The relationship between financial performance and capital structure of companies listed in the Nairobi securities exchange

Abstract

Capital structure decisions are vital decisions with great implication for the firm's performance. The general purpose of this study was to determine the relationship between financial performance and capital structure of manufacturing firms listed in the Nairobi Securities Exchange (NSE) which was guided by the following objectives; to determine the extent to which interest coverage ratio affects the return on capital employed by firms, to assess whether the ratio of total debt to total assets impacts the return on capital employed by firms, to examine the relationship between the return on capital employed and the proportions of debt and equity by firms and, to evaluate the impact of long term debt and total capital on a firm's financial performance. This study used descriptive research design with a target population of all the 58 companies listed on the Nairobi Securities Exchange as at August 2013 where a sample size of 9 (nine) companies listed on the manufacturing sector were used. Secondary sources / annual financial reports for the financial years 2007 to 20 II were used in this study to collect data. The study used both descriptive (measure of central tendency) and inferential statistics (correlations and regression) to undertake data analysis. The major findings regarding the study were that there was a statistically significant strong positive relationship between the financial performance (ROCE) of listed manufacturing companies and the interest coverage ratio while there is also a statistically significant negative relationship between financial performance (ROCE) and debt to asset ratio, debt to equity ratio and long term debt to capital ratio. The study recommends that firms should try to operate using little amounts of loans to avoid higher finance costs which could otherwise be used to invest in other profitable ventures for the firm and even if increased liabilities enlarge repayment obligations curtail free cash flow, a right balance between debt and assets should be used to avoid corporate bankruptcies that can be caused by over-investment which reduces the cash flow and also short-term debt financing should be preferred to long-term debt financing because its associated with less agency costs and thus provides the firm with a lower cost of capital unlike long term debt financing. The study suggests further research to be done using interest rates, competition, and firm size as independent variables to determine the relationship between financial performance and capital structure.