Capital structure and financial performance: A study of listed trading companies in Sri Lanka

Capital structure choice is an important decision for a firm. It is important not only from a return maximization point of view, but also this decision has a great impact on a firm's ability to successfully operate in a competitive environment. The ability of companies to carry out their stakeholders’ needs is tightly related to capital structure. Therefore, this derivation is an important fact that we cannot omit. Capital structure in financial term means the way a firm finances their assets through the combination of equity, debt, or hybrid securities (Saad, 2010). This study investigates the relationship of capital structure and financial performance of trading companies which are listed in CSE (Colombo Stock Exchange) from 2007 to 2011. The results show that debt ratio is negatively correlated with all financial performance measures [Gross Profit (GP); Net Profit (NP); Return on Equity (ROE) and Earnings Per Share (EPS)] similarly debt-equity ratio (D/E) is negatively correlated with all financial performance measures except GP and only (D/E) ratio shows significant relationship with NP. R2 (Regression) value of financial performance ratios indicate that 36.6%; 91.6%; 36% and11.2% to the observed variability in financial performance is explained by the debt/equity and debt ratios.