In the name of Allah, the Most Merciful,

the Most Kind.

 Impact of capital structure on profitability of

Textile industries of Pakistan

A Thesis Submitted to the

Superior University
In Partial Fulfillment of the Requirements for the Degree of
Masters of Commerce

By

Maimoona Malik

(12204)

2013

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 Declaration of Originality

I hereby declare that this project is entirely my own work and that any additional sources of
information have been duly cited.
I hereby declare that any Internet sources published or unpublished works from which I have quoted or
draw references fully in the text and in the content list. I understand that failure to do this will result in
failure of this project due to plagiarism.
I understand I may be called for viva and if so must attend. I acknowledge that this is my
responsibility to check whether I am required to attend and that I will be available during the viva
periods.

Signed.

Date.

Name of Supervisor

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Abstract

This study examined the impact of capital structure on profitability of textile sector of Pakistan. A sum
of ten listed companies in stock exchange was put under study for a period of (2010-2012) for this
study I have collected data from financial annual reports and web sites of those companies. Two main
groups of variables were used to point out capital structure i.e. debt ratio, cost of debt and profitability
i.e. net profit ratio. The variables were examined by using cross sectional and time series methodology.
In order to verify the theory, Histogram, Descriptive statistics, scatter plot, correlation and regression
were used of the project. In the correlation capital structure has weak relation and profitability has
weak relation. In regression analysis all independent variables have no effect on profitability.
Keywords: short term assets, long term assets, short term liabilities, long term liabilities and
profitability.

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 ACKNOWLEDGEMENT:

First of all, I am grateful to the Almighty Allah for establishing me to complete this

thesis.

I acknowledge, with gratitude, my debt of thanks to Mam Khansa Iram for her advice

and encouragement. I also thank to my Lecturers, and to all the faculty members of

Department of Commerce for their help and encouragement. I also thank my parents

for their unceasing encouragement and support.

I also place on record, my sense of gratitude to one and all who, directly or indirectly,

have lent their helping hand in this venture.

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 Table of Content

Declaration of Originality I
Abstract II
Acknowledgement... III
Chapter 1: Introduction.. 8
1.1introduction 8
1.2 Purpose statement. 13
1.3 Research Objective.. 13
1.4 Research Question &Hypothesis. 13
1.5 Significance Statement 14
1.6 Terms Definition.. 15
1.7 Conceptual Framework 16
Chapter 2: Literature Review.. 17
Chapter 3: Data/methodology.. 25
3.1 Research paradigm ... 25
3.2 Research Approach .. 26
3.3 Sources of Data... .. 27
3.4 Population and sample.. 27
3.5 Methodology 28
Chapter 4: Analysis ... . 30
4.1 Descriptive Statistics. 30
4.2 Histogram .. 30
4.3 Scattor Plot.. 32
4.4 Correlation... .. 33
4.5 Regression .. 34

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 Chapter 5: Discussion/Methodology 37
5.1 Discussion 37
5.2 Conclusion..... .. 37
5.3 Implications. 38
5.4 Future Research... 38
5.5 Ethical Consideration .. 38
References.. 39

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Impact of capital structure on profitability of textile industries of Pakistan
Chapter # 1:
Introduction:
Pakistans textile industry is a major contributor to the national economy in terms of exports and
employment. Pakistan holds the distinction of being the worlds 4th largest producer of cotton as well
as the 3rd largest consumer in the world. Textile sector is considered as the backbone of the economy.
On the other hand, it is facing tough competition in the international market due to increase in cost of
production, which is making it less competitive than the neighboring countries India, Bangladesh &
China. According to Pakistan Textile Journal, Pakistan is among top 10 textile exporters of the world.
Textile export of world over is about $400 billion out of which China tops the list with present export
of $55 billion, followed by Hong Kong $38 billion, Korea $35 billion, Taiwan $16 billion and
Indonesia, India, Bangladesh and Pakistan $11billion each. During 2010-2011 textile exports of
Pakistan have continued to grow in the first nine months. According to the Federal Bureau of Statistics
(FBS) and the Trade Development Authority of Pakistan TDAP, textile exports grew by 30.38% from
July 2010 to March 2011. It showed a positive sign in the constant dwindling textile industry of
Pakistan; however this increase can be attributed to the rise in the price of cotton and other inputs
along with a significant increase in terms of quantity as well. Pakistan's textile industry is experiencing
one of the hardest periods in decades. The worldwide subsidence which has hit the worldwide textile
truly hard is not the main foundation for concern. Genuine inside issues likewise influenced Pakistan's
textile industry quite severely. The high cost of handling coming about because of a moment ascent in
the energy expenses has been the primary cause of concern for the industry. Pakistani rupee throughout
a year ago has fundamentally raised the cost of transported in inputs. Besides, twofold digit swelling
and energy crisis have influenced the overall textile sector. The absence of research & development
(R&d) in the cotton segment of Pakistan has brought about low quality of cotton in comparison to rest
of Asia. As a result of the consequent low profitability in cotton crops, agriculturists are moving to
other money yields, for example sugar cane. The textile industry has outdated equipment and
machinery with the exception of few major makers. The powerlessness to convenient modernizes the
equipment and machinery has expedited the decrease of Pakistani textile competitiveness. Because of
old innovation the expense of production is higher in Pakistan as contrasted with different nations like

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India, Bangladesh & China. The cost of production of textile rises because of numerous explanations
like expanding interest rate, double digit inflation & decreasing value of Pakistani rupee. The
expanding interest rate brought barriers in opening new manufacturing units &and also increase the
cost of existing units, additionally builds the evacuation of subsidy & execution of new taxes from
government additionally expand the cost of production. The instant increase in cost of electricity
additionally made an expansion in production. The most importantly excuse for why expanded the cost
of production of textile industry which make issue for a textile industry to compete in international
market. As a consequence of load shedding the textile production capacity of various subsectors has
been reduced. The representatives of the all textile associations presented their serious concerns on the
huge losses being incurred due to electricity & gas load shedding and the instant rise in the Electricity
tariff. They said that the industry has already been crippled due to record high load shedding. The
provisions of Finance Bill 2009-10 are not textile industry friendly at all. Provisions like
reintroduction of 0.5% minimum tax on domestic sales, 1% withholding tax on import of textile and
articles, 16% Federal Excise Duty on banking and insurance services besides withdrawal of exemption
of 16% sales tax and 4% withholding tax on machinery and parts in the Finance Bill 2009-10 are badly
affecting already crippled industry. Pakistan textile industry is confronting issue of Low productivity
because of its old textile machineries. To defeat this issue and to stand in rivalry, Pakistan Textile
Industry will require high ventures. US & EU are the major shipper of Pakistan textile which makes an
enormous distinction in export of Pakistan textile in the wake of encroaching a limitation on import of
Pakistani textile merchandise. Prices of cotton & other raw material used in textile industry fluctuate
rapidly in Pakistan. The rapid increase in the price raw material affects the cost of production badly.
Due to increase in the cost of production the demand for export & home as well decreased which
result in terms of downsizing of a firms resulting in unemployment. Due to high cost of production,
power shortage and stiff competition with regional players, the export performance of Pakistan textile
sector is suffering badly. The increment in expansion makes the increment in the expense of
processing of material exceptional which returns in downsizing. The twofold digit expansion is
additionally influencing fares of materials. An alternate issue helping in the poor execution of our
material segment is the unlucky deficiency of effective inventory network administration and unified
structure. Numerous financial and political components farthest point the capability of the exporters to
meet their dedication auspicious and might likewise bring about losing business in future. Proposals
for the development of the material segment are as takes after; Revision of Government arrangements

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is needed There are non-helpful government approaches in term of bank credits and premium rates. It
is the needs of great importance to improve a reasonable arrange by the administration that permits an
exemption/concession to the material segment. For instance as in India; the Export-Import Bank was
set up with the end goal of financing and expediting the commercial ventures, particularly material.
The legislature may give subsidies to impart the load of the industry. Lessening the expense of
working together in Pakistan At present cost of working together in Pakistan is higher as contrasted
with the provincial nations, which has brought about biting aggressiveness to Pakistani Products in
Foreign Markets. China and India are the greater contenders of Pakistan. We fear if cost of working
together in Pakistan is not carried at standard with other Asian nations, our items might discover no
spot in Market both regarding quality and cost. In the connection of anticipated exchange, there is a
pressing need to present to all the utility charges and collect of assessments down to the base level.
Pakistan is a heading sending out country in crude yarn, cotton, and fabrics. In the event that we stress
on the worth included items like pieces of clothing, Hosiery, knitwear and other material made-up, the
fare volume of materials could be expanded by manifolds. In this appreciation top necessity ought to
be given to sewing industry that accelerates most elevated quality expansion and vocation era.
Complex engineering ought to be acquainted with rival the different nations (India, Bangladesh &
China) in the worldwide market in term of expense and quality. The Textile Board may as well secure
a divide preparing wing as a Center of Human Resource Development where instructional classes
ought to be led for the limit building of labor. There is additionally critical need to build the amount of
such Vocational Institutions where present day specialized instruction is furnished. Consistent with
sources, it is assessed that in later past around 800 units have shut in Punjab throughout power and gas
burden shedding while approx. 500,000 specialists lost their employments. To safeguard the industry
there must be a special medicine with the industry in uninterrupted vigor supply. Speculation in Textile
Sector The venture volume is not acceptable in the material part as contrasted with the potential
accessible. Government may as well take genuine venture to survive the material business. Keeping in
mind the end goal to reduction the value crude material for material we have to expand our creation
competence. Pakistan has changing, overwhelming and fare arranged material industry that has an
overpowering effect on economy. Material being biggest modern segment creates the nation's most
elevated fare income of something like 58%; furnishing the majority of work (39%) to all in all under
used workforce, and helps 8.5% to GDP. The biggest assembling industry of Pakistan and the second
biggest business creating industry of Pakistan, after farming, is none other than the material business

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of Pakistan. It helps 60% of the nation's aggregate fares that whole around 5.2 billion US dollars, 46%
of the nation's sum yield handled, eighth biggest exporter of material industry in Asia, indicates 9.5%
of the nation's GDP, and supplies 3% of United states request of apparel and different types of
materials. Notwithstanding, Pakistan is the fourth biggest maker of cotton with third biggest turning
limit, after china and India. Pakistan likewise helps 5% to the worldwide turning limit. Right now, the
material business claims 1,221 ginning units, 442 turning units, 124 extensive turning units and 425
minor units that transform material items. Shockingly, as of now the material business of Pakistan is
under turmoil. There is a genuine need for the All Pakistan Textile Mills Association (APTMA) to
enhance the nature of material items, carry mechanical headways and empower successful
examination and improvement to make the material items as per worldwide necessities and gauges.
Notwithstanding, APTMA has likewise put light on the different elements that have diminished
Pakistani material item's aggressiveness, for example high investment rates, cost of inputs, unfavorable
government strategies and lacking vigor supply. Then again, a few analysts have a perspective that
unlike whatever remains of Asia, the absence of examination and advancement in cotton segment in
Pakistan has brought about more level nature of cotton. Therefore, because of low benefits in cotton
area ranchers are moving to other money harvests, for example sugar stick. Ineptitude of material
industrialists to redesign their gears and apparatuses has diminished their items intensity in the
mechanical commanded planet markets. Also high investment rates have shut down the modest
materials holders while making genuine issues for material magnates. High premium rates dishearten
any trust of speculation for survival or development and similar low investment rates of contenders,
for example Bangladesh, India and China further add to the decrease of the industry globally. An
alternate principle issue that contrarily influences material industry is inaccessibility of satisfactory
power supply by Water and Power Development Authority (WAPDA). Notwithstanding, some
material firms have advanced their own particular force producing plants that run on gas although all
minor material managers have no other alternative yet to depend on WAPDA. Profitability alludes to
the potential of a dare to be monetarily auspicious. This may be evaluated before entering into a
business or it may be utilized to examine a wander that is at present working. It might rather be
possible to change operational variables, for example estimating or expenses. There are three essential
scenarios that can portray a business' budgetary scenario. It could be gainful, it can make back the
initial investment, or it can work at a misfortune. By and large, a conglomeration's objective is to make
a benefit. The point when there is consistent or plenteous money stream, it could be troublesome to

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confirm profitability. It is simple for an individual to make the error of joining various approaching
and friendly transactions with benefit. Using and getting cash, then again, does not mean a business is
in a solid fiscal state. To figure out profitability, it is indispensible to gain entrance to the cost of the
products or administrations being advertised. There are a few things that have to be recognized when
costs are built. This incorporates variable expenses, for example fuel, work, and stock, and it
additionally incorporates settled expenses, for example contract, repairs, and taxes.
Different researchers write different literatures in this era like, Huang, Song (2000) worked on three
variables Capital Structure, China capital market and State Owned Enterprises and the findings was
the structure affects leverage, Different from those in other countries, leverage in Chinese firms
increases with volatility and firms tend to have much lower long-term debt and Zubairi (2000) used
nine variables Profitability, Working Capital, Capital Structure, Operating Leverage, Financial
Leverage, Firm Size, Liquidity, Pakistans Automobile Industry and Panel Data. The results of the
study was there is a statistically significant and negative association between the profitability of the
automobile sector and operating leverage and automobile sector firms is positively and significantly
related to the size of the firms. Similarly, Frank, Goyal (2003) worked on four variables Capital
structure, pecking order theory, tradeoff theory, stakeholder co-investment. Finding of their study was
that net operating loss carry forwards are generally negatively related to leverage as predicted by the
tradeoff theory.
Moreover, Nazir, Afza (2007) worked on four variables, Aggressive Investment Policy, Aggressive
Financing Policy, Return on Assets and Tobins q. They found investors give weight to the stocks of
those firms that adopt an aggressive approach to managing their short-term liabilities and Myers
(2001) use three variables debt and taxes, taxes and the tradeoff theory and the pecking order theory.
The result of his study was there is variation over time, in taxation; information differences and agency
problems are apparently constant. Mesquita, Lara examines three variables capital structure,
profitability and debt. The results indicate that the return rates present a positive correlation with short-
term debt and equity, and an inverse correlation with long-term debt. Similarly, Henry (2003) use nine
variables D/E, GPR, OPR, NPR, ROCE, ROI, D/A, CG and IC. The outcomes of the study guide
entrepreneurs, loan- creditors and policy planners to formulate better policy decisions in respect of the
mix of debt and equity capital and to exercise control over capital structure planning and thereby to
control and reduce bankruptcy costs. There are hundred or thousand of studies were conducted on this
topic but they were in foreign country and are not according to satisfaction level. I am conducting this

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survey to enhance the knowledge in this era in textile sector of Pakistan. The aim of the study is to
understanding textile industries and its impact on profitability.

1.2 Purpose Statement:

The purpose of this study is to determine the impact of capital structure on profitability of textile
industries of Pakistan. In this proposed study short term assets, long term assets, short term liabilities
and long term liabilities are independent variables, which is defined as: A short term asset is an asset
that is to be sold, converted to cash, or liquidated to pay for liabilities within one year. A long term
asset is the value of a company's property, equipment and other capital assets expected to be useable
for more than one year, minus depreciation. Short term liability is a debt or current liability arising
from normal business operations and recurring expenses that is expected to be satisfied within one
year and a long term liability is a Obligation payable in goods or services at a future period more than
12 months away from today or the date of balance sheet. Whereas, profitability is dependent variable,
which is defined as: The state or condition of yielding a financial profit or gain. It is often measured by
price to earnings ratio.

1.3 Research Objective:

1.3.1 main objective
To determine the impact of capital structure on profitability of textile sector of
Pakistan.

1.3.2 Sub Objective:

To determine the impact of short term assets on profitability.
To determine the impact of long term assets on profitability.
To determine the impact of short term liabilities on profitability.
To determine the impact of long term liabilities on profitability.
1.4 Research Question and Hypothesis:
1.4.1 Research Question:
What is the impact of capital structure on profitability of textile industries of Pakistan?

1.4.2 Hypothesis:

H1 = There is relationship between short term assets and profitability.

Ho = There is no relationship between short term assets and profitability.
H2 = There is relationship between long term assets and profitability.
Ho = There is no relationship between long term assets and profitability.

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 H3 = There is relationship between short term liabilities and profitability.
Ho = There is no relationship between short term liabilities and profitability.
H4 = There is relationship between long term liabilities and profitability.
Ho = There is no relationship between long term liabilities and profitability.
1.5 Significance Statement:
This study will be significant in the following ways:
Firstly, it will provide benefit to researcher to know new dimensions and perspectives
in capital structure and its impact on profitability.
Secondly, it will helpful for managers to make new policies, to compete with previous
deficiencies and policy gab.
To make strategies up-dated.
For the investors to make rational decisions.
For the textile industries to maximize their profitability.
This study is better than previous studies because it is conducted in developing country
while others were in developed countries.
It will assist to make effective strategy and investors will also get benefits by this.
As compare to previous researches, a sample size of ten annual reports for three
continuous years will be taken to enhance the knowledge of the study.
Research done on women empowerment in Pakistan is qualitative method but I am
doing by quantitative method.
The previous studies on this topic were qualitative method but I am doing by
quantitative method.

1.6 Terms Definition:

1.6.1 Short Term Assets:
An asset expected to be converted into cash within the normal operating cycle
(usually one year), e.g. accounts receivable and inventory.
1.6.2 Long Term Assets:
A stock, bond or other asset that an investor plans to hold for a long period of
time.
1.6.3 Short Term Liabilities:

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 An account shown in the current liabilities portion of a company's balance sheet. This
account is comprised of any debt incurred by a company that is due within one year.
1.6.4 Long Term Liabilities:
Obligations of the company that become due more than one year into the future.
Long-term liabilities include items like debentures, loans, deferred tax liabilities and
pension obligations.
1.6.5 Profitability:
The ability to achieve financial gain from a sale or other commercial transaction or
the degree to which an individual, company, or single transaction achieves financial
gain.

1.7 Conceptual Framework:

SHORT TERM
ASSETS

LONG TERM
ASSETS PROFITABILIT
Y
SHORT TERM
LIABILITIES

LONG TERM
Impact of capital structure on profitability
LIABILITIES Page 15
 Chapter # 2:
2. Literature Review:
(Sufian & Chong, 2008) Examines the determinants of Philippines banks profitability during the
period 19902005. The purpose of the study was to determine the relation between the well-being of
the banking sector and the growth of the economy. They worked on three variables includes banks,
profitability and Philippines. They collect data from annual bank level data of all Philippines
commercial banks over the period 19902005. The total number of commercial banks in the sample
varied from nine banks in 1990 to 24 banks in 1995. Regression test used for data analysis finally they
found that the size, credit risk, and overhead expensed are negatively related to bank profitability,
while non-interest income and capitalization have a positive impact. (Koak & ok, 2008) Describes
the Ownership structure and profitability of the banking sector. The purpose of the study was to
investigate the relationship between bank ownership and bank profitability in six South-Eastern
European countries. They worked on five variables includes banking, profitability, determinants,
ownership, South-Eastern Europe. They collect data from the Bank Scope database, IFS dataset
provided by IMF and from the EBRD publications. Hausman test was used for data analysis. The
finding of the study was there is a limited difference between the performance indicators for foreign-
owned banks and domestic banks across countries.

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(Bauer & Cromwell, 1989) investigates the effects of bank structure and profitability on the birth of
new firms, an important component of economic development. They worked on two variables the
dependent variable (BIRTHRATE) is the natural log of the ratio of new firm births and independent
variables into two types. The first are measures of local economic conditions, and the second are
measures of bank structure and profitability. Data was collected from 259 SMSAs across the country.
Descriptive and coefficient was used for data analysis. Finally they found that firm births to be
positively associated with low wages, low taxes, and a large number of existing firms. Their analysis
also shows that the private banking sector appears to be systematically related to the probability of
firm births.
(Naceur, 2003) understand the impact of banks characteristics, financial structure and
macroeconomic indicators on banks net interest margins and profitability in the Tunisian banking
industry for the 1980-2000 period. The purpose of the study was to find complementarities between
bank and stock market growth. They worked on four variables includes bank interest margin, bank
profitability, panel data and Tunisia. They collect data from the Central bank data base. The Sample
include the main deposit banks in Tunisia (10 banks) over the period 1980-2000. Econometric model
was used for data analysis finally they found that disintermediation of the Tunisian financial system is
favorable to the banking sector profitability.
(goldstein, ju, & Leland, 1998) explore an EBIT-Based model of dynamic capital structure. The
purpose of the study was to estimate the tax advantage to debt as a difference in flow between the
levered and unlevered firm dynamics after the debt issuance, arguing that a firm which does not take
on tax benefits receives a below fair expected return. They worked on EBIT-Based model. Data was
collected from levered and unlevered firms. Static model of Graham was used for data analysis. A
finding of their study was if dynamic strategies are considered, the tan advantage to debt arises
significantly.
(Amjed, 2007) reckon the impact of financial structure on profitability. The purpose of the study was
investigates the relationship between capital structure and the financial performance of textile sector of
Pakistan. They worked on two variables capital structure, profitability. Data was extracted from the
financial statements of the companies listed on the Karachi Stock Exchange. Descriptive analysis was
used for data analysis. Finally he found that short term debt has significant positive relationship with
the profitability.

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(Heuvel, 2002) worked on the bank capital channel of monetary policy. The purpose of the study was
to examine the role of bank lending in the transmission of monetary policy in the presence of capital
adequacy regulations. They worked on six variables loan, bank debt and securities, equity, capital
regulation, financial constraints and exogenous shocks. Data was collected from banks. Histogram and
distribution tables were used for data analysis. Finding of his study was well-capitalized banks
frequently lend more than they would if they faced no financial constraint in future periods. An
important implication of the relevance of the banks capital adequacy is that shocks to bank profits,
such as loan defaults, can have a persistent impact on lending.
(Gompers & Lerner, 2000) describes the determinants of corporate venture capital success
organizational structure, incentives and complementarities. The purpose of the study was to
comparison of investments made by traditional venture capital organizations with those of venture
funds sponsored by corporations. They worked on dummy variables. Data was collected from
different corporations. Regression was used for data analysis. The results of their study was Corporate
venture investments are significantly more successful than other investments.
(Henry, 2003) explains capital structure and its impact on profitability. The purpose of the study was
to analyze the capital structure and its impact on profit earning capacity during 2003 to 2007 (05
years) financial year of listed manufacturing companies in Sri Lanka. They worked on nine variables
D/E, GPR, OPR, NPR, ROCE, ROI, D/A, CG and IC. Data was collected from listed companies of Sri
Lanka. Descriptive analysis was used for data analysis. The outcomes of the study guide
entrepreneurs, loan- creditors and policy planners to formulate better policy decisions in respect of the
mix of debt and equity capital and to exercise control over capital structure planning and thereby to
control and reduce bankruptcy costs.
(Haron, 2004) explore determinants of Islamic bank profitability. The purpose of the study was to
examine and identify various factors that have a significant influence on banks profitability. He
worked on two variables effects of internal determinants and effect of external determinants. Assumed
and panel data was used. Regression and F-test used for data for data analysis. The results of this study
indicated that banks in a competitive market were better managed than then their counterparts.
Therefore, it is obvious that protectionism policy adopted by Muslim governments is inappropriate and
could distort future development of Islamic banking.
(Havrylchyk, 2006) examines profitability of foreign and domestic banks in Central and Eastern
Europe. The purpose of the study was to analyses the differences in profitability between domestic and

Impact of capital structure on profitability

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foreign Banks. She worked on four variables foreign banks, bank profits, multinational banking and
transition economies. Data was collected from 265 banks from 10 CEEC (Bulgaria, the Czech
Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia) between
1995-2003. All balance sheet and income statement data is taken from Bureau van Dijks Bank Scope
database. Logit model and hausman test was used for data analysis. Findings show that greenfield
banks perform better in terms of ROA than domestic and takeover banks but the profitability of
takeover banks is not significantly different from domestic banks.
(Teruel & Solano, 2007) investigate effects of working capital management on SME profitability. The
object of the study was to provide empirical evidence on the effects of working capital management on
the profitability of a sample of small and medium-sized Spanish firms. They worked on three variables
Profit, Small to medium-sized enterprises and Working capital. Data was collected from a panel of
8,872 small to medium-sized enterprises (SMEs) covering the period 1996-2002. Panel data
methodology was used for data analysis. Findings of their study was the presence of endogeneity,
demonstrate that managers can create value by reducing their inventories and the number of days for
which their accounts are outstanding. Moreover, shortening the cash conversion cycle also improves
the firm's profitability.
(Mesquita & Lara) had reckoned the capital structure and profitability. The purpose of the study was
to examine the Influence of the capital structure of Brazilian companies regarding the factor
profitability. They worked on three variables capital structure, profitability and debt. Data was
collected from financial statements of 70 companies Industrial, commercial and service firms -
operating in the Brazilian market, covering the period that includes the fiscal years 1995-2001.
Regression model was used for data analysis. The results indicate that the return rates present a
positive correlation with short-term debt and equity, and an inverse correlation with long-term debt.
(HARRIS & RAVIV, 1990) worked on capital structure and the informational role of debt. The
purpose of the study was is to provide a theory of capital structure based on the effect of debt on
investors' information about the firm and on their ability to oversee management. They worked on
variables debt and liquidation. They collect data from different debt holders. Statical tests used for data
analysis. They found that managers are reluctant to relinquish control and unwilling to provide
information that could result in such an outcome. Debt is a disciplining device because default allows
creditors the option to force the firm into liquidation and generates information useful to investors.

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(Huang & Ritter, 2004) understand the testing the market timing theory of capital structure. The
purpose of the study was to examine time-series patterns of external financing decisions. They worked
on three variables static tradeoff theory, pecking order theory and market timing theory. Data was
collected from CRSP and Compustat. The sample consists of firms from 1963 to 2001. Regression,
scatter plot and logit model was used for data analysis. Finally they found that the market timing
theory over alternative theories as an explanation for observed time-series patterns of external
financing decisions of U.S. publicly traded firms they also explore the importance of the implied
equity risk premium for corporate financing decisions in other countries.
(Froot & Stein, 1997) highlighted the risk management, capital budgeting, and capital structure policy
for financial institutions. The purpose of the study was to develop a framework for analyzing the
capital allocation and capital structure decisions facing financial institutions. They worked on three
variables risk management, financial institutions and capital allocation. Data was collected from
different banks, derivatives used foe data analysis. Finally they found that value-maximizing banks
have a well-founded concern with risk management and not all the risks they face could be frictionless
hedged in the capital market.
(LEMMON, ROBERTS, & ZENDER, 2008) describe the persistence and the cross-section of
corporate capital structure. The purpose of the study was to address these questions. Specifically, we
quantify the extent to which existing determinants govern cross-sectional and time-series variation in
observed capital structures by examining the evolution of corporate leverage ratios. They worked on
dummy variables. Data was collected from nonfinancial firm-year observations in the annual
Compustat database between 1965 and 2003.3 they require that all firm-years have non-missing data
for book assets, while all multivariate analysis implicitly requires non-missing data for the relevant
variables. Descriptive statics used for data analysis. Findings of their study were show that the
majority of variation in capital structure is time-invariant and that much of this variation is
unaccounted for by existing empirical specifications. (Padachi, 2006) explain the trends in working
capital management and its Impact on firms Performance. The purpose of the study was to examine
the trends in working capital management and its impact on firms performance. The trend in working
capital needs and profitability of firms are examined to identify the causes for any significant
differences between the industries. They worked on four variables inventories days, accounts
receivables days, accounts payable days and cash conversion cycle. Data was collected from 58 small
manufacturing firms, using panel data analysis for the period 1998- 2003. Regression used for data

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analysis finally he found that the paper and printing industry has been able to achieve high scores on
the various components of working capital and this has positively impact on its profitability.
(Myers, 2001) explores Capital Structure. The purpose of the study was to explain the mix of securities
and financing sources used by corporations to finance real investment. They worked on three variables
debt and taxes, taxes and the tradeoff theory and the pecking order theory. Data was collected from
several useful conditional theories. The result of his study was there is variation over time, in taxation;
information differences and agency problems are apparently constant.
(Olufunso, Herbst, & Lombard, 2010) investigated the impact of the usage of debt on the profitability
of small and medium Enterprises (SMEs) in the manufacturing sector. They worked on four variables
SMEs, debt, profitability and accessibility. Data for the study was gathered through self-administered
questionnaires, which involved a direct and face-to-face meeting between the researcher and the
respondent. Multiple regression equation was used for data analysis. The result of the study was
commercial banks undertake a substantial public awareness campaign on their requirements from
SMEs who intend to request for credit. This will help to eliminate the problems, and also increase
awareness of the criteria that commercial banks set for the financing of small firms.
(Bektas, 2006) reckon the test of market structure and profitability in liberalizing the deposit market.
The purpose of the study was to investigate the profitability determinants of North Cyprus depository
institutions. They worked on four variables, market structure, banking, profitability and North Cyprus.
Data was collected from 30 commercial banks and 24 cooperative financial institutions for the period
1991-1997. Regression equation was used for data analysis. Findings of his study were the absence of
collusion reflects fair pricing of banking services and this is good for the economy in general.
(Nazir & Afza, 2009) worked on impact of aggressive working capital management policy on firms
profitability. The purpose of the study was to investigate the traditional relationship between working
capital management policies and a firms profitability. They worked on four variables, Aggressive
Investment Policy, Aggressive Financing Policy, Return on Assets and Tobins q. Data was collected
from 204 non-financial firms for the period 1998-2005. Regression model, t-statistics was used for
data analysis. Finally they found investors give weight to the stocks of those firms that adopt an
aggressive approach to managing their short-term liabilities.
(Schmalensee, 1989) describes inter-industry studies of structure and performance. The purpose of the
study was investigating the relations among various measures of market structure, conduct and
performance. They worked on four variables measure of profitability, accounting problems, measures

Impact of capital structure on profitability

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of concentration and measures of entry barriers. Data was collected from different industries. T and F-
statistics was used for data analysis. Finally he found differences related to the nationality of
diversifying entrant firms.
(Sunder & Myers, 1999) explores testing static tradeoff against pecking order models of capital
structure. The purpose of the study was tests traditional capital structure models against the alternative
of a pecking order model of corporate financing. They worked on four variables Financing, Capital
structure, Static tradeoff theory, Pecking order theory. Data was collected from 157 firms, Frequency
distributions was used for data analysis. Finally they found firms plan to finance anticipated deficits
with debt.
(Frank & Goyal, 2003) explain capital structure decisions. The purpose of the study was to examine
the relative importance of 39 factors in the leverage decisions of publicly traded U.S. firms. They
worked on four variables Capital structure, pecking order theory, tradeoff theory, stakeholder co-
investment. Data was collected from the Center for Research in Security Prices for stock return and
macroeconomic data are from various public databases. Linear regressions were used for data analysis.
Finding of their study was that net operating loss carry forwards are generally negatively related to
leverage as predicted by the tradeoff theory.
(Jiraporn & Liu, 2007) Highlighted the capital structure, staggered boards, and firm value. The
purpose of the study was to investigate whether staggered boards influence capital structure choices.
They worked on four variables capital structure, classified boards, staggered boards, corporate
governance. Data was collected from 13,459 firm from 1990 to 2004. Descriptive Statistics used for
data analysis. Finally they found that firm value is affected by abnormal leverage that can be attributed
to the presence of staggered boards.
(Zubairi, 2000) Describe impact of working capital management and capital structure on profitability
of automobile firms of Pakistan. The aim of the study was to Investigates how profitability of firms, in
the automobile sector of Pakistan, is influenced by working capital management and capital structure
of firms. They worked on nine variables Profitability, Working Capital, Capital Structure, Operating
Leverage, Financial Leverage, Firm Size, Liquidity, Pakistans Automobile Industry and Panel Data.
Data was collected from seven firms out of thirteen automobile sector companies presently quoted on
the Karachi Stock Exchange 2000-2008. Descriptive statistics used for data analysis. The results of the
study was there is a statistically significant and negative association between the profitability of the

Impact of capital structure on profitability

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automobile sector and operating leverage and automobile sector firms is positively and significantly
related to the size of the firms.
(Titman & Wessels, 1988) Reckoned the Determinants of Capital Structure Choice. The aim of the
study was to analyze the explanatory power of some of the recent theories of optimal capital structure.
They worked on seven variables Collateral Value of Assets, Non-Debt Tax Shields, Growth,
Uniqueness, Industry Classification, Volatility and Profitability. Data was collected from Annual
Compustat Industrial Files 1974-1982. Different model were used for data analysis. Their result does
not provide support for an effect on debt ratios arising from non-debt tax shields, volatility, collateral
value, or future growth.
(Welch, 2004) explores capital structure and stock returns. The aim of the study was to investigate
capital structure changes into effects caused by corporate issuing net of retirement activity and into
effects caused by stock returns. They worked on two variables IDR and ADR. Data was collected from
Compustat and Center for Research in Security Prices (CRSP) files 1962-2000. Regression was used
for data analysis. Findings of the study was the stock returns are a first order determinant of debt
ratios, that they are perhaps the only well understood influence of debt ratio dynamics, and that many
previously used proxies seem to have helped explain capital structure dynamics primarily because they
correlated with omitted dynamics caused by stock price changes.
(Huang & Song, 2000) Describes the determinants of capital structure. The purpose of the study was to
investigate the determinants of capital structure in Chinese listed companies and investigates whether
firms in the largest developing and transition economy of the world entertain any unique features.
They worked on three variables Capital Structure, China capital market and State Owned Enterprises.
Data was collected from more than 1000 Chinese listed companies up to the year 2000. Descriptive
statistics was used for data analysis. The results that structure affects leverage, Different from those in
other countries, leverage in Chinese firms increases with volatility and firms tend to have much lower
long-term debt.

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Chapter # 3:
Data/methodology

3.1 Research Paradigm:

3.1.1 Positivism:
Positivist assumes that true knowledge is based on experience of senses and can be obtained by
observation and experiment. Positivistic thinkers adopt scientific methods as a means to generate
knowledge. It is used for knowledge based on: determination or cause and effect thinking, to intent the
ideas into small, discrete set of ideas to test, such as variables that constitutes hypothesis and research
question. Detailed observation and measurement of objective variables that exists out there in the
world and for the testing of theories that is continually refined.
3.1.2 Interpretivism:
Sometimes also called Constructivism, social contructivism and qualitative research. Assumptions
identifies in this paradigm, that individuals seek an understanding of the world in which they live and
work. They develop subjective meanings of their experiences or toward certain objects or things.

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These meanings are varied and multiple, leading the researcher to look for the complexity of views
rather than narrowing meaning into few categories. The objective of the researcher, then, is to rely as
much as possible on the participants view of the situation being studied.
3.1.3 Pragmatism:
The final paradigm is typically associated with mixed method research. The object of pragmatic
research is not to replace either of these approaches but rather to draw from the strengths and minimize
the weaknesses of both in single research studies. The focus is on the consequences of the research, the
primary importance on the questions asked rather than the method, and multiple methods of data
collection inform the problem under study. Thus it is concerned with application what works and
solutions to the problems. Instead of methods being important, the problem is most important and
researchers use all approaches to understand the problems.
The research paradigm that is adopted is positivism because Positivist assumes that true knowledge is
based on experience of senses and can be obtained by observation and experiment. Positivistic
thinkers adopt scientific methods as a means to generate knowledge. Means to this paradigm if
research is positivist then knowledge is true.

3.2 Research Approach:

3.2.1 Quantitative:
Quantitative research is a formal, objective, systematic process in which numerical data is utilized to
obtain information about the world. Quantitative research in inclined to be deductive. In other words
it tests theory. Survey is a quantitative research strategy that involves the structured collection of data
from pre-determined sample. It involves questionnaire, structured interview and structured
observation.
3.2.2 Qualitative:
Qualitative research is an informal, subjective, semi systematic research approaches that usually
emphasizes the words rather numbers in the collection and analysis of data and it is inductive in
nature. In other words it generates theory. It involves interview, focus group, document analysis and
unstructured observation.
3.2.3 Mixed method:
Mixed methods research based on pragmatic, a mixed methods research is one that integrates both
quantitative and qualitative research approaches by collecting both numerical as well as text data with

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a central premise to better understand the research problems that either approaches alone. It is also
called multi method research.
The important thing is to the selection of approaches this is the nature or research problem. So, I have
decided to choose deductive or quantitative research approach. The reason of selection is that it is the
collection of numerical data and analysis of data that would be required for testing and verifying of
this theory.

3.3 Sources of Data:

3.3.1 Primary sources:
Primary sources are the first occurrence of a piece of work. They include published sources such as
reports and some central and local government publications such as white papers and planning
documents. They also include unpublished manuscript sources such as letters, memos and committee
minutes that may be analyzed as data in their right. It includes reports, conference proceedings and
theses.
3.3.2 Secondary sources:
Secondary sources such as books and journals are the subsequent publication of primary sources.
These publications are aimed at a wider audience. They are easier to locate than primary sources as
they are better covered by the tertiary sources. It includes journals, books and newspapers.
In this study I use secondary source of data which is annual reports data ten textile industries.

3.4 Population and sample:

. The proposed population for this study is textile sector of Pakistan. A
Sample of 10 textile industries annual reports will be selected using simple random sampling
technique based on Probability sampling procedures.
Table:

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Sr.no Company name Current status of co. Years
1 Azgard Nine ltd Loss in 2012 2009-2012
2 Gul Ahmed textile mills ltd Loss in 2012 2010-2012
3 Kohinoor textile ltd Profit in 2012 2010-2012
4 Mehmood textile ltd Profit in 2010 2008-2010
5 Nishat (chunian) ltd Profit in 2012 2008-11-12
6 Nishat mills ltd Profit in 2012 2010-2012
7 Sajjad textile mills Profit in 2012 2010-2012
8 Sapphire textile mills ltd Profit in 2010 2000-09-10
9 Shams textile mills Profit in 2012 2010-2012
10 Cresent textile mills ltd Loss in 2012 2010-2012
3.5 METHODOLOGY:
Descriptive statistics includes statistical procedures that we use to describe the population we are
studying. The data could be collected from either a sample or a population, but the results help us
organize and describe data. Descriptive statistics can only be used to describe the group that is being
studying. That is, the results cannot be generalized to any larger group. Inferential statistics is
concerned with making predictions or inferences about a population from observations and analyses of
a sample. That is, we can take the results of an analysis using a sample and can generalize it to the
larger population that the sample represents. In order to do this, however, it is imperative that the
sample is representative of the group to which it is being generalized. We selected of the test from
descriptive and from inferential which are:
A set of brief descriptive coefficients that summarizes a given data set, which can either be a
representation of the entire population or a sample. The measures used to describe the data set are
measures of central tendency and measures of variability or dispersion.
A bar graph of a frequency distribution in which the widths of the bars are proportional to the classes
into which the variable has been divided and the heights of the bars are proportional to the class
frequencies.
A graph of plotted points that show the relationship between two sets of data. In a Scatchard plot,
assumptions of independence in linear regression model is violated because B is used in the X and Y
axes. Generally, Scattor plot and Lineweaver-Burk plots are outdated. Their original intention was to
transform the data into linear representations of the original data such that linear regression methods
could be applied. These transformations frequently distort experimental error and can be misleading if
results are not accurate.

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Correlation is a statistical measure that indicates the extent to which two or more variables fluctuate
together. A positive correlation indicates the extent to which those variables increase or decrease in
parallel; a negative correlation indicates the extent to which one variable increases as the other
decreases.

Regression is a statistical technique used to find relationships between variables for the purpose of
predicting future values. It includes many techniques for modeling and analyzing several variables,
when the focus is on the relationship between a dependent variable and one or more independent
variables. More specifically, regression analysis helps one understand how the typical value of the
dependent variable changes when any one of the independent variables is varied, while the other
independent variables are held fixed.

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Chapter # 4:
Analysis
4.1 Descriptive Summary:
Descriptive Statistics
N Minimum Maximum Mean Std. Deviation

short term assets 30 8.350600000000E6 1.958967353400E10 3.90583601776667E9 5.092065223895301E9

long term assets 30 2.978630000000E5 2.619867463600E10 4.52923640030000E9 5.965458854697030E9

short term liabilities 30 8.574670000000E6 2.205645887400E10 4.36471371016667E9 5.358833589657175E9

long term liabilities 30 2.065970000000E5 7.381033769000E9 1.20474999643333E9 1.806845087456162E9

return on asset 30 1.571214000000E-3 1.880357530000E-1 .06796719780000 .060569019339302

Valid N (listwise) 30

Interpretation:
Descriptive statistics is the discipline of quantitatively describing the main features of a collection of
data. Table one represent the descriptive value of following variables, short term assets, long term
assets, short term liabilities, long term liabilities and return on asset. The minimum value of our data is
varying between ranged from (8.5-1.5), maximum value ranged from (7.3-1.8), mean (4.5-0.06) and
the standard deviation varying between (5.9-0.06). The results shows that is no consistency between
variables.

4.2 Histogram:

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 Figure
figure
Figure 2
1

Interpretation:
Figure 1 shows the graphical representation of short term assets which has a slope to greater values
and our data is positively skewed and figure 2 shows the graphical representation of long term assets
which has a slope to greater values and our data is positively skewed.

Figur
Figure
Figure
4
3

Interpretation:
Figure 3 shows the graphical representation of short term liabilities which has a slope to greater values
and our data is positively skewed and figure 4 shows the graphical representation of long term
liabilities our data is positively skewed.

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 Figure
5

Interpretation:
Figure 5 shows the graphical representation of return on asset. Our data is approximately normal
distributed.

4.3 Scattor plot:

Figure
11
Figure
Figure
2
1

Interpretation:
Figure 1 shows that there is positive trend between return on asset and short term assets because the
linear line moves from down to upward and the significant value is more than 0.05(quadratic value is
0.154 and linear value is 0.038) . In figure 2 there is no trend between return on asset and long term
assets because the linear line moves straight and the significant value is more than 0.05(quadratic
value is 0.007 and linear value is 4.14).
Figure
3

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 Figure Correlations Figure
3 4 term assets
short long term assets return on asset
**
Spearman's rho short term assets Correlation Coefficient 1.000 .968 -.024
Sig. (2-tailed) . .000 .901
N 30 30 30
long term assets Correlation Coefficient .968** 1.000 -.030
Sig. (2-tailed) .000 . .877
N 30 30 30
return on asset Correlation Coefficient -.024 -.030 1.000
Sig. (2-tailed) .901 .877 .
N 30 30 30

**. Correlation is significant at the 0.01 level (2-tailed).

Interpretation:

Figure 3 shows that there is positive trend between return on asset and short term liabilities because
the linear line moves from down to upward and the significant value is less than 0.05(quadratic value
is 0.053 and linear value is 0.008). In figure 4 there is positive trend between return on asset and long
term liabilities because the linear line moves down to upward and the significant value is less than
0.05(quadratic value is 0.09 and linear value is 0.064).
Figure
3

4.4 Correlation:
Table 1.1

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Interpretation:
Table 1.1 represents the table of correlations. Where three variables short term assets and long term assets
are positively correlated to profitability (r= 1.000, p = o, and r= .965, p= .000, respectively). Return on asset is
negatively correlated to the perceived profitability (r= -.024, p = .901). The magnitudes of the above discussed
two correlations are greater than 0.70 in the absolute terms, which shows the strong correlations between the
said pairs of the variables but the correlation of return on asset is lesser than 0.33 in absolute terms, which
shows the weak correlation.

Table 1.2

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 Correlations
short term liabilities long term liabilities return on asset

short term liabilities Pearson Correlation 1 .693** .092

Sig. (2-tailed) .000 .629

N 30 30 30

long term liabilities Pearson Correlation .693** 1 .253

Sig. (2-tailed) .000 .177

N 30 30 30

return on asset Pearson Correlation .092 .253 1

Sig. (2-tailed) .629 .177

N 30 30 30

**. Correlation is significant at the 0.01 level (2-tailed).

Interpretation:
To investigate if there was a statistically significant association between return on asset, short term
liabilities and long term liabilities a correlation was computed. All the variables were approximately
normal there is linear relationship between them hence fulfilling the assumptions for Pearson's
correlation. Thus, the Pearsons r is calculated, r= 0.092, p < .529 relating that there is highly
significant relationship between the variables. The positive sign of the Pearson's test value shows that
there is positive relationship. Using Cohens (1988) guidelines the effect size is large relating that
there is strong relationship all variables.

4.5 Regression:
Variables Entered/Removed
Model Variables Entered Variables Removed Method

1 long term liabilities, short term liabilities, long term assets, short term assets . Enter

a. All requested variables entered.

b. Dependent Variable: return on asset

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 Model Summary
Model R R Square Adjusted R Square Std. Error of the Estimate

1 .516a .267 .149 .055865531467614

a. Predictors: (Constant), long term liabilities, short term liabilities, long term assets, short term assets

ANOVAs
Model Sum of Squares df Mean Square F Sig.

1 Regression .028 4 .007 2.272 .090a

Residual .078 25 .003

Total .106 29
a. Predictors: (Constant), long term liabilities, short term liabilities, long term assets, short term assets
b. Dependent Variable: return on asset

Interpretation:
The value of the coefficient of determinations R square is .257. This shows that the correlation
between the observed values of short term assets, long term assets, short term liabilities, long term
liabilities and the fitted value of the return on asset is 25% percent. The adjusted coefficient of
determination adj. R square shows is adjusted for the degrees of freedom. The value of the adjusted
coefficient of determination adj. R square is not affected. The value of the adjusted coefficient of
determination adj. R square is .149, which shows that 14% variations in profitability.

Coefficients
Unstandardized Coefficients Standardized Coefficients

Model B Std. Error Beta t Sig.

1 (Constant) .061 .013 4.529 .000

short term assets 1.517E-12 .000 .128 .149 .883

long term assets -1.188E-11 .000 -1.170 -2.308 .030

short term liabilities 5.708E-12 .000 .505 .631 .534

long term liabilities 2.485E-11 .000 .741 1.530 .139

a. Dependent Variable: return on asset

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Interpretation:
The coefficient table presents the results of the regression analysis. The objective of the regression in
this study is to find such an equation that could be used to find the impact of capital structure (short
term assets, long term assets, short term liabilities and long term liabilities) on profitability (return on
asset). The specified regression equation takes the following form:

4.5.1 Regression Equation:

1. Y= a + b X

Return on asset = .051 + 1.517(sort term assets)

2.
Return on asset = .051 + (-1.188) (long term assets)
3.
Return on asset = .051 + 5.708 (short term liabilities)
4.
Return on asset = .051 + 2.485 (long term liabilities)

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Chapter # 5
Discussion/Conclusion
5.1 Discussion:
In this study we have determined the relationship between capital structure and profitability. Our
research is based on financial management of textile sector. The topic of our study was investigating
the impact of capital structure on profitability. We have used different kind of techniques for checking
the effect of independent variable on the dependent variable. A sum of 10 textile companies listed in
stock exchange was put under study for period of three years (2010-2012). For this study I have
collected data from the financial annual reports. We have used different statistical tools descriptive
analysis, correlation for getting the overall results of our study. We found through these techniques that
overall result of our study is significant positive and negative relationship.
Second chapter consist of literature of different researchers and world views. Methodology chapter
consist overall data analysis to be conducted and how it would further generate the output. The
elements of the methodology of data are research paradigm which is positivism, research approach
which is quantitative, sources of data which is annual reports and secondary source, population is
textile sector with a sum of 10 textile industries. After the collection of data SPSS software is used for
the purpose of data analysis. Descriptive and inferential analysis was used.

5.2 Conclusion:
This study examined the relationship between capital structures on profitability of textile sector of
Pakistan over the period 2010-2012. A sum of ten listed companies in stock exchange was put under

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study for a period of (2010-2012) for this study I have collected data from financial annual reports and
web sites of those companies. Two main groups of variables were used to point out capital structure
short term assets, long term assets, short term liabilities, long term liabilities and profitability i.e.
return on asset. The variables were examined by using cross sectional and time series methodology. In
order to verify the theory, Histogram, Descriptive statistics, scatter plot, correlation and regression
were used. In this study profitability has been used as dependent variable while long term assets, short
term assets, long term liabilities and short term liabilities used as the independent variables. The
purpose of this study is to guide both researcher and policy makers, to develop and implementation of
such policies that improve the profitability in textile sector. Using the time series and cross sectional
methodology it was discovered that total liabilities are insignificant in determining profitability.
Descriptive analysis is used to describe the data by using descriptive summary. Correlation analysis
used to describe the relation between variables by checking the acceptance or rejection of hypothesis
and to see the nature of relationship between variables. In the correlation capital structure has weak
relation and profitability has weak relation. In regression analysis all independent variables have no
effect on profitability.

5.3 Implications:
The purpose of this study is to guide both researcher and policy makers, to develop and
implementation of such policies that improve the profitability in textile sector. Secondly, it will
helpful for managers to make new policies, to compete with previous deficiencies and policy gab. For
the investors to make rational decisions. It will assist to make effective strategy and investor will also
get benefits by this.

5.4 Future Research:

In future research on capital structure and profitability can be conduct on a vast level. I use long term
assets, short term assets, long term liability and short term liability as dependent variables and
profitability as dependent variable but in future this research can be conduct on other variables that can
affect profitability. In future this research can be held with qualitative or mixed method with a different
approach and research paradigm and sources of data can be primary or tertiary. Sample or population
size can be increased or decreased according to situation.
5.5 Ethical Consideration:

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The subject of study will be briefed about the nature of study before collecting data. The data provided
by respondents will be kept confidential. Further, a permission form will be signed from the
participant before they engage in research in order to protect the participant right.

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