Effect of Capital Structure on Financial Performance of Non Financial Firms Listed at the Nairobi Security Exchange

Abstract

The company’s financial health is measured by the cash flows, if the cash inflows are more than the cash outflows at any given time; it is considered a good sign for the organization. In Kenya, interest on debt is tax deductible, thus the use of debt to finance the operations of a firm is an advantage on one side as debt interest will be tax deductible. Every organization expects a capital structure best fitted to its situation and one that simultaneously minimizes the cost of capital and maximizes the value of the firm. This study sought to investigate the impact of capital structure on financial performance of non listed financial firms. The study adopted descriptive research design. The target population for the study consisted of 47 non financial firms listed at NSE. The collected data was analyzed using SPSS software. The study found out that 17.5% change in capital structure among non financial firms listed on the NSE is explained by the four independent variables of the study (Financial Leverage, Solvency, Size, and GPD Growth Rate), moderate negative correlation exists between financial leverage of non financial firms listed at NSE and financial performance, a strong positive relationship exists between solvency and financial performance and that a strong positive correlation exists between the size of the non financial firm and financial performance. The study concludes that capital structure affects financial performance of the non financial firms listed at NSE. The study further concludes that statistically significant association exists between the independent variables (leverage, solvency, and size and GDP growth rate) and the dependent variable financial performance among non financial listed firms on NSE. The study recommends that the management of all non financial firms listed at NSE should judiciously strike a balance between the debts and equity in their capital structure. Non financial listed firms should not have too much debt (leverage) in their capital structure as this increase the risk of insolvency. Non financial firms listed at NSE should have considerable levels of debts in their capital structure so as to enjoy the interest tax shield that accrue from the use of debts in the capital structure, non financial firms listed at NSE should also enhance their solvency positions by proper working capital management practices. This calls for shortening of their cash conversion cycles. Sound management of accounts receivables, accounts payables, inventory and cash of non financial firms will also enhance their solvency and therefore their ability to meet short term obligations as and when they fall due, there is also need for non financial listed firms at NSE to employ growth strategies that will see their increment in sizes. An increase in size will enable non financial firms to enjoy the advantages of economies of scale that accrue out of large scale of operations. This will enhance their financial performance and the central bank of Kenya CBK should put in place sound fiscal and monetary policies that will enhance growth in GDP. Some of these policies should include devaluation of the local currency in respect to foreign currencies and improvement in infrastructure. Devaluation of the domestic currency will boost the exports and therefore growing the GDP that will increase financial performance of non financial firms listed at the NSE.