Nexus between firm fundamentals and financial leverage in Nepalese nonfinancial firms (original) (raw)
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SSRN Electronic Journal, 2017
This research of the relationship of firms' financial leverage with firms' performance is based on six year (2008-2013) financial record of 151 textile companies. The net profit before tax (NPBT) has been used as proxy to represent the firm profitability while total debt as a ratio of total equity has been defined as financial leverage. Of the total, 17 firms (11%) have been found with negative NPBTs, 36 firms (24%) have positive NPBTs and 98 firms (65%) have mix NPBTs (having positive for some years and negative for some years). The trend analysis suggests that on average financial leverage of negative NPBT yielding firms remained at-28.756 and increased by 2.747 every year during the period of 2008 to 2013. While the average leverage of mixed NPBT yielding firms remained positive at 1.939 and increased by 0.174 every year, and the average leverage of positive NPBT yielding firms remained at 1.547 and decreased by 0.007 every year during the studied period (2008-13). Leaving negative NPBT yielding firms aside, the average leverage of mixed NPBT yielding firms is higher (1.939) and has been being increased (0.174 per year) while that of positive NPBT yielding firms is relatively lower (1.547) and has decreased (0.007 per year). suggest that there is an inverse relationship between leverage and profitability; for every one unit of leverage (L) increase, profitability (NPTA) decreases by 0.016 units. The results of the Quadratic form are reproduced, as follows: NPTA = 0.122-0.036L + 0.003L 2. Taking the F.O.C, and solving for L helps us estimate L = 6. These results suggest that with L = 0, the NPTA estimates at 0.122 (net profits are 12.20% of total assets) and with L = 6, NPTA minimizes at 0.014 (net profits drops to 1.40%). The existence of statistically significant inverse relationship between firms' profitability and financial leverage persuades one to recommend that financial leverage be kept and managed as low as possible for greater firms' profitability.