IMPACT OF LIQUIDITY ON PROFITABILITY OF

BANKING SECTOR
By

NATIQ NIZAR

Enrollment No: BAC/CBF/7742/2012

Seat No: A-1329026

This Report Submitted To The

Karachi University Business School
In Partial Fulfillment
Of The Requirements for the Degree Of
BSBA
Fall 2017

Submitted on December 2017

 PROJECT REPORT
ON
IMPACT OF LIQUIDITY ON PROFITABILITY OF
BANKING SECTOR
IMPACT OF LIQUIDITY ON PROFITABILITY OF
BANKING SECTOR
By

NATIQ NIZAR

Enrollment No: BAC/CBF/7742/2012

Seat No: A-1329026

This Report Submitted To The

Karachi University Business School
In Partial Fulfillment
Of The Requirements for the Degree Of
BSBA
Fall 2017
 LETTER OF TRANSMITTAL

To, December 2017

Head of Department,
Karachi University Business School,
University of Karachi.

Subject: Letter of Transmittal

Respected Sir,

With due respect and courteous submission, I undertook my Project under the supervision and guidance
of Sir. Zia with the purpose of analyzing the “Impact of Liquidity on profitability of Banking Sector”
which is mandatory element of my BS degree as Major in Finance.

The purpose of the study to analyze the impact of Liquidity (current ratio) on profitability (ROA) of
banking sector.

This will make the report a complete and extensive one. Therefore, I am confident of the validity of this
study. Given the time constraint and the limited resources, the report is best prepared and gives an
overview to the reader about the topic. This was made through the help of student and teachers assistance
in the College of Banking and Finance.

If you have any query and suggestion about this process, I would be happy to oblige for any further
clarification.

Yours Sincerely,

Natiq Nizar

BS VIII- CBF
 ACKNOWLEDGMENT

First of all I would like to thank my Beneficial and Merciful Allah for giving me the strength and
knowledge and blessing me with such parents who supported me in all difficulties and in every aspect, I
thanks my Parents for guiding me and helping all the way in my studies. I would like to thank our
respectable and coordinating course instructor Sir. Zia for the valuable guidance and advice, without their
precious guidance and time it would not be possible for me to complete this report successfully. Moreover
I would like to thank the College of Banking and Finance for enlightening my knowledge and supporting
me in aspects for the completion of this report. I will also like to thank all my friends who helped me in
collecting responses on this research and those who have been a part of this report and all those who have
contributed in this report regardless of the quantity of their contribution, without the help of the
mentioned above people it would have been impossible to complete my report.

TABLE OF CONTENTS
TOPICS PAGE NO:

a. Letter of transmittal i
b. Acknowledgment ii

CHAPTER 1: INTRODUCTION 7-10

CHAPTER 2: LITERATURE REVIEW 11-12

CHAPTER 3: METHODOLOGY 13-14

CHAPTER 4: DATA ANALYSIS & INTERPRETATION 15-18

CHAPTER 5: CONCLUSION 19

CHAPTER 6: BIBLIOGRAPHY 20-21

CHAPTER 1
 INTRODUCTION

LIQUIDITY:

Liquidity and profitability are most important part of business which gives complete information of
business work. Liquidity refers to the management of current assets and liabilities of a firm. It usually
explains, is the company capable for paying short term obligations. It is really important for firms to
maintain liquidity at some certain level neither too high nor too low, it should be maintain at some certain
level for the effectiveness and profitability of a firm. Liquidity ratios are most useful when they are used
in comparative form. This analysis may be performed internally or externally. For example, internal
analysis regarding liquidity ratios involves utilizing multiple accounting periods that are reported using
the same accounting methods. Comparing previous time periods to current operations allows analysts to
track changes in the business. Alternatively, external analysis involves comparing the liquidity ratios of
one company to another company or entire industry. This information is useful to compare the company's
strategic positioning in relation to its competitors when establishing benchmark goals. Liquidity ratio
analysis may not be as effective when looking across industries, as various businesses require different
financing structures. Liquidity ratio analysis is less effective for comparing businesses of different sizes in
different geographical locations.

Following are the most common liquidity ratios:

1: CURRENT RATIO: The current ratio is a liquidity ratio that measures a company’s ability to pay
short term obligations.

Formula: Current Ratio = Current Assets / Current Liabilities

(Higher the current ratio, the more capable the company is of paying its obligations)

2: WORKING CAPITAL: Working capital is a second liquidity ratio that measures both a company’s
efficiency and its short term financial health.

Formula: Working Capital = Current Assets - Current Liabilities

(It indicates whether a company has enough short term assets to cover its short term debts).

3: QUICK RATIO: A company’s ability to meet its short term obligations with its most liquid assets. It
is also known as Acid test ratio.

Formula: Quick Ratio = Current Assets-Inventories/Current Liabilities

(The ratio derives its name from the fact that assets such as: cash, account receivables, marketable
securities etc are quick sources of cash, while inventories take time to be converted into cash).

4: CASH RATIO: It is the most commonly used as a measure of company’s liquidity. The ratio
calculates a company’s ability to pay current liabilities using only cash and cash equivalents on hand.

Formula: Cash Ratio = Cash Equivalents+ Marketable Securities/ Current Liabilities

(Account receivables, inventory, prepaid assets, and certain investments are not included in the cash ratio,
because these items may require time and effort to find a buyer in the market).

PROFITABILITY:

Profitability refers to the ability of a firm to generate earnings. Analysis of profit is of vital concern to
stockholders because they derive revenue in the form of dividends. Further, increased profits can cause a
rise in market price, leading to capital gains. Profits are also important to creditors because profits are one
source of funds for debt coverage, so in order to find the profitability level of the firms, different
profitability ratios are used, so it can easily be evaluated that where the firm ranks in terms of
profitability.

Following are the most common profitability ratios:

1: GROSS PROFIT MARGIN: Total margin available to cover expenses and yield of profit.

Formula: Sales- COGS/ Sales

2: OPERATING PROFIT MARGIN: Profitability without concern for taxes and interest.

Formula: Earnings before interest and taxes (EBIT)/Sales

3: NET PROFIT MARGIN: After tax profits per dollars of sales

Formula: Net Income/Sales

4: RETURN ON ASSETS: After tax profits per dollar of assets; this ratio is also called return on
investment.

Formula: Net Income/ Total Assets

5: RETURN ON EQUITY: After tax profits per dollar of stockholders investment in the firm.

Formula: Net Income/ Total Equity

1.1: BACKGROUND:

A day to day management of a firm’s short term assets and liabilities plays an important role in the
success of the firm. Firms with glowing long term prospects and healthy bottom lines do not remain
solvent without good liquidity management. Hence, despite maximization of shareholders wealth still
remaining the ultimate objective of any firm preserving the liquidity of a firm is equally an important
objective and as such a firm should balance among the different interest objectives. Increasing profits at
the cost of liquidity can bring serious problems to the firm and a tradeoff between these two objectives of
the firms needs to be struck. If a firm doesn’t care about a profit, it will not survive for a longer duration
while on the other hand if it doesn’t care about liquidity, it may face the problem of insolvency or
bankruptcy; for these reasons, liquidity management should be given proper consideration and will
ultimately affect the profitability of the firm.

1.2: PROBLEM STATEEMNT:

Liquidity risk is one of the most prominent risks faced by the firms. Determining the optimum level of
liquidity is quite critical and important too, because it can affect the firm’s performance and profitability.

1.3: PURPOSE OF STUDY:

The purpose of the study to analyze the impact of Liquidity (current ratio) on profitability (ROA) of
firms. Liquidity position is important for daily bases operations as well as for survival. Strong liquidity
position helps firms to pay its current obligations as well as not avoiding profitability. Strong liquidity
also helps to better use of all resources and generate profits without any risk.

1.4: SIGNIFICANCE OF THE STUDY:

Liquidity plays a significant role in the successful functioning of a business firm. A firm should ensure
that it doesn’t suffer from lack of or excess liquidity to meet its short term obligations. A study of
liquidity is of major importance to both the internal and external analysts because of its close relationship
with daily basis operations of a firm. Liquidity management and profitability are very important in the
development, survival, sustainability, growth and performance. Profitability doesn’t translate to liquidity
in all cases. A company may be profitable without necessarily being liquid. Therefore, liquidity should be
managed in order to obtain at certain level, that is a level that avoid excess liquidity as well as liquidity
level should not fall below minimum requirement as it will lead to problems to meet short term
obligations.

1.5: LIMITATIONS OF THE STUDY:

 Only secondary data analysis was carried out due to limited time frame.
 Only 3 banks were selected in this study because of the limited time frame.
 The data is collected from secondary sources; hence the reliability of data is questionable.
 Only those banks are selected in this research whose financial statements were properly available
on their official website.
1.6: OBJECTIVES OF THE STUDY:

 To study the impact of Liquidity (Current Ratio) on profitability (ROA)

 To create an opportunity for future research to be conducted on the subject.

1.7: HYPOTHESIS:

HO: There is no significant relationship between liquidity (current ratio) and profitability (ROA).

H1: There is significant relationship between liquidity (current ratio) and profitability (ROA).
 CHAPTER 2

LITERATURE REVIEW

(Rizwan Ali Khan & Mahathir Ali, 2016)

Investigated the relationship of Liquidity (Current and quick ratio) with profitability i.e.: GP Margin, &
Net profit margin and the impact of profitability on commercial banks of Pakistan. It was found that
liquidity has a positive relationship with profitability with the growing liquidity level to a certain limit the
profitability also increases. Therefore research concluded that banks should keep some certain amount of
their liquid assets for more profits.

(Tahir Maqsood, Muhammad Akmal Anwar, et.al, 2016)

Research Examined the impact of liquidity (current ratio and cash ratio) on profitability (ROA). It was
found by covering 8 banks financial reports from 2004 to 2015, pooled analysis used to summarize the
data of correlation and regression which shows a significant relationship between liquidity and
profitability.

(Lina Warrad, Munther Al Nimer, et.al, 2015)

Studied the banking sector in Jordan, Middle East, to investigate the relationship of liquidity (Quick ratio)
on profitability (ROA). It was found by covering the simple regression from 2005 to 2011 as well as
based on statistical results; there is significant impact of independent variable quick ratio on dependent
variable ROA that means profitability in Jordanian banks significantly influenced by liquidity.

(Sunny Obiler Ibe et.al, 2013)

Investigated the liquidity profitability tradeoff that means to find the solution to liquidity management
problems in Nigerian banking industry. Taking three banks to cover the entire banking industry, to
conclude that there is need for each bank to adopt right decisions to determine its optimal liquidity
position.

(Afia Akhter & Khalid mahmood, 2014)

Attempted to make sense of how much liquidity (current ratio) of bank can clarify its benefits (ROA).
Considered twelve banks in four different sectors, used linear regression to find out the relationship. It
was concluded that there is no significant relationship between liquidity and profitability in banks of
different sectors of Bangladesh, perhaps; liquidity is essential for any establishments and productivity
demonstrates the money related quality of that organization.

(Muhammad shaukat Malik, Mustabsar Awais, et.al, 2016)

Study was conducted to find the tradeoff between liquidity measures and profitability (ROA) in private
sector banks of Pakistan, results shows a negative relationship and it has been prescribed that the banks
ought to evaluate and rebuild their mythologies for over seeing liquidity. This won’t just enhance yields
on investors value however likewise improve the utilization of the advantages of the bank.
(Ali Suleiman Alshatti, 2015)

Investigate the effect of liquidity management (investment ratio, quick ratio, capital ratio, net
credit facilities, total assets ratio as well as liquid asset ratio) on profitability (ROE & ROA) in Jordanian
commercial bank during 2005-12. In view of the findings it was found that there is an effect of liquidity
management on profitability. The investment and quick ratio on the profitability is certain when measured
with ROE. The impact of capital on profitability is certain when measured with ROA, and the remaining
factors of liquidity on the two measure of profitability are negative. To conclude that there is need to
contribute the over abundance of liquidity accessible at the banks in different parts of interests so as to
expand the bank’s profitability and to get profits by t e time estimation of the access cash.

(Moses Mwizarubi, Dr.Harjit Singh et.al, 2015)

Study was conducted to find the tradeoff between liquidity and profitability in Tanzania banking sector.
By utilizing all factors that were mulled over, and it was found that there is no statistically significant
relationship between liquidity and profitability. This prompts the conclusion that the banks can
concentrate on expanding their gainfulness without influencing their liquidity and vice versa.
 CHAPTER 3

METHODOLOGY

3.1: THEORETICAL FRAME WORK:

Theoretical frame-work focuses on the relationship between the dependent and independent variables.
The distinction between dependent and independent variables is as important in a comparative study as in
a regression analysis. Dependent variable in case of a comparative study is the one which we aim to
predict and independent variables here the ones who are used to predict the dependent variable.

Liquidity Firm’s Profitability

Independent Variable Dependent Variable

Current Ratio Return on Assets

Current Ratio Return on Assets

The secondary data was essentially required to carry out the research. The data was collected from the
official websites of the banks operating in Pakistan. Various financial statements of 3 banks were used for
data collection.

3.2: DATA COLLECTION:

There are two basic types of data collection approaches:

1. Quantitative tool.
2. Qualitative tool.

1) Quantitative Tool:
Quantitative data method is the method in which data can be numerically counted or expressed is
collected.

2) Qualitative Tool:
Qualitative data collection is the method in which the characteristics, attributes, properties,
qualities etc of phenomenon or thing is described. It is the description of data in language rather
than in numbers.
According to my research topic the technique I used to collect the data is the quantitative technique
because it requires various ratios for calculation in order to get the better results.

The research is a quantitative research in which secondary data is used. Secondary data are those data
which have been previously collected for some other research. The data regarding this research has been
collected from the annual reports of the particular banks which provided aid in reaching the authentic
results. Moreover, other data was gathered from different publications related to the topic. The data
collection of this research was based on Convenience Sampling.

3.3: SAMPLE SIZE:

There were 16 private banks shown in list of private banks operating in Pakistan, 3 banks were selected.
The data used for the purpose of research of 5 Years annual data of the variables used in this study. Data
of all the variables belonging to period from year 2012 to year 2016 was taken in this study.

1. Faysal Bank Limited

2. Habib Bank Limited
3. United Bank Limited.
 CHAPTER 4

DATA ANALYSIS AND INTERPRETATIONS

Regression:

1: BANK 1

Model Summary

Std. Error of the

Model R R Square Adjusted R Square Estimate

1 .894a .800 .733 .00130657

a: Predictors: (Constant), FaysalBankCR

This table provides the R and R square values. The R value represents the simple correlation (overall
relationship) and is 0.894 (the “R” Column), which indicates a high degree of correlation. The R square
value (the “R” square column) indicates how much of the total variation in the dependent variable, Return
on Asset, can be explained by the independent variable, current ratio. In this case, 80% can be explained,
which is very large.

ANOVAb

Model Sum of Squares df Mean Square F Sig.

1 Regression .000 1 .000 11.973 .041a

Residual .000 3 .000

Total .000 4

a. Predictors: (Constant), FaysalbankCR

b. Dependent Variable: FaysalbankROA

Anova test whether the regression model is valid or not. F statistics is 11.973 which is high and
significant value. Value p is highly significantly .041 which is less than p<0.05 (.041<0.05) 5% level of
significance this implies that the test of ANOVA is highly significant and model is valid from the given
predictors.
 Coefficientsa

Standardized

Unstandardized Coefficients Coefficients

Model B Std. Error Beta t Sig.

1 (Constant) .031 .007 4.514 .020

FaysalBankCR -.026 .008 .894 -3.460 .041

a. Dependent Variable: FaysalBankROA

1. t-values are calculated by taking the ratio between β and the standard error. (e.g. .031/.007 =
4.514)
2. as far as standard error is increases the t-value is decreases and as t-value decreases the significant
value (p-value) will increases which is usually less than 0.05 than the predictor become
significant and important for the model
3. Here the significance value (the p-value) is 0.020 and 0.041; both are less than 0.05 which means
that the constant term as well as the coefficient of x both is significant for model.

Correlations

FaysalBankR0A FaysalBankCR

FaysalBankR0A Pearson Correlation 1 .894*

Sig. (2-tailed) .041

N 5 5

FaysalBankCR Pearson Correlation .894* 1

Sig. (2-tailed) .041

N 5 5
*. Correlation is significant at the 0.01 level (2-tailed).

We can see that Pearson Correlation for Return on Assets across Current ratio is .894, which is far from
value 0, it means the relationship across Current ratio and Return on Assets is strong.
2: BANK 2

Model Summary

Std. Error of the

Model R R Square Adjusted R Square Estimate

1 .799a .638 .517 .00130018

a: Predictors: (Constant), HblbankCR

 R = 0.799 implies that the dependent

and independent variables having
direct relation with each other.
 R-square = 0.638 this means 63.8%
variation in dependent variable is
explained by the predictors
(independent variable) of the model.
 1-R Square = 0.362 or 36.2 is the
unexplained variation in dependent
variables due to all those independent
variables which are not in our study or
in our model.
3: BANK 3

Model Summary

Std. Error of the

Model R R Square Adjusted R Square Estimate

1 1.000a 1.000 1.000 .00000000

a. Predictors: (Constant), UblbankCR

 R = 1.000 implies that the dependent

and independent variables having
strong and direct relation with each
other.
 R-square = 1.000 this means 100%
variation in dependent variable is
explained by the predictors
(independent variable) of the model.

The hypothesis of the study was, there is a

significant relationship exists between
Liquidity (current ratio) and profitability
(ROA) of the banking sector, so we reject
H0 and accept H1.
 CHAPTER 5

CONCLUSION

It has been empirically proved through analysis that liquidity (CR) has positive relationship with
profitability (ROA), and has considerable impact on the profitability of commercial banks. In order to
identify the nature of relationship between current ratio and profitability the study conducted in statistics
probability sequential software (SPSS) that will asset in discovering the nature of relationship between
the dependent and independent variable. Based on the results that were presented and the model that was
used for the linear regression analysis showed significance, and we can use to predict that (ROA) have a
positive relationship with Current ratio, so we reject H0 and accept H1. Based on these findings, we
conclude that the liquidity has positive relationship with profitability. Therefore, it is suggested that banks
should keep considerable amount of their liquid assets in order to get higher rate of profit.
 CHAPTER 6

BIBLIOGRAPHY

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