Relationship Between Firm Gearing and Financial Performance of Sugar Processing Companies in Western Kenya Region

Abstract

Gearing is the use of the debt capital to finance activities of the firm. The capital structure of the firm consists of debt and equity. Studies have been done based on capital structure theories on which this research has been anchored on, such as static trade off theory, pecking order theory and agency theory which analyzed the extent, proportion of finance and costs related with the use of gearing respectively. All this theories gave a conflicting results as to whether the relationship between Gearing and Financial Performance was either positively or negatively related or their was no relationship. The purpose of this study was to examine this conflict by investigating the relationship between Firm Gearing and Financial Performance of sugar processing companies in western Kenya region. The specific objective was to; establish determinant, extent of Gearing and the relationship between Gearing and Financial Performance in the capital structure of Sugar processing companies in western Kenya region based on their financial statements from 2009 to 2013 and factors affecting the capital structure decisions The study was guided by the conceptual framework which showed equity and debt as independent variable quantified by the gearing ratios measuring extent of gearing and dependent variables measuring financial performance in the form of ratios to bring out the relationship while the intervening variables measured the determinant of gearing. The population comprised of 364 employees in the finance department of the nine manufacturing companies where random sampling was used to select 187 employees. The research was conducted using descriptive survey research and data panel regression analysis. Primary data was collected using structured questionnaires while secondary data was collected from financial statements and were analyzed using factor analysis and data panel regression: analysis respectively. The study found out that; objective one, as more gearing was used past optimum level it become expensive concurring with trade off and pecking order theories of positive relationship between gearing and financial performance with a correlation of +0.473, objective two found a correlation of +0.551 which concurred with the Modigliani and miller (1968) and trade off theory on the usage of debt which had a positive relationship with financial performance due to interest tax shield making debt a cheaper. source of finance. The third objective found out that their was a strong positive relationship between financial gearing and financial performance at a confidence level of 99%,99% and95% ,R-Squire of 0.9811 %,0.9156% and 0.9346% for return on asset, operating profit margin and net profit margin respectively. The study concluded that indeed their was a strong positive relationship between financial gearing and financial performance concurring with Modigliani and miller (1968) and trade off theories of capital structure. The study is significant as it will help investors to gauge how effective to use debt to finance firm's activities in sugar manufacturing companies and contribute to the literature on relationship between financial gearing and financial performance in public and private sector.