Liquidity - profitability tradeoff: An empirical investigation in an emerging market

International Journal of Commerce and Management 05/2004; 14(2):48-61. DOI: 10.1108/10569210480000179

ABSTRACT This study empirically examines the relation between profitability and liquidity, as measured by current ratio and cash gap (cash conversion cycle) on a sample of joint stock companies in Saudi Arabia. Using correlation and regression analysis the study found significant negative relation between the firm’s profitability and its liquidity level, as measured by current ratio. This relationship is more evident in firms with high current ratios and longer cash conversion cycles. At the industry level, however, the study found that the cash conversion cycle or the cash gap is of more importance as a measure of liquidity than current ratio that affects profitability. The size variable is also found to have significant effect on profitability at the industry level. Finally, the results are stable over the period under study.

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    ABSTRACT: Purpose: The paper seeks to empirically investigate the relationship between liquidity and profitability. It also examines the impact of working capital management on profitability and the impact of investment & financing policies on profitability and risk. Design/Methodology/Approach: The analysis is based on 14 companies of Information Technology Sector (as per BSE 200 index) in India in respect of whom data from 2000-2010 has been taken from CMIE database. Karl Pearson correlation and regression analysis has been used. Findings: It was found that there is a strong significant relationship between the measures of liquidity and corporate profitability. The regression analysis reveals that there is a negative relationship between profitability and accounts receivables days, inventory days and cash conversion cycle but a positive relationship between profitability and accounts payables days. There is a negative relationship between degree of aggressiveness of investment policy and accounting measures of returns. However there is a positive relationship between degree of aggressiveness of financing policy and return. The results also indicate a positive relationship between the degree of aggressiveness of investment policy & financing policy and relative risk. Practical Implications: The findings suggest that managers can increase profitability by efficiently managing liquidity. Managers can create value for their firms by reducing the days inventory is held, days of accounts receivables and reducing cash conversion cycle.
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