Abstract:
The ongoing economic crisis in Sri Lanka has created significant obstacles
for companies in obtaining and managing debt and equity financing, thereby shaping
their capital structure choices. These decisions play a vital role in determining a firm’s
financial health and long-term sustainability. However, existing empirical and theoretical
studies present conflicting findings on this relationship. In light of this, the present
study investigates the impact of capital structure on the firm performance of materials
companies listed on the Colombo Stock Exchange in Sri Lanka by examining
the Total Debt Ratio (TDR) and Long-Term Debt Ratio (LTDR) as indicators of capital
structure and evaluating performance through Return on Assets (ROA) and Return on
Equity (ROE). The analysis is based on panel data collected from the annual reports of 18 prominent companies covering the period from 2020/21 to 2024/25. Pearson’s correlation
analysis and Random Effects Generalized Least Squares regression are applied
to evaluate the data. The findings reveal that the TDR negatively and significantly impacts
both ROA and ROE, suggesting that higher debt levels adversely affect profitability.
Conversely, the LTDR does not significantly impact either ROA or ROE, indicating
that long-term debt does not substantially influence profitability. The study’s drawbacks
encompass the use of a restricted range of factors to evaluate capital structure
and financial performance, in addition to a comparatively small sample size. Notwithstanding
these constraints, the study offers significant insights for investors, managers,
legislators, and business decision-makers regarding the impact of capital structure
on financial performance.
