Title: The Impact of Liquidity on Firms Profitability

Supervised by:

Mr. Muhammad Awais Aslam

Submitted by:

Irfan Asghar
Section-B
2011-ag-1400
Semester 7th
MBA 3.5 Years

Institute of Business Management Sciences

UNIVERSITY OF AGRICULTURE FAISALABAD

Abstract
The present study aims to investigate the impact of liquidity on profitability
so that every firm has to maintain this relationship while in conducting day to
day operations. This study examine the impact of liquidity on firms
profitability of chemical firms that are listed in Karachi Stock Exchange for
the period of 5 years from 2009 to 2013. Current ratio, Quick ratio and Liquid
ratios are used as on the other side Return on Asset (ROA) used as indicators
of firms profitability. Multiple Regressions is used to determine the impact of
liquidity on firms profitability. The result of the study shows that there is
significant impact of current ratio on return on asset and there, but quick
ratio and liquid ratio have weak impact on ROA. The main results of the study
demonstrate that each ratio (variable) has an impact on the financial
positions of enterprises.
Key words: Liquidity ratios, Return on Assets, Regression analysis

1. Introduction
Chemical sector plays a fundamental role in the economic development of
any nation. The global business of chemical forms the structure of the
modern world. It converts essential raw materials into more than 70,000
various products, for industry as well as the goods of consumers that people
depend on in their daily life. The modern chemical industry can be divided
into four wide categories, including basic chemicals, specialty chemicals, life
sciences, and consumer products. The cause for its outstanding success is
the constant scientific and technological advances and breakthroughs, which
have

led

to

the

expansion

of

new

products

and

procedures.

During the time of independence, chemical industry in Pakistan was almost

non-existent. Some traditional sectors have been developed over the years.
However; the Chemical Industry in Pakistan is still at an emerging phase.
As far as the classification of the Chemical industry development of Pakistan
is concerned, it can be classified into two sectors.1) the primary sector and
2) the secondary sector. Primary sector industries are at a large-scale. They
are capital intensive industries that comprise refineries, natural gas,
petrochemicals, metallurgical and projects based on mineral. They also
supply feed stocks to the secondary chemical industry. Secondary industries
are based on feed stocks which are either derived from primary sector of
industries, or other different sources of raw materials. These industries are
less capital intensive and they are based on high, medium or less advanced
technologies. Discussing the consolidated figures for imports & exports such
as chemicals, fertilizers, plastics, rubber, medicines, dyes & pigments, soaps
& detergents, and the section of chemicals for the period from 2004-05 to

2010-11. Imports increased from 768 Million US $ in 2004-05 to 5,166 Million

US $ in 2010-11 .On the other hand increment in exports was shown from
118 Million US $ in 2004-05 to 411 Million US $. Chemical shares in the total
imports were about 15% while its share in exports was about 2.3%. The total
imports of plants and equipment used for the manufacture of chemicals
contributed about 23% of overall imports of Pakistan. The combined shares
of the two categories like plants/equipments and chemicals were about 38%
of countrys general imports and among major contributors of countrys
imports.
For the recent development in the chemical sector of Pakistan, it must create
its own capability and accomplish self-sufficiency in project design,
engineering as well as the construction management required for the
commercialization of technologies. There is a need to develop qualifications
in the creation of medium and high technology based chemicals for export,
along with the present industrial structure based on low technology resource
based products. Above all, Pakistan must provide suitable inducements to
entrepreneurs for the enlargement of an export-oriented chemical industry.
Now there are many companies and small units are produced chemical
products in Pakistan and 34 companies are listed in Karachi Stock Exchange
(KSE) and this study is based on the chemical sector of Pakistan listed in
Karachi Stock exchange
Profitability and liquidity are the most prominent issues in the corporate
finance context. Financial liquidity is not straight it has many aspects,
although generally financial liquidity refers to current assets and current
liabilities management. Financial liquidity with profitability are two main
activities of enterprise, and company should treat as equally important in
order to function efficiently. The growth of the financial liquidity may
negatively affect the profitability because if the company has high liquidity
than some capital will be frozen in current assets and it may negatively
affect the profitability. Decision on the liquidity or profitability its all about

planning which is very important for the efficient working of firm. For efficient
performance of the firm, there must be proper flow of funds. This fund is
called working capital which is equally defined as the net current assets, or
the current assets less the current liabilities (Prasana, 2000).
Liquidity has been a source of worry for the management of the firm.
Liquidity plays an important role in the successful functioning of a firm. When
we say about the liquidity of an asset its mean that how quickly it can be
transformed into cash. When we referring to company liquidity is the
condition which shows that firms are able to pay its current liabilities and it is
measured by different financial ratios. Liquidity ratios are used for liquidity
management in every organization in the form of current ratio, quick ratio
and Liquid ratio that greatly effect on profitability of organization
Profitability is a measure of the amount by which a companys revenue
exceeds its relevant expenses. The profitability of a firm means its ability to
generate income which surpasses its liabilities. Profitability is usually
measured by different ratios such as ROA, ROE. Profitability ratios shows that
how effectively management can make profits from the sales. Profitability
ratios are very important for the company because potential investors are
interested in the dividends and market price of the stock, so they focus on
profitability ratios. But managers are more interested in measuring the
operating performance in terms of profitability. So a low profit margin leads
to ineffective management and we may lost our potential investors.
Efficient liquidity management includes planning and controlling current
assets and current liabilities in such a manner that eliminates the risk of the
inability to meet due short-term obligations, on one hand, and avoids
excessive investment in these assets, on the other. A firm must ensure that it
does not suffer from lack-of or excess liquidity to meet its short-term
obligations. Therefore firm should try to maintain a balance between liquidity
and profitability.

Because if firm has not more liquid assets than it suffer

from low liquidity position and if it has high liquid assets than it reduce the
firms profitability. The firms liquidity should not be too high or too low.
Excessive dependence on liquidity indicates the accumulation of idle funds
that dont fetch any profits for the firm (Smith, 1980).On other side,
insufficient liquidity might be damage the firms goodwill. Hence in this study
we will examine the impact of liquidity on profitability of listed chemical
companies in Pakistan.

Research Question
The concept of Liquidity has been a source of worry to the management of
firms of the uncertainty of the future.
Increasing profitability would tend to reduce firms liquidity and too much
attention on liquidity would tend to affect the profitability (Smith, 1980).
Saleem and Rehman (2011) they conclude that liquidity ratios affect the
profitability ratios and profitability is improved for oil and gas sector that hold
some liquid assets. Shahchera (2012), Bordeleau and Graham (2010) also
find that liquidity is improved for the banks which hold some liquid assets.

Niresh (2012) conclude that there is no significant relationship between

liquidity and profitability. Some argued that liquidity not affect the profit
ability so the question is:

Is Liquidity has impact on profitability?

In this study we find the impact of liquidity on profitability of chemical sector

of Pakistan listed on Karachi Stock Exchange.

2. Literature Review

Liquidity and Profitability, both are very important topics of finance. So,
many researchers of finance seeks to evaluate the connections between
liquidity and profitability and large number of studies have been conducted
to find the relationship between the Liquidity and Profitability. In research
papers, some scholars argued that profitability is more important than
liquidity and others are against this statement, and some of them said that
both are equally important.
In the literature review, many researchers said that there is a significant
relationship exist between liquidity and profitability and some said that there
is no relationship exist between liquidity and profitability.
As of one of Pakistani researchers Qasim Saleem and Ramiz Ur Rehman
(2011) in his study of Impacts of liquidity ratios on profitability with
the samples of 26 Oil and Gas companies listed on KSE using the data
representing the periods of 2004 2009 found that liquidity ratios
affect the profitability ratios. They have used CR, QR, LR as
independent variables and ROA, ROE, ROI as dependent variable. They
conclude that liquidity ratios affect the profitability ratios and
profitability is improved for oil and gas sector that hold some liquid
assets.
Shahchera (2012) in his study of The Impact of Liquidity Asset on
Iranian Bank Profitability with the samples of 17 commercial banks
using the data representing the periods of 2000-2009 find evidence of
a nonlinear relationship between profitability and liquid asset holdings.
And conclude that Profitability is improved for banks that hold some
liquid assets, however, there is a point at which holding further liquid
assets diminishes a banks profitability.
Other researchers Bordeleau and Graham (2010) also study The
Impact of Liquidity on Bank Profitability with the sample of Canadian
and American banks from 1997 t0 2009 and also find the nonlinear

relationship between profitability and liquidity. The study conclude that

Profitability is improved for banks that hold some liquid assets,
however, there is a point at which holding further liquid assets
diminishes a banks profitability, all else equal.
A study has been conducted by Ben-Caleb, Egbide (Ph.D Candidate),
Olubukunola, Uwuigbe (Ph.D), and Uwuigbe, Uwalomwa (Ph.D) (2013)
Liquidity Management and Profitability of Manufacturing Companies in
Nigeria with the sample of 30 manufacturing companies listed on the
Nigeria stock exchange using the data representing the periods of
2006-2010.Current Ratio and Liquid Ratio is used as independent
variable and Return on capital employed used as dependent variable.
The study revealed that CR and LR are positively associated with
profitability and study conclude that if overall state of liquidity should
be improved so as to have a favorable impact on the profitability.
Niresh (2012) in his study Trade-off between liquidity & Profitability: A
study of selected Manufacturing firms in Sri Lanka with the sample of
31 listed manufacturing firms over the period of five years from 2007
to 2011 found the correlation values to be negative between
profitability and all the liquidity variables. CR, QR, LR is used as
independent variable and Net profit, Return on Capital Employed and
ROE used as dependent variable. This study conclude that there is no
significant relationship between liquidity and profitability.
Bhunia, Khan, and Mukhuti (2011) in the study A Study of Managing
Liquidity with the preferred samples of private sector steel companies
from the year of 1997 to 2006 found that the optimal of working capital
management is could be achieve by firm that manage the tradeoff
between profitability and liquidity. Current Ratio, Liquid Ratio and
absolute Liquid Ratio used as independent variable and Return on
Investment used as dependent variable. Results of this study found

that correlation and regression results are significantly positive

associated to the firm profitability.
Some other Pakistani researchers Abdul Raheman, Talat Afza, Abdul
Qayyum, and Mahmood Ahmed Bodla (2010) in the study Working
Capital Management and Corporate Performance of Manufacturing
Sector in Pakistan with the panel data of 204 manufacturing firms is
used which are listed on Karachi Stock Exchange using the data
representing the periods of 1998 to 2007 conclude that Working
Capital Management has a significant impact on profitability of the
firms.
Al Nimer, Warrad, and Al Omari (2013) in the study The impact of
Liquidity on Jordanian banks Profitability through Return on Asset the
study checks financial reports for overall Jordanian Banks listed on the
Amman Stock Exchange (ASE) for the period 2005- 2011 conclude that
there is significant impact of independent variable quick ratio on
dependent variable return on asset (ROA). That means profitability in
Jordanian banks is significantly influenced by liquidity. QR is used as
independent variable and ROA is used as dependent variable and there
is significant impact of independent variable quick ratio on dependent
variable return on asset (ROA).
Chukwunweike (2014) investigated the association between liquidity
and profitability through The Impact of Liquidity on Profitability of
Some Selected Companies: The Financial Statement Analysis (FSA)
Approach the population of this study consist of all companies in the
industrial/Domestic products industry; that are quoted in the
Nigerian Stock Exchange (NSE).Current Ratio and Quick Ratio used as
independent variable and ROA is used as dependent variable. Result of
this study found that there is a significant positive correlation between
current ratio and profitability (ROA) and there is no definite significant
correlation between Acid test ratio and profitability (ROA).

A.Ajanthan (2013) in his study A Nexus between Liquidity &

Profitability: A Study of Trading Companies in Sri Lanka using the
sample of trading sector consists of 08 trading companies listed in the
Colombo Stock Exchange (CSE) over a period of past 5 years from
2008 to 2012 found that there is relationship between liquidity and
profitability

and

there

is

significance

impact

of

liquidity

on

profitability.CR, QR ,LR used as measure of Liquidity and ROA, ROE are

used as measure of Profitability. Results of this study found that
correlation and regression results are significantly positive associated
to the firm profitability.
Kurawa, Abubakar (2014) in the study An Evaluation of the Impact Of
Liquidity on the Profitability of Nigerian Banks using the sample size of
five banks to cover the period of the study from 2003 2012. Linear
regression

were used

in the analysis and the results revealed that

there is positive relationship between ROA and CBTOTL so also the

same thing with ROE and CBTOTL but, negative relationship between
ROE and LATOTA. The main findings of the study suggest that there is
no significant impact between liquidity and profitability among the
listed banking firms in Nigeria.
Lartey, Antwi, Boadi (2013) in the study The Relationship between
Liquidity and Profitability of Listed Banks in Ghana by sample size of
seven out of the nine listed banks for the period of 2005-2010 found
that there was a weak positive relationship between the liquidity and
the profitability of the listed banks in Ghana.
Agha (2014) in the study Impact of working capital management on
profitability by using the data of Glaxo Smith Kline pharmaceutical
company registered in Karachi stock exchange for the period of 19962011. In this study return on assets ratio used to measure the
profitability of company and variables of account receivable turnover,

creditors turnover, inventory turnover and current ratio used as

working capital management criteria.
The results of the research show that there is a significant impact of
the working capital management on profitability of company.

3. Research Design and Methodology

This

section

explain

the

data

collection,

sampling,

and

research

methodology.
3.1.

Data Source

The present study used secondary data for the analysis. The data employed
in the study is exerted from the comprehensive income statements and
annual financial reports of the sample firms and financial position of the
sample trading companies quoted in Karachi Stock Exchange (KSE)
database. In addition to this, scholarly articles from academic journals and
relevant textbooks were also used.

3.2.

Sampling Design

Sampling design is a definite plan for obtaining a sample from a given

population. It refers to the technique or the procedure the researcher would
adopt on selecting items for the sample (Kothari, C.R., 2004). The sample of
this study is consists of five years which is from the financial year 20092013.In this study thirty (30) firms of chemical industry has been taken as
sample. All the sample firms are listed in Karachi stock exchange in Pakistan
and the data-base of the study is completely based on secondary data which
has been collected from various web sites and annual financial reports of the
sample firms For the purpose of achieving the objectives of study the
Profitability Ratio return on assets is taken as dependent variables and for

liquidity current ratio, quick ratio, and liquid ratio taken as independent
variables.

Table-1
Liquidity Ratios/Independent variables
Current Ratio
Quick Ratio
Liquidity Ratio

= Current Assets (CA)/ Current Liability (CL)

= [Current Assets- Inventory]/ Current Liability
= [Cash in hand + Short Term Investment]/ Current
Liability

Profitability Ratio/Dependent variable

Return

on

= Profit after Interest and Tax / Total Assets X100

Assets
Notes: Above table shows that profitability is our dependent variable and it is
measured by return on assets, and liquidity is independent variable which is
measured by current ratio, quick ratio and liquid ratio.

Data Source: Karachi stock exchange

Variables Explanation
Table-1 explain the liquidity ratios as independent variables which are
current ratio, quick ratio, liquid ratio and profitability ratio as dependent
variable which is return on asset.

Table 2
Descriptive Statistics of the variables
Variable

Mean

Std.
Deviation

Minimum

Maximum

Return

on .0435598

.1864559

-1.2138

.4625

Asset
Current Ratio

1.364732

1.432717

.0181

13.3211

Quick Ratio

.9140507

1.299267

.0152

13.3123

Liquid Ratio

.4343018

1.164176

.00181

12.5961

NOTE: Table 2 explains the summary statistics of Chemical sector in Pakistan.

Data source: Self calculated on state bank data of Pakistan.
Table 2 enlighten the descriptive statistics of chemical companies in Pakistan
Descriptive statistics means a set of concise illustrative coefficients that
reduces given information set, which can either be a representation of the
whole populace or a specimen. The measures used to depict the information
set that are measures of focal propensity and measures of variability or
scattering. Measures of central tendency contain the mean, median and
mode, on the other hand measures of variability contain the standard
deviation (or variance), the minimum and maximum variables. The above
table shows the mean, standard deviation, maximum and minimum values of
our dependent and independent variables. Mean is the basic numerical
average of a set of two or more numbers. The mean can be calculated in
more than one way. We can calculate the Mean by using Arithmetic mean
and Geometric mean. Standard deviation is used to find the dispersion in a
data set. More dispersion in a data set means higher the standard deviation.
Standard deviation is the square root of variance .Maximum and minimum
shows the highest and lowest value in a data set.

3.3 .

Research Methodology

In this research, to test the impact of liquidity on profitability we analyze our

data by employing multiple regressions model. For the regression analysis

first we may create a research hypothesis and then empirical model for the
regression analysis.

Research Hypothesis
Hypothesis One
H0: There is no impact of liquidity on profitability.
H1: There is impact of liquidity on profitability.

Empirical Model
Multiple regression analysis was performed to investigate the impact of
liquidity on profitability the model which is used in this study is given below:
Profitability=f (CR; QR; and LR)
It is important to note that the profitability depend upon Current ratio (CR),
Quick Ratio (QR) and Liquid Ratio (LR).The following models are formulated
to measure the impact of liquidity on profitability.
ROA=0 + 1 (CR) + 2 (QR) +3 (LR) +. (1)
Where:
ROA stands for return on asset, 0 is the intercept, and 1, 2 and 3 are
the regression coefficient. CR, QR, and LR is Current ratio, quick ratio, and
liquid ratio respectively.

4. Research Analysis

This section explain the result and analysis of our research. To find the
relationship we take correlation and to find the impact between liquidity and
profitability in this study we analyze our data by multiple regression models.
A well-known statistical software STATA is used in order to analyze the
data. For the study, entire analysis is done by personal computer.

Table 3
Correlation among Explanatory Variables for Chemical
Sector
Variables

CR

QR

CR

1.0000

QR

0.9610

1.0000

LR

0.8658

0.9238

LR

1.0000

Note: Table 3 explains the correlation results and in the table, CR is stand for
current ratio, QR, and LR is quick ratio, and liquid ratio respectively.
Data Source: Self calculated on state bank of Pakistan data.

Table 3 explains the Correlation results of chemical sector of Pakistan.

Correlation is used to measure how two random variables are related.
Because standard deviation is always positive, the sign of the correlation
between two variables must be the same as that of the covariance between
the two variables. If the correlation is positive, we can say that variables are
positively correlated. If it is negative, we can say that they are negatively
correlated; and if it is zero, we say they are uncorrelated. Furthermore, it can
be proved that the correlation is always between +1 and -1. The R values
were found to be positive between liquidity variables as measured by current
ratio (CR), quick ratio (QR) and liquidity ratio (LR).

Table 4
Impact of Independent Variable on Dependent by Utilizing
Multiple Linear Regressions

COEF.

T- VALUE

P > [t]

Intercept

-0.0335415

-1.38

0.168

CR

0.0956547

2.54

0.012

QR

-0.0477885

-0.88

0.379

LR

-0.0224742

-0.67

0.502

Notes: R2= 0.1081, Adjusted R2= 0.0898, No of obs. 150, COEF. is coefficient and
shows the impact of independent variable on dependent variable, P > [t] is
probability. Intercept depicts that there are other factors that impact our dependent
variable other than variables used in our study.
Data source: Self calculated on state bank of Pakistan data.

The above table shows the regression analysis which is used to test the
impact of liquidity on profitability of listed companies of chemicals sector in
Karachi Stock Exchange. The result shows return on asset is significantly
affected by current ratio, but quick ratio and liquid ratio have weak impact
on ROA. According to this regression analysis return on asset is significantly
affected by current ratio because p-value is 0.012.This means that one
increase in current ratio increase the return on asset by 9.56%. Quick ratio
has insignificant negative relationship with return on assets this mean that
an increase in quick ratio by one will reduce the return on asset by
4.77%.Liquid ratio also insignificant negative relationship with return on

assets this mean that an increase in liquid ratio by one will reduce the return
on asset by 2.247%.

Hypothesis Testing
No.
H0

Hypothesis
There is no impact of liquidity on profitability.

Results
Rejected

Tool
Regression

H1

There is impact of liquidity on profitability.

Accepted

Regression

Conclusion
Liquidity plays an important part in the firms performance and the purpose
of this research study is to determine the impact of liquidity on profitability of
chemical sector in Pakistan. For this purpose 30 chemical firms selected as
study sample and data is collected for the period of 2009-2013. First of all
data is tested for correlation in order to check the association between
explanatory variables. The results show that there is high correlation
between independent variables. Multiple linear regression model is used to
test the relationship among dependent and independent variables and the
results reveal that current ratio has a strong and positive impact on liquidity
while quick ratio and liquid ratio have negative and insignificant impact on
ROA. Since liquidity has impact on profitability of the firms of chemical sector
thats why we accept H1.

Recommendations

Based on the conclusions drawn from the findings of this study, the
researcher recommends that firms should maintain a moderate level of
liquidity that does not threaten their going concern status, and yet allows
them to make adequate profits on their investments. This is because when
there is no significant impact between liquidity and profitability then firm
may freeze its capital in its current asset which is not favorable for the
company. In this case firm may utilize its capital for profit. Thus, firms should
try to find an optimum balance between liquidity and profitability. According
to some studies Bordeleau and Graham (2010), Shahchera (2012) they
conclude that Profitability is improved for firms that hold some liquid assets,
however, there is a point at which holding further liquid assets diminishes a
firms profitability. So firms should try to find the optimum level between
liquidity and profitability.

Recommendation for Future Research

I carry out the research on the topic of impact of liquidity on the profitability
of chemical sector of Pakistan. In order to expand this topic it should be look
at by other researchers, as this area demand a lot of work for development.
The present study is confined only to the listed chemicals firms in the
chemical sector of Pakistan. Findings and conclusions were drawn with the
help of secondary data. Due to the shortage of time data representing the
period of 5 years and it should be given for a long period of time in order to
get more meaningful and better results. Furthermore, there is clearly
enormous scope for more research work in the present study. Therefore, I
suggest the following for further research:

This study may be very useful for the financial managers of chemical
industry in framing policies for managing the firms liquidity and
profitability but there are 580 companies listed in Karachi stock
Exchange (KSE) under 36 sectors. This study only covers the chemical
firms in chemical sector. Therefore, further investigation is required to

examine the impact between liquidity and profitability of firms in the

different sectors.

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