IMPACT OF LIQUIDITY RATIOS ON PROFITABILITY
With Special Reference to Listed Manufacturing Companies in Sri Lanka.
Deshan W. G. R.
A research report submitted to the Department of Commerce in partial fulfilment of the requirements for the subject COM 3345 – Research Methodology
Department of commerce
Faculty of Management Studies and Commerce
University of Sri Jayewardenepura
Table of Contents
TOC o “1-7” h z u CHAPTER ONE PAGEREF _Toc523946297 h 4INTRODUCTION PAGEREF _Toc523946298 h 41.1Background of the Study PAGEREF _Toc523946299 h 41.2Problem Statement PAGEREF _Toc523946300 h 51.3 Objectives of The Study PAGEREF _Toc523946301 h 61.4 Research question PAGEREF _Toc523946302 h 61.5Significance of the Study PAGEREF _Toc523946303 h 61.6Limitations of the study PAGEREF _Toc523946304 h 61.7 organization of the chapters PAGEREF _Toc523946305 h 71.7.1 Chapter Organization PAGEREF _Toc523946306 h 22.214.171.124 Introduction chapter PAGEREF _Toc523946307 h 126.96.36.199 Literature Review PAGEREF _Toc523946308 h 188.8.131.52 Results and analysis PAGEREF _Toc523946309 h 184.108.40.206 Conclusion PAGEREF _Toc523946310 h 7CHAPTER TWO PAGEREF _Toc523946311 h 7LITERATURE REVIEW PAGEREF _Toc523946312 h 72.1 Introduction PAGEREF _Toc523946313 h 82.2 Theoretical Review PAGEREF _Toc523946314 h 82.2.1 Liquidity PAGEREF _Toc523946315 h 82.2.2Liquidity Ratios PAGEREF _Toc523946316 h 220.127.116.11Current Ratio PAGEREF _Toc523946317 h 18.104.22.168Quick Ratio PAGEREF _Toc523946318 h 122.2.3Profitability PAGEREF _Toc523946319 h 22.214.171.124 Profitability Ratios PAGEREF _Toc523946320 h 126.96.36.199.1 Return on Assets (ROA) PAGEREF _Toc523946321 h 188.8.131.52.2 Return on Equity (ROE) PAGEREF _Toc523946322 h 184.108.40.206.3 Return on Sales (ROS) PAGEREF _Toc523946323 h 152.3 Empirical review PAGEREF _Toc523946324 h 152.3.1 Liquidity VS Profitability PAGEREF _Toc523946325 h 15CHAPTER THREE PAGEREF _Toc523946326 h 17METHODOLOGY PAGEREF _Toc523946327 h 173.1Introduction PAGEREF _Toc523946328 h 173.2 Conceptual framework of the study PAGEREF _Toc523946329 h 173.3 Hypotheses PAGEREF _Toc523946330 h 173.4 Research Design PAGEREF _Toc523946331 h 183.5 Population and sample of the study PAGEREF _Toc523946332 h 183.6 Operationalization PAGEREF _Toc523946333 h 193.7Data Collection PAGEREF _Toc523946334 h 193.8Data Analysis PAGEREF _Toc523946335 h 193.9 References PAGEREF _Toc523946336 h 20
TOC h z c “Figure” Figure 1 Inverse relationship between liquidity and profitability PAGEREF _Toc523949729 h 16Figure 2 Conceptual Framework of the study PAGEREF _Toc523949730 h 18 TOC h z c “Table”
Table 1 Operationalization PAGEREF _Toc523949746 h 20
CHAPTER ONEINTRODUCTION1.1Background of the Study
situations. This situation can be seen in the considerable number of developing countries as well as developed countries economy (Ajao & Obida, 2012). As the result of this financial crisis, most of the countries in the world become as debtors in another countries and various international organizations such as International Monetary Fund, World Bank. Within this situation, the liquidity concept become as the most significant in the economy (Lamberg & Valming, 2009).
When concerning about that financial crisis this situation similar for the companies also. The main reasons for that is higher level of inflation rate and disadvantageous foreign exchange rates (Ajao & Obida, 2012). The actual value of the money is declined as above factors. Hence managers have the higher responsibility relating with the maintaining sufficient liquidity level within the company. However, the business owners and managers in overall the world devise policies to enhance the profitability level and shareholders’ wealth in organizations. As there has a financial crisis situation, to perform the day to day financial requirements managers need to maintain adequate level of liquidity level within firms (Eljelly, 2004).
The meaning of maintaining liquidity assets within the firm is the opportunity cost of earning profitability (Nandi, 2012). The liquidity management can be identified as the backbone of the company. Without maintaining adequate liquidity level within the firm, managers cannot predict their future. If the firm cannot earn any profit, it is considered as the sick. But if the firm has not any liquidity, it is downfallen and then died. As that matter, liquidity is the pre-requisite for determining the survival of the company (Nandi, 2012). Hence the liquidity management is become as more significant role rather than other activities.
Managers are the decision makers of the company. They need to get better and favorable decisions for the company Hence, managers should concern about the both short term and long term financial positions of the company because, short term is the foundation for long term activities and survival. Managers have a responsibility to ensure the continuously operation of production cycle in efficiently and solve the short term financial obligations in promptly as well as enhance the profit level to ensure the prosperity of firm. Hence the lack of or excess liquidity is not favorable to the company in the present or future time.
Further, this relationship is significant for the creditors. Creditors can be divided in to two parts based on the maturing period as short and long-term creditors. Short term creditors will check the liquidity of company before selling goods on credit. They expect to get money within short term period for their selling items. To fulfill it’s as they wish, company should be maintained sufficient level of liquidity assets. Long term creditors also concern about the liquidity position for receiving interest income and concern about the profitability level for the security of lending capital amount.
Employees and trade unions are concerning about the liquidity level of the company. Because they need to know whether the company can meet its employee related obligations– salary, pension, provident fund, etc. For pay that obligations, company should ensure the smooth of production process. As well as the profitability level is highly impacted to determining the security of jobs, promotions, salary increments etc. Hence the excess or lack of liquidity level may not be good for employees.
After analyzing the above factors, can be identified that the liquidity is very significance criterion. Because of most of the parties get better decisions by considering the liquidity position of the companies. A company needs to maintain adequate level of liquidity because liquidity is greatly affected to the profitability as the close relationship among them.
As the result of that, when one variable is increased, other variable is decreased.
There has not standard or formal rule to determine the best suited liquidity level for the companies. It depends on the balance sheet situations of the firms (Ajao & Obida, 2012). However, if firms with low current assets it will be a problem for the continuous operations. Instead of low balances, if companies have the much more liquidity assets rather than daily requirements, it is also badly affected for the profitability purpose (Horne & Wachowicz, 2000).
1.2ProblemStatement Many studies in the literature are based on developed countries. Therefore, those findings cannot be applied to the Sri Lankan context since, the nature of economic activities, economic conditions, of developed countries are different from in developing countries. Moreover, few studies have been conducted to analyze the association between liquidity and profitability of manufacturing industry in Sri Lanka. After considering above factors, this study tries to fill this gap by doing research on manufacturing companies in Sri Lanka.
1.3 Objectives of The StudyThe main objective is to identify of the impact of liquidity ratios on profitability of listed manufacturing companies in Sri Lanka. Researcher expected to use two types of liquidity ratios for achieving above objective. In here, current ratio and quick ratio is used for calculating the liquidity position of companies.
1.4 Research questionquestion of the study is, The
How liquidity ratios effects on profitability of listed manufacturing companies in Sri Lanka?
1.5Significance of the StudyThe findings of this are significant for the internal and external parties of the organization for making favorable decisions. Because of some persons have not well understanding about the degree of impact in each element on the profitability level. As this study targeted developing countries’ manufacturing companies, managers and investors can apply the findings of this study in making decisions.
Furthermore, the findings of this study can be used to realize the theories relating with the liquidity and profitability relationship. Because of this described the above relationship with using one by one ratio.
1.6Limitations of the studyThis study focuses to identify the relationship between liquidity and profitability of listed manufacturing companies in Sri Lanka. However, not all of the manufacturing companies are listed in the Colombo Stock Market. Hence, the finding of the study cannot be generalized to the entire manufacturing industry in Sri Lanka.
Researcher provides the conclusion about the impact of liquidity ratios on profitability, only by using published annual reports. The accuracy of the data included in the financial statements may be high. But cannot be trusted worthy in hundred percent of the transparency and correctness of the rupee values in the transactions. The auditors also checked the sample of transactions. Hence the actual situation might be changed from financial statements. Therefore, the validity can be limited as this reason.
Liquidity level is not only one factor for affecting to determine the profitability of manufacturing companies. Seasonal changes, price levels or competitors’ activities can be influenced to the profitability level. But this study focuses only the impact from liquidity position. This is also can be mentioned as the limitation for this one.
1.7 organization of the chaptersThe basic idea relating with the research study can be obtained from the introduction chapter. Because this describes about the background, objectives, problems as well as limitations which are binding with the research study.
This chapter is mainly categorized under the headings of the background, objectives, problems & questions, significance and limitations of the study. This study is conducted by targeting liquidity and profitability relationship of manufacturing companies in Sri Lanka.
Relating with the topic of this study mainly focused about the liquidity and profitability concepts, definitions and significance of them. For that selected fifteen listed manufacturing companies in Sri Lanka.
1.7.1 Chapter Organization220.127.116.11 Introduction chapterDiscuss about the basic things related with the research topic. Especially, main variables of the study and other important factors are described through this chapter.
18.104.22.168 Literature ReviewBy analyzing previous research articles, described about the various definitions, concepts, findings, relationships and other things related with the research topic via this chapter.
22.214.171.124 Results and analysisIdentify the relationship between independent and dependent variables of the research topic are the basic objective of this chapter. For that purpose, descriptive statistics, correlation analysis and regression analysis techniques are used.
126.96.36.199 ConclusionThe findings are summarized through this chapter. Recommendations are also provided via this. CHAPTER TWOLITERATURE REVIEWI
2.1 IntroductionThis chapter reviews literaturerelating to the liquidity ratios and profitability from previous studies. Through this chapter, it mainly focuses about meanings, significance and findings of the liquidity and profitability variables.
2.2 Theoretical ReviewThedefinitions and liquidity management are outlined and explained in this section.
2.2.1LiquidityThere have the various definitions for the liquidity. The simply meaning of the liquidity is the ability of converting assets in to the cash quickly at the lowest possible cost. When analyzing previous research articles can be identified more definitions and concepts relating with the liquidity.
Bolek & Wilinski (2012) defined the liquidity in three contexts such as, assets, asset equity and cash aspects of financial liquidity. The financial liquidity of company’s assets is categorized under the assets aspect. They explained liquidity concept as the ability to convert the assets in to cash within lowest possible time and cost.
Herald, (2012) explains that the liquidity of an asset means how quickly it can be transformed in to cash. Further he describes this concept is combined with the short term maturing obligations. Through his research, he emphasized that liquidity assets are needed to resolve the short term maturing obligations.
Brahma (2012) stated, liquidity is the ability to meet current obligations and sudden expenses. Hence, pointed out the importance of maintaining appropriate level of liquidity assets within firm by his research study.
Liquidity resources including cash balances provide the protection for the company against the financial problem. In most generally and frequently use the financial liquidity concept with concerning mutual relationship between current assets and current liabilities. In the company financial liquidity has in better level when large part of the assets is representing the liquid assets. If an enterprise needs to maintain higher level of liquidity, it needs to maintain large volume of cash and other liquidity assets and small portion of current liabilities (Bolek ; Wilinski, 2012).
Liquidity management is important for the manufacturing companies, as substantial portion of total assets are represented by current assets (Home and Wachowitz, 2000). Because of the main activity of manufacturing companies is converting raw materials in to the finished goods. Hence there has the substantial portion of current assets within firm. The time gap between converting raw materials in to finished goods and convert them in to the money are high. Therefore, those companies must maintain sufficient level of liquidity assets within firm to satisfy the current obligations. When converting liquidity assets into cash, the conversion cost should be minimized. The spent time, money and effort should be minimized on this purpose.
The Liquidity may be kept in various forms by firms, such as cash in hand and cash at bank in current assets, reserve drawing power under a cash credit or overdraft arrangement and short-term deposits (Nandi, 2012).
According to the economic and financial analysts, four possible reasons behind to hold liquid assets within firms are, transaction motive, the precautionary motive, tax motive ; agency motive (Qasim, Ramiz, 2011). Those are the very essential day to day activities and unpreventable legal obligations. The liquidity plays a key role for the success of business firms, since it has a close relationship with day-to-day operations. Particularly, there is no any specific rule for determining the standard level of liquidity level for firms. It depends on the nature of the business (Ajao ; Obida, 2012). Therefore, a firm should keep a sufficient liquidity level instead of maintaining deficit or surplus level. Pandy (2005) points out some crucial factors that influence to the liquidity requirement of the company. Those are nature ; size of the business, manufacturing cycle, business fluctuations, production cycle, turnover of circulatory capital, credit terms, growth ; expansion activities, operating efficiency and price level changes.
Kamath, Srinivasan ; Kim (1986) state that, to ensure the proper operation of trading cycle, responsible parties should calculate the best suited amount of cash to their level of activities and, they need to plan the dates of payments and collections of receivables with reducing transformational cost. It is therefore essential to establish the right level of disposable assets to short-term financial investments at companies. Holding the wrong amount in cash or cash equivalent may interrupt the normal flow of business activities.
Maintaining wrong amount of current assets may be interrupted to the day to day business activities. As well as the wrong safety margin is caused to miss the unexpected advantage investment opportunities and as this reason cannot be met unexpected financial requirements. Hence the proper liquidity management is provided the facilities for the smooth running of production process and avoids any treasury gaps (Kamath, et al, 1986).
Home ; Wachowiz (2000) stated that if the firm has fewer current assets it may be a problem for continuing operational activities and if the current assets are too much it may be reduced the return on investment. Hence both increment and recession are not good for the company.
The required liquidity level for each business firm depends on the balance sheet situation of the firm (Banso ; Dardac, 2004). Accordingly, the article of Bank of Jamaica in 2005, Liquid assets should be consisted with following attributes: diversified, residual maturities appropriate for the institution’s specific cash flow needs; readily marketable or convertible into cash; and minimal credit risk.
However, the liquidity level is determined by the balance sheet conditions and it may be affected to the short-term obligations and long-term success as well as to the survival. As well as some thinkers believe that liquidity has more importance because companies with low profitability or even without profitability can serve economy more than companies without liquidity (Farzane).
Palom & Prat (1984) identified that keeping liquid assets within the firm is an opportunity cost if the benefits on maintaining them within firm are lower than the return on productive investments. However, this is prevented the transformation cost or immediate purchasing cost of financial assets as well as from the disadvantageous taxation (Palom & Prat, 1984).
John (1993) expressed that the considerable number of total assets are represented by the liquid assets. Hence it is affected to the profitability and to company risks.
However, Kim et al. (1998) said that, if there has an optimal market conditions need not to maintain excess liquidity level within firm. Because of they can cover any shortfalls from the capital market under a fair price levels. This statement is correct one because excess liquidity level means the opportunity cost of profitability. Further Kim et, al (1998) identified two reasons for maintaining excess level of liquidity within firms. First one is, decrease the firm’s dependence on costly external financing and other one is, they can get the advantages from unforeseen future investment opportunities. However, in the actual situation the optimal market conditions are very seldom and firms like to hold excess liquidity level within firms for facing unforeseen opportunities.
Further Petereson ; Rajan (1997) identified that, the management of liquid assets is particularly importance for the small and medium sized companies. Because of most of those companies’ assets are in the form of current assets. Current liabilities are the main source of external finance. As the above fact, the liquidity management is become more useful and significant tool of large, medium and small-scale companies.
2.2.2Liquidity RatiosFinancial ratios are provided the more meaningful information for the decision makers. Ratios are the combination of two variables. Hence the validity of the ratios is increased rather than other data.
Liquidity ratios determine the ability of a firm to generate the cash flow in the year and compared it with short term obligations. This is provided the clear picture if the firm has a problem relating with the short-term debt paying ability (Saleem & Rehman, 2011).
Most of the organizations use Current ratio and Quick ratio as the liquid ratios and those are greatly affected to the profitability of organization. Liquidity ratios combine with the cash and near cash assets in one side of the business and the immediate payment obligations on the other side. Inventory and receivables from customers are the main parts of near cash assets. (Qasim &Ramiz, 2011).
To measure the short-term success, analysts use the liquidity ratios. But there have some limitations of this. If the firms’ sales are occurred in seasonally, the correct value of receivables and inventories cannot be predicted. All the liquidity ratios are not uniform and differ on industry characteristics (Gibson Charles, 1991).
188.8.131.52Current RatioCurrent ratio is the most common and oldest measure of cooperate liquidity (Sanna ; Valming, 2009). Beaver (1996) stated that the current ratio was firstly used for evaluating the credit- worthiness of the companies. This ratio is the most frequently used technique for measuring the liquidity. From this ratio can be measured the ability of covering current liabilities by using current assets (Czekai ; Dresler, 2001). As a benchmark, companies keep value of 2:1 for current ratio (Maness ; Zietlow, 2005). It means, companies need to hold twice of the current assets value as the current liabilities. The meaning of higher value of the current ratio, the higher this ability is (Bolek ; Wilinski, 2012). This ratio provides good picture for the relationship between current assets and liabilities. Because of all the current assets and current liabilities are included in this ratio.
Most of the companies use this ratio to calculate the liquidity position of each company. This ratio is represented the substantial portion of assets in total assets. Cash and cash equivalents, trade and other receivables, inventories and amount due from related parties are related with the current assets. Current liabilities are consisted with the trade and other payables, amount due to related parties, bank overdrafts and interest-bearing borrowings. All of those assets and liabilities have the short term maturing period.
The value of the current ratio is significance for most of the parties’ decisions. Managers of the company can evaluate the existing and future financial strengths of the company through this ratio. As well as this provides good indication about the short-term debt paying ability, the requirement of changing policies relating with the debtors, creditors, inventories and bank activities also.
Especially, trade suppliers are concerning about this ratio. Because of they provide goods to companies with short term maturing period. Hence, they highly concern about the liquidity position of the company. Therefore, current ratio is provided highly support to get better decisions.
To predict the current and future profitability and ascertain the success of company, existing and prospective investors are also concerning about this ratio.
184.108.40.206Quick RatioAcid test ratio is used as another name for identifying the quick ratio. This is included only the higher liquid assets. The least liquid assets include in the current assets are the inventory. Therefore, this ratio shows the degree of relationship between most liquid assets and liabilities (Bolek & Wilinski, 2012). Inventory and prepayments are excluded from this ratio. Other all current assets and liability components are included in this ratio (Saleem & Rehman, 2011). Hence this shows the relationship between more liquid assets and current liabilities.
As only used the more liquidity assets for this, can be got clearer picture about the management of liquidity in each company. To get more favorable decisions to internal and external parties, this ratio is provided the highly support (Drake).
Inventory cannot be converted in to cash quickly to meet unexpected events. As well as the prepaid expenses cannot be converted in to cash. Hence, that is not indicative of the firm’s ability to repay its’ urgent liabilities. For this ratio, assumed that trade receivables can be converted in to cash quickly. By using this can get more realistic decisions relating with the company (Drake).
When comparing distinct size of companies’ financial statements data, Huff, et al (1990) found the differences in liquidity ratios of small and large-scale businesses. Further he identified that companies little or no inventory caused to lower current ratio as the lower level of current assets. Not only above he also identified that most of the small companies have the negative working capital balance rather than large scale businesses. Hence the comparison of current ratio by using large scale businesses is more meaningful because there has not much variation. However, the current and quick ratios are widely used ratios by most of the internal and external parties.
2.2.3ProfitabilityProfit is the very important for all businesses, Because of the survival is depended on this factor. Profitability plays as a tool in measuring the management efficiency in the use of organizational resources by adding value to the business firm.
When company’s revenue exceeds its’ expenses, it can be defined as the profitability.
This one is used as the tool for measuring management’s ability to create earnings from the revenue generating activities and to measure the operating performances. Potential investors concern about this to predict the dividends values and level of appreciation in stock prices (Bolek & Wilinski, 2012).
Ajao & Obida, (2012), mentioned that a company should earn profit to ensure the survival and growth over a lengthy period of time. Further he mentioned that the profit is essential, but all management decisions should not be profit centered.
Profitability provides more valuable information to get favorable decisions. That information is always used by investors, managers and financial statement analyzers to get known about the dividend payment, for measuring management efficiency and to predict and evaluate the made decisions (Saghafi and Aghayie, 1994).
220.127.116.11 Profitability RatiosThereare several ratios that can be used for evaluating profitability of a business. Those ratios are commonly used for identifying the adequacy of profits to satisfy various parties’ expectations. Most of the ratios are calculated with combining assets, sales and shareholders’ equity. By using these ratios, managers can get good decisions or can be revised the existing policies if the existing ones are not suited to the company’s activities. Also, the profitability ratios can be used for measuring efficiency of managers.
The profitability ratios are used to evaluate the managers’ efficiency relating with the ability to create earnings from revenue generating activities within the firm. Potential investors focus about the profitability ratios as they interested in dividends and appreciation in share prices (Ajanthan, 2013).
18.104.22.168.1 Return on Assets (ROA)Return on Assets ratio expresses that the gross income earned by the company with using current and noncurrent assets of the company. This ratio suggests that, higher level of returns should be earned by using higher level of assets. Through the ROA can be measured the managers’ efficiency relating with the handling company’s assets for earning income (Ajao & Obida, 2012).
To calculate the ROA, use the profit before deducting tax and interest expenses. The reason to add back the interest expenses on borrowed funds is as follows. The efficient use of the resources is not affected by the method of financing. To remove the effects of external policy the income tax is added back to the profits. The simply mean of this ratio is, this ratio provides an indication about the efficiency of using assets to earn profits with removing external impacts (Bolek & Wilinski, 2012). This ratio is very importance for the managers. Because of this ratio provides best indication about the efficiency of policies (Ajao & Obida, 2012).
22.214.171.124.2 Return on Equity (ROE)Companies’ capital structure is consisted with both debt and equity capital. Equity holders are the owners of the company and they have the higher risk relating to their investments. Because of they do not earn fixed rate of income/ benefits for their investment. But the risk relating to the receiving interest for the debt money is differed from the equity investment. Because of debt holders can earn fixed rate of income for their investments. A return on shareholders’ equity is calculated for identifying the profitability of shareholders’ investments (Ajao ; Obida, 2012).
The last answer of this ratio is very significance for the shareholders. They can predict their future earnings from this ratio. Also, they can better decisions relating with the company. This ratio is very importance for the prospective investors also.
After calculating this ratio, managers can get good decisions establish policies as well as can revise the existing policies. Because of they have a higher responsibility to satisfy the owners of the company. The value of this ratio is greatly affected to attract and retain equity investors to the company.
126.96.36.199.3 Return on Sales (ROS)This is also identified as the profit margin ratio or net profit ratio. This is also used for measuring the operating performance of the firm. By using this ratio, measured the net profit received from the sales. The profit margin is arisen as the result of selling the products of company. The company’s profitability level can be expressed clearly via this ratio (Barad, 2010).
From this ratio measured that how much profit is earned from the selling activity. The efficiency of doing sales and earning profits can be measured through this. Profit before tax is got for this, as income tax is not combined with the earning profits from the sales (Bolek & Wilinski, 2012).
2.3 Empirical review2.3.1 Liquidity VS ProfitabilityLiquidity and profitability are two main concepts which are significance for the company (Szczepaniak, 1996). To maintain the higher level of liquidity position within the firm, needs to hold large share of current assets, especially in cash balances in the company. When increasing the liquidity position of the company, increased the ability of paying short term maturing obligations without any delays. As well as can be obtained the discounts from suppliers and clients and can be obtained loans from the lenders with holding good trust among them. Further, can be reduced the insolvency risk as maintain higher liquidity position within firm. Liquidity can be considered as the backbone of the success in company (Saleem & Rehman, 2011).
The excess current assets hold within company to face for the unexpected events. The receivables from the trade creditors are the potential asset. Because of there has no guarantee about the receivable amounts from the debtors. Inventories included in the current assets cannot be converted in to cash quickly. Hence the cash in hand plays the vital role for fulfill the liquidity requirements of the firm.
The surplus of cash, inventories and receivables included in the current assets are caused to generate the cost of lost opportunities. The mean of the opportunity cost is the loss of profit which can be earned from the investing in other profitable ways. These excess current assets can be used to purchase required fixed assets such as buildings, equipment, furniture etc. If the firm use excess assets for achieve such as requirements, it may be the saving source of the firm (Gajdka and Walinska, 2004).
On the other hand, these excess current assets can be invested in another profitable investment sources such as deposits, invest in shares etc. This may be the additional income source for the company. Actually, the excess inventory stock is affected to increase the expenses of company. Because of the insurance fees, security fee as well as the cost of deterioration of the goods is increased as the excess inventory stock (Gajdka and Walinska, 2004).
The generally accepted theory is there having an inverse relationship between liquidity and profitability of the company. Because one variable is increased, other one is decreased (Saleem & Rehman, 2011). This inverse relationship can be shown as follows.
Figure SEQ Figure * ARABIC 1Inverse relationship between liquidity and profitabilityLiquidity
(Gajdka and Walinska, 2004).The excess liquidity level is caused to reduce the profitability level. As well as the inadequacy liquidity position affected in badly for the smooth-running process of the company. Hence the optimal level of liquidity and profitability level should be maintained for ensure the continuous operations and development of the company (Wojciechowska, 2001).
CHAPTER THREEMETHODOLOGY3.1IntroductionThis chapter discusses about the procedure for sample selection and the method of data collection, as well as the models used to analyze the collected data are also presented from this chapter.
Based on the information of the method section the procedure of measurement in validity and significance can be determined. Because through this part, the data collection method, analyzing method and other things related with the analysis are described. Hence, in this part should be included clear and precise description relating to the way of experiment is done, reasons or selecting specific experimental procedures, how find out the answers for the research questions as well as the procedure for analyzing the results is also discussed through this chapter
3.2 Conceptual framework of the study Current Ratio(x1)
Quick Ratio (X2)
Return on Equity(X3)Profitability(y)
Return on Asset (X4)
Return on sale (X5)
Figure SEQ Figure * ARABIC 2 Conceptual Framework of the studyIn this part of framework researcher has identify what are the factors that seek the emerge this problem. this help to anybody obtain clear idea and launching methods about that problem factors.
3.3 HypothesesHypotheses testing is the needed when data collection method is quantitative. Under the conceptual framework hypotheses testing is developed as follows.
H0: There is no relationship between liquidity and profitability.
H1: There is a meaningful relationship between liquidity and profitability.
Descriptive statistics method was used to identify the mean, maximum, minimum and standard deviation values of the entered data. From this can be identified as the whole how companies maintain liquidity levels within company and the level of profitability. Correlation analysis is used as a tool for identifying the nature and extent of the relationship between variables. In here checked the Pearson correlation coefficients and the significance under the two tailed diagrams for identifying the validity and reliability of used data.
Furthermore, used the Anova test for measured the F value and its’ significance relating with the link between liquidity level and profitability level. The extent of correlation between current ratio and quick ratio was also studied through this study.
3.4 Research DesignThe study seeks to describe the impact of liquidity ratio on profitability in listed companies.
There are two types of approaches like as quantitative or qualitative. Including statistical analysis, numerical values and required hypotheses to obtain the conclusion for the quantitative research approach. Qualitative approach has no meaningful theme. It is consisting with unstructured data collection qualitative kind of research approach that cannot be countable. If someone comprehend the qualitative, it has analysis method to understand and also this approach is abstruse.
In this research, Quantitative approach is use for doing the research. It is most suitable method for this research. Under the quantitative, deductive approach is applicable. Deductive approach helps to explain relationship between independent variable and dependent variable.
3.5 Population and sample of the studyThis study targeted the listed manufacturing companies on Colombo Stock Exchange (CSE), Sri Lanka. The study composed of fifteen manufacturing companies from the manufacturing sector of CSE for the period of five years from 2012 – 2017.
In CSE, 298 companies are listed under the 20 sectors (at the date of 29.06.2018). Among them 39 companies are listed under the manufacturing sector. Out of 39 companies, 15 manufacturing companies were selected to gather the secondary data. Those companies were selected on random basis and concerned about the availability of information.
To select the manufacturing firms for the research purpose, listed all manufacturing firms in orderly the market capitalization. Then removed some listed companies from this order which are not published annual reports for the period of 2017-2012.
Profitability Ratio of profit before tax to total assets.
Return on Assets Ratio of total equity to total assets.
Return on Equity (Net profit after tax – Preference dividends)/ Average total equity *100
Liquidity Ratio of liquid assets to total liability deposits.
Current Ratio Current Assets / Current Liabilities
Quick Ratio Current Assets / Current Liabilities
Table SEQ Table * ARABIC 1 Operationalization3.7Data CollectionThrough this study mainly focused about the liquidity and profitability variables in listed manufacturing companies in Sri Lanka. This study used secondary data extracted from the published financial statements of the selected companies for the period of five years, from 2012 to 2017. For obtaining information, study used the income statements and balance sheets of the selected companies. In some cases, some data and information have been extracted from the websites of the sample firms.
3.8Data AnalysisThe main purpose of this research is to study the relationship between liquidity and profitability of listed manufacturing companies in Sri Lanka. In order to evaluate the profitability, ROA, ROE and ROS have been used separately. Current ratio and quick ratio is used for measuring liquidity position of each company. Hypothesis was designed to study the relationship between liquidity and profitability. The research model can be represented as follows,
P= ?0+ ?1 LR+ ?……………
P = Profitability
L = Liquidity
Under these three models are used to analyze the relationship between liquidity and the profitability.
ROE = ?0+ ?1 CR+ ?2 QR ? (I)
ROA = ?0+ ?1 CR+ ?2 QR ? (II)
ROS = ?0+ ?1 CR+ ?2 QR ? (III)
3.9 ReferencesAjanthan, A. (2013). A nexus between Liquidity and Profitability. Journal of Business and Managementement.
Aloy Niresh, J.(2012).Tradeoff Between Liquidity and Profitability. Journal of International Referred Research.
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