INTRODUCTION

 

Background of the study

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

 

A key function in the elevation of a firm is performed by liquidity. Liquidity is a measure which represents the potential of a company that how much money it has to meet its immediate and short time period obligations or portfolio of assets that can be shortly converted to do this, its excessive degree of trading activity, permitting buying and selling with minimum price disturbance and in context of a corporation, the potential of the corporation to meet its temporary obligations. The capital structure actually displays the efficiency of a company in term of its assets in use, financed through different options. The three most simple methods to finance are through debt, equity (or the issuing of stock), and for a small business, personal savings. The capital structure generally refers to how much of each kind of financing an organization holds as a proportion of all its finance. Generally speaking, a firm with an excessive level of debt in contrast to equity is thought to carry greater risk, even though some analysts do not agree that capital structure matters to risk or profitability of a firm. Investment returns help in offering an idea of efficient management to generate earnings through assets. Which can be acquired by dividing the firm’s annual (total) earnings by its total assets and it is shown in percentage, often it is intended as “return on investment”. The capital of the company characterizes the amount of funds that are used for the firm’s fixed assets, accounts receivable, marketable securities and inventories that help in the firm’s corporate growth. It is essential for any kind of business and its development to have a well-strengthened capital structure. Business firms need to be very selective in setting up the capital structure for to achieve firm’s goals and objectives. Capital structure and liquidity in affiliation with financial performance have been separately investigated and their mixed influence has been hardly ever touched in the context of Pakistan. Rehman.A (2011) investigated capital structure and its relationship with profitability of cement sector and textile sector firms. The same kind of study was also conducted by Shah and Hijazi (2004). This study has been conducted using the cement sector firms’ data for the period of 2009 to 2014, covering the most recent period and very compact size of capital structure variables.

 

 

Problem Statement

 

A major concern for the financial managers in different companies has always been the combination of liquidity variables and capital structure variables. An issue with these variables is that how best to combine these elements to improve the firm’s financial performance. This research is intended to find the gray area about the impact of these variables on the financial performance of the selected cement sector firms.

 

 

Objectives of the Research

 

I.                   To describe and analyze the liquidity and capital structure practices in cement sector for the period of 2009-2014.

 

II.        To investigate the effects and impact of capital structure and liquidity on the financial performance of cement sector firms.

 

 

 

Significance of the study

 

The research holds its significance in the following:

 

·         This study will provide some essential guidelines to the financial managers of these firms in combining the elements of these variables.

·         This study will help the managers in how best to combine these proxies, which will be helpful in uplifting the firm’s profitability.

·         This study will enable the practitioners who are somehow curious about the underlying practices of liquidity and capital structure.

·         This research will add quality literature of liquidity and capital structure from local context.

·         This research will provide some social benefits to the society.

 

 

 

Theoretical Framework

 

On the basis of the literature following theoretical framework has been developed.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hypotheses

 

H01 (a): Firm’s quick ratio has a negative impact on the financial performance of cement sector.

H1 (a): Firm’s quick ratio has a positive and significant impact on the financial performance of cement    sector.

H01 (b): Firm’s current ratio has a negative impact on cement sector financial performance.

H1 (b): Firm’s current ratio has a positive and significant impact on cement sector financial performance

H02 : Firm’s debt to equity ratio has a negative impact on cement sector financial performance.

H2 : Firm’s debt to equity ratio has a positive and significant impact on cement sector financial performance.

 

 

LITERATURE REVIEW

 

Meaning of capital structure

 

A firm’s capital structure can be a mixture of long-term debts, short-term debts, common equity and preferred equity. A company’s proportion of short and long term debts is considered when analyzing capital structure. When analysts refer to capital structure, they are most likely referring to a firm’s debt-to-equity (DE) ratio, which provides insight into how risky a company is. Usually, a company that is heavily financed by debt has a more aggressive capital structure and therefore poses greater risk to investors. This risk, however, may be the primary source of the firm’s growth. Zulfiqar and Mustafa (2007) argued that every business or firm uses variety of different levels of combination of equity, debt for the reason to maximize the market value of the firm, as capital structure can affect liquidity and profitability of a firm.

 

Capital structure and Firm’s Profitability

 

Chudson made the contribution in 1945 on capital structure phenomenon and it was analyzed and examined by Modigliani & Miller (1958). A deep focused study was done to highlight the importance of capital structure and its effect. Their study plays a vital role in the field of capital structure and will play for more time to come. They argued that, a strengthened and well planned capital structure has many advantages like tax benefits and several others. They argued that this has been taken from the market imperfection.

 

Miller & Modigliani fostered two major propositions:

 

Propositions I – It tells that the firm’s value is completely independent form its capital structure.

 

Propositions II – It tells that the cost of equity capital has direct association with the firm’s capital structure.

 

These MM propositions are very important, that predict about equity cost which is dependent on the rate of return from assets, the cost of debt and the firm’s debt to equity. The Miller comprehend as, “Our propositions regarding the weighted average of the cost of capital about any firm would remain the same irrespective of the firm’s different financing sources, which firm chooses from the available sources” (Miller, 1988, P.307). The M propositions were also tested by many researchers time and time again. Barges (1962) tested their propositions within the time frame of just four years. He founded some laws in their propositions like he argued that biases do occur in the situations and the traditional views. Barges found out some weaknesses in their research propositions and the methodology they applied. Barges concluded that the independent nature of the firm from its value is wrong (1962 P. 147).

 

A research was done by Jensen and Mackling (1976) on capital structure. They identified the issues which existed between shareholders and managers because of the manager’s shares in the company which are less than 100%. They found out that the element of agency problem can be better dealt if the firm increases the share of the managers in board or increases the portion of financing debts. These types of alternative steps can reduce this issue. In such a situation where there is more cash flow available, the managers may use it for their personal benefits, rather than helping in maximize the firm’s value. Jensen (1986) argued that such kind of problems can be handled by increasing the value of the stakeholders. This can be ensured by increasing debts.

 

Ahmad Farid (1980) analyzed and examined the Malaysian firms and argued that the capital structure has positive and strong effect on the financial performance of firm. He argued that if the firm’s debt to equity increases it will negatively affect the firm profitability if it is increased beyond certain limits. He also elaborated that the firm’s debt ratio has positive impact. He found out that the firm’s funded leverage ratio has negative impact on the firm financial performance proxies. Lamothe (1982) also viewed the importance of capital structure combination. He argued that an optimal capital structure does exist for any firm. Myers (1984) explored the capital structure, which he termed as the Tradeoff Theory, which tells that every firm holds some specific and targeted debts for the reason of getting profits from debts as these combination makes proper ratio. Myers further explains his work as follow.

 

 

 

1. Interest expense helps in decreasing the tax liability and causes an increase in cash saving. The companies use the taxes as shield and there target is to meet the interest liability.

 

2. Myers found that with an increase in the firm’s debt will definitely increase the firm default chances.

 

3. Myers and Majluf (1984) investigated capital structure and termed their work as POT theory. This theory suggests that every firm uses a thorough level of decisions whenever they formulate capital structure.

 

4. Initially every firm likes to prefer common stock financing which means using funds from internal sources i.e. retained earnings.

 

In this case the company needs external funds or extra finance so for this, they go to banks for loans and they may also choose other options for example public debt.

 

Myers and Majluf (1977) argued that the underpricing is due to less knowledge or less information, so they argued that better information helps in the firm’s expected cash flows both at present and past.

Ross (1977) investigated the impact of capital structure and finds that firm’s ROE can be negatively affected by the firm debt to equity ratio, if not balanced. He also argued that firm’s funded leverage ratio is very important for the financial performance. In his particular theory he explained that the amount of debt financing is very important which highlights the trust of the investors in the firm. It is assumed that the levels of debts give more confidence to the managers and helps the future cash flows.

 

Baskin (1985) did an examination and found that capital structure is extremely unsafe component of a firm. He reasoned that it is exceptionally vital for the firm’s achievement and enhanced monetary execution. He found that a firm should keep up such a level of the capital structure which won’t begin influencing contrarily the money related execution. Baskin underscored that the greater part of administrators attempt to have an adjusted profit approach and endeavor to be kept away from new issuance of value offers and thought that these are only for the auxiliary concern.

Kamma (1986) argued that the capital structure has strong effect on the financial performance of firm. He argued that if firm’s debt to equity increases it will negatively affect the firm profitability if increased beyond certain limits. There are various studies which focused on the relationship between the firm’s characteristics and the capital structure of the firm. There are numerous studies which found out a relationship between capital structure and profitability (Malitz, 1985; Kester ,1986; friend and Lang, Titman and Wessels, 1988; El Khouri, 1989 and Canda, 1991).

 

Myers (1995) analyzed in his research study that profitability and leverage is negatively correlated with each other. The important point is that the above studies were comprehensive in United States. For example Malitz used the least squares for the analyses and examination by using data of manufacturing companies for years (1978-1980).

Rehman Alam (2011) found that both debt to equity ratio and Debt ratio have positive impact on the firm’s performance. Titman and Wessels used linear structural modeling for the analysis of 469 manufacturing companies’ data from (1974-1982). Canda used 820 companies’ data from all of US industries from (1972-1987). Bradley, Jarrell and Rim (1984) conducted a research study on capital structure and found that profitability has negative relationship with capital structure. They used ordinary least square to check the data of 20 years (1962-1981).

 

El-Khouri (1989) agrees to the conclusion of Bradley, Jarrell and Kim and conducted a review on capital structure and profitability. He used a sample of 27 different sectors for 19 years. He found that profitability and optimal capital structure are considered negatively related with profitability of the company.

Mohammad Khan Jamal (1994) conducted a study on capital structure and profitability of listed companies of Kuala Lumpur stock exchange (KLSE). In his study, ordinary leased square and correlation were used to analyze the data. ROI was used for profitability and debt Z-ratio and debt to equity ratio was used for capital structure. There is an adverse relationship between equity size and debt with return on investment.

 

Yasir, Ilyas (2006) analyzed and conducted a research on the determinants of capital structure variables by investigating the non-financial companies of KSE which showed that profitability was inversely related to capital structure. Along this debt increased the profitability of a firm.

 

Hijazi and Shah (2004) analyzed capital structure of KSE non-financial firm using data of five years. He found that capital structure variables i.e. Debt ratio and debt equity ratio has negative impact on the firm profitability. He found that capital structure variables financial liquidity ratio has also negative impact on profitability.

Hijazi and Yasir Bin Tariq (2006) underwent a research on components of capital structure by investigating cement industry of KSE. They concluded that high fixed asset ratios will lead to high debt ratios. Besides this, low profitability is the result of high debts.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RESEARCH METHODOLOGY

 

Population, Sampling and Sources of Data

 

Secondary data consists of previously published data for other purposes but is found fruitful and usable for this particular research. Population refers to the entire group of people, events, or things of interest that the researcher wishes to investigate. It represents the total number in any set up to be taken for the research purposes. The population of this study is all the cement sector firms listed on KSE.

The utilized data encompass annual reports, the stock exchange’s web site and state bank of Pakistan’s position statement analysis of the cement sector firms for the period of 2009 – 2014. For sample purposes, randomly ten firms have been selected for the data analysis of this study.

The sample consists of:

1.      Attock Cement Pakistan Ltd.

2.      Bestway Cement Ltd.

3.      Cherat Cement Co. Ltd.

4.      D.G. Khan Cement Co. Ltd.

5.      Deewan Cement Ltd.

6.      Fauji Cement Co. Ltd.

7.      Kohat Cement Co. Ltd.

8.      Lucky Cement Ltd.

9.      Maple Leaf Cement Factory Ltd.

10.  Mustehkam Cement Ltd.

 

Statistical Tools and Technique

Analysis of the data has been done through the statistical techniques like Pearson correlation and regression in order to find out the relationship between variables and the effect and impact of independent variables on dependent variables.

 

 

Research Model

The model used in this study incorporates dependent as well as independent variables. The independent variables encompass liquidity which is operationalised through current ratio (current assets / current liabilities) and quick ratio (current assets – inventories / current liabilities) and capital structure which is operationalised through debt to equity ratio (total liability to total equity) in the independent variables. The traditional theory of capital structure was employed to determine the significance of leverage and macroeconomic variables on firm’s performance (Ogebe et al 2013). The dependent variables encompass the accounting measure of financial performance of the firm which is operationalised through return on assets (ROA) which is net income / total assets.

In order to test the hypotheses of this research and to reach the conclusion of our objectives the following model will be used.

 

ROA = B0 + B1DE + B2QR + B3CR + ?

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RESEARCH ANALYSIS AND FINDINGS

 

The following sections represent the findings of the study. They include the descriptive statistics, correlation analysis in addition to multiple regression analysis.

 

Pearson correlation analysis

To understand the correlation among different variables of this study i.e. the liquidity and capital structure with financial performance, correlation has been applied here. On the basis of statistical significance and insignificant coefficients results have been analyzed.

 
 
Table 1: Correlations Matrix

 

ROA

CR

QR

DE

ROA

1

CR

.662**

1

QR

.407**

.819**

1

DE

-.689**

-.632**

-.458**

1

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

 

Table 1 shows the correlation matrix regarding all the independent and dependent variables which have been used in this particular research study. These results show that the firm’s liquidity is having positive association with firm’s financial performance as the proxies being used to show the liquidity are QR and CR which indicate positive correlation with the dependent variable of this study, the financial performance i.e. ROA. However the proxy of capital structure is showing negative association with the firm’s financial performance. The capital structure facets known as the capital structure proxies are showing negative association.

 

 

 

 

Regression analysis

Linear regression or bivariate linear regression has been applied in this research. It is used to predict or to find the effect and impact of the value of a dependent variable based on the value of an independent variable (predictors).

 

Model: ROA = B0 + B1DE + B2QR + B3CR + ?

 

Table 2 : Regression Analysis

Variables

Coefficient

Standard error

T- statistics

P – value

CR

.672

.672

3.918

.000

QR

-.334

-.334

-2.235

.029

DE

-.417

-.417

-3.768

.000

Constant

3.505

2.251

.028

Adjusted R-Square

0.574

F-statistics

27.53

F-statistics (P Value)

0.000

 

Table 2 represents the results of this research’s model. The results indicate that capital structure proxy is showing negative impact on the financial performance of the firm i.e. DE is showing negative but insignificant impact on the financial proxy ROA. Further the results are showing that the proxy of liquidity i.e. CR has positive but significant effects on the firm return on assets whereas QR has negative but significant effects on the firm return on assets. The adjusted R-square of the model is 0.574 which tells that almost 57.4 % changes are occurred in ROA due to changes in these set of independent variables. The F-value is 27.53 which represents that this over all model is significant.

x

Hi!
I'm Erica!

Would you like to get a custom essay? How about receiving a customized one?

Check it out