Effect of Income Source Diversification on Financial Performance: Evidence from Sri Lanka

Abstract

Decisions in income source diversification are very important in achieving the financial performance of finance companies. Also, diversification is one of the portfolio strategies to reduce the risk by combining various investments, and to increase the firms’ financial performance indicating a sound financial strength of a company and a firmed guarantee of making the profitable investment to its depositors, shareholders, employees, and the economy at large. This study aims to investigate the effect of income source diversification on financial performance based on the data concerning finance companies listed at the Colombo stock exchange in Sri Lanka. This paper investigates the effect of income source diversification on financial performance based on the data concerning fifteen (15) listed finance companies in Sri Lanka during the period ranging from 2014 to 2020. The study measures financial performance in terms of Return on Assets, whereas income source diversification is measured by Herfindahl- Hirschman Index. Four control variables were considered namely firm size, firm age, operational efficiency, and debt to equity in order to strengthen the data analysis model. Findings of this study revealed that the HHI index and debt to equity ratio are negatively significantly correlated with financial performance while other correlations; firm size, age, and operational efficiency are insignificant at a 5% significant level. Regression (R2) result indicates that only 12.7% (approx.) variation in financial performance can be explained by the income source diversification and other 87.3% (approx.) variations come from other factors. Further, this study reiterated that the diversification is a sun shed for enlightening the investment process of any source with aiding through intermediation and performing through the portfolios for the finance companies, because, they always promptly concentrate the dynamic investment appraisal and management activities in Sri Lanka as well as abroad. Further, this study recommends that the managers in finance companies focus on different sources of revenue generation in order to minimize their level of risk through a diversification strategy to enhance efficiency. This study contributes to the finance sector literature of Sri Lankan markets.