INTRODUCTION funds that are used for the firm’s

INTRODUCTION

 

Background
of the study

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Liquidity performs key function in the elevation of
a firm. 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. 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.
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 very 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 frame work has been
developed.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hypotheses

 

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

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

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

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

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

H2
: Firm’s debt to equity ratio has 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

 

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 cement sector firms listed on KSE. For sample,
randomly ten firms have been selected for the data analysis of this study. Data
collection of research in hand was from the cement sector firms’ annual
reports, the stock exchange’s web site and state bank of
Pakistan’s position statement analysis.

 

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

We
will reach to the conclusion of our objectives through this model. Model for
our study is as follows.

 

ROA
= B0
+ B1DE + B2QR + B3CR + ?

 

 

 

 

 

 

 

 

 

 

Data
Analysis and Findings

 

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.

 
 
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.

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