Examining The Financial Factors Affecting Profitability Of Firms

Major factors affecting the profitability of firms

There has been a continuous debate going on about the factors affecting the profitability of the firms. On one hand some scholars argued that the financial factors such as the assets, firm size, capital structure and other related factors(Salavou, 2002; Akpan and Riman, 2012; Akram, 2014; Ahmed, 2015; Hailu, 2015; Mistry and Savani, 2015; Goel, 2016). On the other hand some scholars argue that the along with the financial factors there are other non-financial factors which affect the profitability of the firms, such as the corporate governance and the business environment of the company where the firm is operating(Cheffins, 2011; Alzoubi and Hisyam Selamat, 2012; Akbar, 2015; Ali, 2016). The current research is aimed to examine the financial factors affecting the profitability of the firms.  Five different firms has been selected for the analysis purpose. These firms include SKY plc, BAE plc, BP plc, SDN plc and British American Tobacco.

There are many factors which affect the profitability of a firm. The main motive of the all the firms (except the not for profit organization) is to maximize the profit. So, it is important to identify the factors which affect the profitability of the firm. If the firms are not able to identify those factors, it becomes very difficult for the firms to survive in the current competitive world. There are many factors which can be taken into consideration such as the capital structure of the firm, the performance of the employees, investment opportunities etc. However on the basis of the previous literature it has been found that the factors such as the debt, equity, firm size etc are the major factors(Akpan and Riman, 2012; Ahmed, 2015; Mistry and Savani, 2015). So, the current research is to examine the impact of such factors on the profitability of the selected firm. Other objectives of the research includes;

To examine the capital structure of the selected firm

To examine the impact of various financial factors on the profitability of the firm

To recommend on the basis of the results from the data analysis

Q1. What are the major factors affecting the profitability of the firm?

Q2. What is the magnitude of the effect of each factors on the profitability of the firm?

This section has been devoted to provide an overview about the existing research in the current field. Literature review will help the researcher to not only get to know what has already been studied in this research area but also to find the research gap. There has been many researches which were aimed to identify the major factors affecting the profitability of the firm.  Some of the major researches and their findings are discussed below:

Magnitude of impact of each factor on profitability

(Mohammed, Kovan and Islam, 2017) examined the impact of the capital structure on the profitability of the firms taking into account the microfinance institution in Iraq. Using the secondary data from 171 employees in those institutions authors concluded that the proportion of equity on the microfinance institutions was increasing and the capital structure and profitability are significantly related. On the other hand a study by (Welch, 2011)identified different factors which may affect the profitability of the firm. These factors includes:

Political- legal environment

Economic environment

Tide of the market

Unemployment

Social –cultural environment

Technological environment

On the basis of the results from the data analysis authors concluded that these external factors have also significant impact on the profitability. However the magnitude of the internal factors is higher than the external factors. Authors have used both the correlation and regression analysis to examine the impact(Supa Tongkong, 2012; Vergas1, Cerqueira1 and Brandão1, 2015).

Another study by (Wahab and Ramli, 2014) also conducted a study to identify the factors which affect the profitability of the firms. In this research the profitability of the firm was measured in terms of return on assets and the major factors identified were debt level, efficiency of the capital and the leverage of the firms. Author used regression analysis to examine the impact and the results from the statistical analysis show that these factors have significant impact on the return on assets.  Furthermore in another study by (ONSOMU, 2014)examined the impact of some specific factors on the firms’ profitability taking into consideration the firms in the food sector. Secondary data was collected for the time period 2002- 2006. The major factors taken into consideration for the analysis includes debt to equity ratio, growth, size of the firm and macroeconomic factors.  Authors have used correlation, regression and granger causality test to examine the relationship between the dependent and the independent variables(In et al., 2012; Shukla et al., 2013).

So, on the basis of the literature review it can be said that the major techniques used to examine the impact of different factors on the profitability of the firms includes the correlation analysis, regression analysis and the granger causality between the variables. So in the current research also the regression and correlation analysis has been used. The granger causality requires more research and data, which can be used in future research.

Data collection

For the current research secondary data has been collected for five different firms namely the Sky Plc, British American Tobacco Plc, BAE plc BP plc and SDL LN Plc. The selection of the firms was based on the objectives of the firm and also the availability of the data. The data has been collected from the open source data base of Yahoo Finance as all the firms are listed on the stock market. The data for each firm was stored on excel for further analysis. The data has been collected for the time perioe 2007 -2015(Hancock, 2009).

Overview of existing research in the field

Variables included

Dependent variable

Return on assets ( ROA)

Independent variables

Total debt

Total assets

Total liabilities

Share holders’ fund

Tobin’s Q

Current assets

Goodwill

Book value of the equity

Market value of the equity

Data analysis techniques

To analyze the collected data and address the research question proposed in the previous section following statistical techniques have been used:

Descriptive statistics:

The descriptive statistics is one of the widely used technique for every type of research which allows the researcher to have an overview of the data both graphically and numerically. In this case the mean and the standard deviation of both the dependent and independent variable has been calculated along with the graphical representation of the various variable which are important from the current research perspective(Saunders, Lewis and Thornhill, 2007, 2009).

Correlation analysis

Correlation analysis is used to examine the relationship between the two variable and the value of the correlation coefficient lies between +1 and -1. The correlation coefficient close to -1 shows that the two variable are strongly and negatively related. Similarly correlation coefficient close to +1 indicates the variables are strongly and positively related. In this case also the correlation analysis has been performed to examine the relationship between dependent and independent variables(Wooldridge, 2002).

Regression analysis

Another important technique used in the current case is the regression analysis. The regression analysis is used to examine the impact of the independent variable on the dependent variable. The impact is investigated based on the regression coefficient and the statistical significance is measured in terms of the t statistics and the standard error. The independent variable have positive impact on the dependent variable if the regression coefficient is positive and negative if the regression coefficient is negative(Wooldridge, 2002; McCarty and Hastak, 2007; Armstrong, 2012; Monem A Mohammed, 2014) 

In this section the results from the data analysis has been presented. In the first section descriptive statistics for each firm has been presented separately followed by the correlation and regression analysis for all the firms

Sky Plc

For the Sky plc, the results shows that on total average assets was 6265.55 million whereas the average liabilities was 5414. This shows that on an average the assets are higher than the liabilities for Sky plc. The mean and standard deviation of all other variables are shown in the table below.

	Mean	SD
Total current assets	2363.333333	915.786
Total assets	6265.555556	3524.908
Total current liabilities	2260.333333	792.2111
Total liabilities	5414.222222	2568.915
Total debt	3094.555556	1825.062
Return on assets	12.79333333	7.092836
Dividends paid	-377.2222222	99.48087
Total shareholders’ funds	839.5555556	1009.65
Market value of equity	12313.83333	3100.776

 

Figure 1 Total assets and Total debt for Sky plc

Data collection and variables included

The comparison of the total assets and total debt is also shown graphically in the above figure. The trend of the total assets and the total debt are moving in similar direction till 2014. However after 2014 the increase in the total assets is higher than the increase in the total liabilities indicating that the firm has performed well after 2014. However it can also be the case the firm reduced borrowing and raise funds from some other source(Hutchinson, 2010; Kirabaeva and Razin, 2013).

Figure 2 Total debt and shareholders’ fund for Sky plc

The capital structure of the firm can be seen from the trend of the debt and equity of the firm. As the figure suggests the debt is higher than the shareholders’ fund indicating that the debt equity ratio was always more than 1 for Sky plc(Awan, Rashid and Zia-ur-Rehman, 2011; Mishra, 2011; Supa Tongkong, 2012).

Figure 3 Return on assets for Sky plc

Lastly the profitability of the Sky plc was measured in terms of return and assets and the results shows that the ROA has declined significantly during 2008, which is may be due to the global financial crisis of 2007-08. However after 2008 the company regain its returns and improved significantly after that.

The second company included in the analysis is the BAE plc and the descriptive statistics for BAE plc is shown in the table below. On an average assets are higher than the liabilities, however the gap is not so large. Similarly the average ROA is 3.87 which is considered to be good.

	Mean	SD
Total current assets	7035.667	957.1149356
Total assets	22264.56	2434.907858
Total current liabilities	9660.667	1685.697556
Total liabilities	17850.44	1840.262149
Total debt	3122.111	425.5436066
Return on assets	3.874444	2.339519775
Dividends paid	-3394.11	426.6686198
Total shareholders funds	4366.111	1637.044856
Market value of equity	13608.02	2212.547507

 
Table 1 Descriptive statistics fof BAE Plc

 

Figure 4 Total assets and total debt for BAE plc

Results from the comparison of the total assets and debt shows that the assets are much higher than the total debt indicating the firm do not raise much fund through debt.  However the gap is decreasing as the total asserts are declining and total debt is increasing.

 

Figure 5 Total debt and shareholders’ fund for BAE plc

The capital structure of BAE plc shows that shareholders’ fund was the major components till 2012, however the equity proportion was declining continuously and the debt portion is increasing rapidly. As a results the debt equity ratio was higher than 1 after 2013.

 

Figure 6 Return on assets for BAE plc

The return on assets trend in this case also suggests that the ROA was negative in 2009 which has increased significantly after that before declining in 2013. However in the recent time the ROA has increased again.

Statistical techniques used

The third firm is the BP plc and the descriptive statistics has been shown in the following table. Results show that the average assets is 268816 and the average liabilities is 162163 which shows that the assets are higher than the liabilities. Descriptive statistics of all other variables are shown in the table below.

	Mean	SD
Total current assets	86084.88889	15840.89874
Total assets	268816.1111	29877.4035
Total current liabilities	71429.66667	10482.96967
Total liabilities	162163.3333	19553.32407
Total debt	3122.111111	425.5436066
Return on assets	4.825555556	4.670929006
Dividends paid	-6541.555556	2671.796171
Total shareholders funds	7403.555556	2009.995281
Market value of equity	148646.3333	39234.41096

 
Table 2 Descriptive statistics for BP plc

 

Figure 7 Total assets and total debt for BP plc

The comparison of the total assets and debt shows that total assets are much higher than the total debt of the firm for all time period.

Figure 8  Total debt and shareholders’ fund for BP plc

In terms of the capital structure the proportion of equity has been declining significantly and the proportion of debt is increasing. The gap is closing very fast. This indicates that the firm is relying on debt in the recent time.

 

Figure 9 Total return on assets for BP plc

SDN plc is the fourth firm included in the current research. Average assets is 269.84 whereas the average liabilities are 85.84. The average return on assets is 3.29, which is not very good as compare to the industry average. Descriptive results from other variables are also shown in the table below.

	Mean	SD
Total current assets	90.1	18.15537
Total assets	269.8444444	53.89808
Total current liabilities	76.31111111	25.71816
Total liabilities	85.84444444	25.16218
Total debt	6.877777778	8.706862
Return on assets	3.298888889	7.56257
Dividends paid	-1.755555556	2.233893
Total shareholders’ funds	344.8444444	120.8768
Market value of equity	344.8444444	120.8768

 
Table 3 Descriptive statistics for SDN Plc

 

Figure 10 Total assets and total debt for SDN plc

The comparison of the assets and debt show that the assets are much higher than the total debt for the entire time period.

 

Figure 11 Total debt and total shareholders fund for SDN plc

The capital structure shows interesting facts. The shareholders’ fund is much higher than the total debt indicating that the firm rely more on equity than debt. However the shareholder’s equity also increase after 2008 and start declining after 2011.

 

Figure 12 Return on assets for SDN plc

The ROA figure suggests that there are negative returns on assets after 2012 which indicates the poor performance of the firm.

The last firm included in the analysis is the British American Tobacco and the results shows that the average assets are 26639.78 whereas the average liabilities are 19333.33. The return on assets is 12.12 on an average, which shows the good performance of the firm.

	Mean	SD
Total current assets	8557	1306.842
Total assets	26639.78	3335.939
Total current liabilities	7799.222	1388.396
Total liabilities	19333.33	3777.397
Total debt	11374	2644.861
Return on assets	12.12	1.813077
Dividends paid	-2163.44	582.1783
Total shareholders’ funds	5683.111	2943.983
Market value of equity	53936.03	12661.25

 
Table 4 Descriptive statistics for British American Tobacco

 

Figure 13 Total assets and total debt for British American Tobacco

Total assets are higher than the total debt for all the time period and they are moving in similar pattern.

Results from data analysis

 

Figure 14 Total debt and shareholders’ fund for British American Tobacco

The proportion of debt is higher as compared to the proportion of equity indicating that the firm rely heavily on debt as compared to equity.

 

Figure 15 Return on assets for British American Tobacco

The ROA has been over 10 for the entire time period indicating strong financial performance of the firm.

In this section the results from the correlation analysis has been shown and the results show that ROA has positive correlation with dividend , shareholders’ fund market value of the equity and total debt. All other variables included in the analysis are negatively correlated to the dependent variable.

	TA	CL	TL	debt	ROA	div	SF	MVE	Goodwill	BE	tobin
TA	1
CL	0.984749	1
TL	0.99847	0.986416	1
debt	-0.04712	-0.05101	-0.02834	1
ROA	-0.18589	-0.17416	-0.19206	0.423485	1
div	-0.75606	-0.7681	-0.7533	-0.11217	0.121874	1
SF	0.606339	0.648133	0.612847	0.386531	0.043674	-0.71465	1
MVE	0.892932	0.913957	0.888293	0.188402	0.019023	-0.82166	0.738533	1
Goodwill	0.534125	0.548638	0.552526	0.548408	-0.02881	-0.70676	0.783608	0.584673	1
BE	0.986971	0.964162	0.978313	-0.14693	-0.1822	-0.71105	0.529706	0.872997	0.408401	1
tobin	-0.52224	-0.53137	-0.5278	0.346123	0.60445	0.51797	-0.32413	-0.30058	-0.42592	-0.48726	1

 
Table 5 Results from the correlation analysis

The results from the regression analysis are shown in this section. The results from the summary statistic shows that the R squared is 0.51 indicating that 51 % of the variation in the dependent variable is due to the independent variables included in the study.

SUMMARY OUTPUT
Regression Statistics
Multiple R	0.717847442
R Square	0.515304951
Adjusted R Square	0.343335818
Standard Error	5.190428024
Observations	45

Table 6 Results from the summary statistics

Similarly the results from the ANOVA shows that the F statistics is statistically significant as the p value is less than 0.05. This indicates that the cumulative impact of independent variable on dependent variable is statistically significant.

ANOVA
	df	SS	MS	F	Significance F
Regression	11	973.8251667	88.52956061	3.614719882	0.002028094
Residual	34	915.9784644	26.94054307
Total	45	1889.803631
	Coefficients	Standard Error	t Stat	P-value	Lower 95%	Upper 95%	Lower 95.0%	Upper 95.0%
Intercept	-3.683648364	3.441140532	-1.070473097	0.291947037	-10.67688731	3.309590587	-10.67688731	3.309590587
CA	-0.000101422	0.000327727	-0.309472857	0.758850589	-0.000767443	0.000564598	-0.000767443	0.000564598
TA	0.000355005	0.000587833	0.603922302	0.549903901	-0.000839614	0.001549625	-0.000839614	0.001549625
CL	0.000675487	0.000362843	1.861653302	0.071315041	-6.18978E-05	0.001412873	-6.18978E-05	0.001412873
TL	-0.000756285	0.000648368	-1.166443888	0.251551842	-0.002073929	0.000561358	-0.002073929	0.000561358
debt	0.00090552	0.00053348	1.69738355	0.098761197	-0.000178641	0.001989681	-0.000178641	0.001989681
div	-0.000544497	0.000992156	-0.548801255	0.586728047	-0.002560801	0.001471808	-0.002560801	0.001471808
SF	4.9429E-05	0.000505875	0.097709889	0.922736416	-0.000978633	0.001077491	-0.000978633	0.001077491
MVE	-0.000125072	8.52552E-05	-1.467029971	0.151557609	-0.000298331	4.81875E-05	-0.000298331	4.81875E-05
Goodwill	0	0	65535	#NUM!	0	0	0	0
BE	4.66863E-05	0.000509888	0.091562053	#NUM!	-0.00098953	0.001082902	-0.00098953	0.001082902
tobin	6.340633086	1.97744935	3.20647054	0.002923238	2.321972502	10.35929367	2.321972502	10.35929367

Table 7 Results from the regression analysis

The results from the regression coefficient show that the total assets, total debt and shareholders’ fund have positive impact on ROA. All other variables have negative regression coefficient indicating negative impact on ROA. However only the coefficient of debt is statistically significant, that is also at 90 % confidence level. This shows that debt level is one of the most important factors affecting profitability of the firms.

On the basis of the results from the data analysis following recommendations can be made:

The capital structure of the firm is one of the most important factors affecting profitability of the entire firm, so the firms should make the balance between both debt and equity while raising the fund

Total   liabilities shows negative impact on the profitability so firms try to reduce the total liabilities

The ROA for most of the firms are lower than the industry average, so the firms should invest more wisely.

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