than 5% it asserts the result in a way that there is a
significant relationship between Capital Structure and Firm‟s Financial Performance.

According to the regression model with respect to the ROE, ROA and EPS have an
R2 of 10%, 9% and 1% respectively (R2: ROE = 0.10; ROA = 0.087, EPS=0.010).
This indicated that 10% variation in Return on equity was influenced by independent
variables (Debt capital and Equity capital). Note that the predictor variables did not
explain Return on Equity (ROE) very well, because the value of R2 was quite low
(10%). Here it can be seen that the remaining 90% can be explain by other variables
which were not included in this study.

According to the Gill, Biger, and Mathur (2011) indicated that short-term debt to
total assets; long-term debt to total assets; and total debt to total assets had positive
impact on profitability. Gill, Biger, and Mathur (2011) presented that the impact of
short-term debt to total assets and total debt to assets on ROA was positive in both the
service and manufacturing industries.
The significant value is 0.040 of debt asset ratio to ROA. It shows there is a
significant relationship between debt asset ratio and financial performance. Therefore
capital structure impact to the Return on Assets ratio in a positive way . Hypothesis 3
stated that there is a positive relationship between debt asset ratio and financial
performance. This hypothesis is accepted and hypothesis 4 is rejected. The study
done by Nirajini and Priya (2013) found that correlation of Debt to Assets ratio and
Return on Equity is 0.493. Since this study also demonstrates positive relationship,
when the Debt to Assets ratio is increase it positively impact to increase Return on
Equity

Titman (1988) found that levels of debt had a negative influence of firms‟ financial
performance. This result was supported by Rajan and Zingales (1995) who addressed
26
that profitability was negatively correlated with leverage. In this research findings
also prove that there is no significant relationship among the Debt to Equity ratio and
financial performance. Therefore H1 Hypothesis rejected and accepts the alternative
Ho Hypothesis.

4.7 Chapter summary

In this chapter mainly concerned about the identify relationship between independent
and dependent variable based on the interpreting captured data from descr iptive
analysis, correlation analysis and regression analysis. In addition to that considered
regarding the testing hypothesis based on the research findings with the support of
previous research findings.

27
 CHAPTER V
5 Conclusion, Limitations and Further Research

5.1 Conclusion

The study has been done with the purpose of to investigate impact of capital structure
to the financial performance of manufacturing companies in Sri Lankan context.
According to the findings of research following conc lusions can be identify. There is
no significant relationship among the Debt Equity Ratio to Return on Assets. The
relationship between the Debt to Equity ratio to Return on Equity also no significant
and there is no any significant relationship among the Debt Equity ratio to Earning per
Shares. Therefore when consider the Debt to equity ratio and financial performance
there is no significant relationship among the variables. There is significant
relationship among the Debt Assets ratio to Return on Assets and the Return on
Equity whereas there is no any significant relationship among the Debt Assets ratio to
Earnings per Shares.

Finally this study concludes that there is no significant impact of capital structure to
the financial performance.

5.2 Implications

This research findings shows that when the debt is increase the financial performance
is decreased in manufacturing sector. When debt capital becomes high amount
comparatively equity capital the financial performance is reduced. This study
demonstrates the capital structure should be consists both equity and debt and it
should be better the composition of debt and equity which minimize the Weighted
Average Cost of Capital to enhance the firms value. This study results provides the
information to increase the financial performance using capital structure to decision
makers in manufacturing companies.

28
5.3 Limitations

This study limited to the sample which is consisted few companies related to
manufacturing sector listed in Colombo Stock Exchanges and in addition to this sector
there are more valuable sector companies such as banking, trading, services, and
plantation companies in Sri Lanka. Therefore these findings not provide clear image
about the impact of capital structure to financial performance of overall Sri Lankan
context.

This study used audited annual reports which were published in Colombo stock
exchange to collect data and totally depended on the secondary data .Because of the
company policies directly impact to the financial reporting there were some impact to
consistency of financial details gathered from Annual reports.

The findings of this research limited to five years (from 2011 to 2015) It is difficult to
determine the better opinion about the impact of capital structure to the financial
performance by using only five years.

This study concern about the capital structure only using Debt Equity Ratio and Debt
to Assets ratio whereas concentration of financial performance limited to Return on
Assets ratio, Return on Equity ratio and Earnings per shares. In addition to that there
are so many factors in capital structure which influence to the financial performance
and should have to concern about other variables also to measure financial
performance.

5.4 Further Research

End of this study, it can identify the impact of capital structure to the financial
performance in manufacturing firms in Sri Lankan context. Based on this research
new researchers can get idea about the impact of capital structure and financial
performance of manufacturing companies.

This study sample consisted with few companies. Therefore it is better to increase
sample and also focuses should not be limited to listed companies. The future
researchers can be considered non listed companies also for getting optimum results
by using the topic of the impact of capital structure to the financial performance. And

29
also can recommend to attention also other ratios in addition to Debt to equity ratio,
Debt asset ratio, ROE, ROA and EPS to measure the capital structure and financial
performance.

30
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xvii
 Appendix

Capital structure ratios and financial performance variables

Company
Name Year DE ratio DA ratio ROA ROE EPS

Hemas Holding PLC 2015 0.455 0.313 0.071 0.104 0.001

2014 0.283 0.221 0.088 0.113 0.002
2013 0.406 0.289 0.069 0.097 0.001
2012 0.250 0.199 0.061 0.076 0.001
2011 0.228 0.186 0.047 0.058 0.001
Hayleys PLC 2015 0.639 0.390 0.039 0.006 0.368
2014 0.444 0.308 0.035 0.051 2.667
2013 0.345 0.257 0.037 0.049 2.463
2012 0.786 0.461 0.005 0.009 0.368
2011 0.716 0.417 0.055 0.095 3.806
Singer Sri Lanka PLC 2015 3.599 0.783 0.067 0.169 6.866
2014 3.280 0.766 0.066 0.101 3.703
2013 3.093 0.756 0.071 0.070 2.411
2012 2.433 0.709 0.076 0.216 8.224
2011 1.951 0.661 0.090 0.266 9.288
Richerd Piries PLC 2015 2.436 0.709 0.090 0.309 0.000
2014 2.411 0.707 0.168 0.398 0.000
2013 1.939 0.660 0.077 0.167 0.000
2012 1.453 0.592 0.576 0.677 0.001
2011 1.103 0.525 0.151 0.212 0.000
Lanka Tiles PLC 2015 0.464 0.317 0.140 0.205 0.016
2014 0.614 0.380 0.059 0.015 0.001
2013 0.771 0.435 0.511 0.196 0.012
2012 0.542 0.351 0.141 0.217 0.011
2011 0.873 0.466 0.161 0.301 0.010
Brown and Company
PLC 2015 0.556 0.357 0.060 0.093 0.019
2014 0.607 0.430 0.313 0.159 0.030
2013 0.684 0.406 0.050 -0.034 -0.007
2012 0.531 0.347 0.049 0.029 0.006
2011 0.495 0.331 0.035 0.053 0.007
Laugfs Gass PLC, 2015 0.644 0.392 0.127 0.209 40.804
2014 0.698 0.411 0.117 0.199 34.606
2013 0.674 0.402 0.121 0.203 31.125
2012 0.750 0.429 0.059 0.103 14.713
2011 0.532 0.347 0.080 0.122 17.467
Tokio Cement PLC 2015 1.072 0.517 0.048 0.100 2.128

xviii
 2014 0.811 0.448 0.087 0.157 3.254
2013 1.007 0.554 0.081 0.069 1.193
2012 0.724 0.420 0.086 0.149 2.589
2011 0.693 0.409 0.090 0.152 2.329
ACL Cabel PLC 2015 1.468 0.595 0.055 0.136 0.008
2014 1.276 0.561 0.147 0.033 0.002
2013 1.206 0.547 0.065 0.055 0.003
2012 1.108 0.526 0.041 0.087 3.967
2011 1.550 0.608 0.060 0.004 0.143
Royal Ceyramic PLC, 2015 0.957 0.489 0.156 0.109 7.036
2014 0.692 0.360 0.066 0.126 7.714
2013 0.673 0.434 0.110 0.171 9.187
2012 0.836 0.504 0.240 0.398 17.777
2011 0.701 0.412 0.236 0.401 12.400

xix