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JES
45,3 Factors affecting profitability
in Malaysia
Ali Saleh Alarussi
Tunku Puteri Intan Safinaz School of Accountancy, Universiti Utara Malaysia,
442 Sintok, Malaysia, and
Received 16 May 2017 Sami Mohammed Alhaderi
Revised 8 July 2017 Department of Management, Universiti Utara Malaysia, Sintok, Malaysia
27 August 2017
Accepted 20 September 2017
Abstract
Purpose – The purpose of this paper is to examine the factors affecting profitability in Malaysian-listed
companies. It has been argued that profitability is the main pillar for any company to survive in the long run.
Although profitability is the primary goal of all business ventures, scant attention has been paid to the factors
that affect profitability in developing countries. This study investigates the factors affecting profitability in
Malaysian-listed companies.
Design/methodology/approach – This research is based on five independent variables that were
empirically examined for their relationship with profitability. These variables are: firm size (as measured by
total sales), working capital (WC), company efficiency (assets turnover ratio), liquidity (current ratio) and
leverage (debt equity ratio and leverage ratio). Data of 120 companies listed on Bursa Malaysia covering the
period from 2012 to 2014 were extracted from companies’ annual reports. Pooled ordinary least squares
regression and fixed-effects were used to analyze the data.
Findings – The findings show a strong positive relationship between firm size (total sales), WC, company
efficiency (assets turnover ratio) and profitability. The results also show a negative relationship between both
debt equity ratio and leverage ratio and profitability. Liquidity (current ratio) has no significant relationship
with profitability.
Research limitations/implications – Due to the time limitation, the data includes only 120 companies
listed in bursa Malaysia and covers the period from 2012 to 2014.
Practical implications – These results benefit internal users (such as mangers, shareholders and
employees). They can realize the determinants of enhancing the profitability of their company after the
depreciation of the Malaysian currency and therefore concentrate more on the factors that enhance their
companies’ profitability. On the other side, other external users (such as investors, creditors, new established
companies, tax authority) also may get advantages of these results. It is clear that those users concern about
the profitability of companies and the determinants of their profitability after the currency’s depreciation.
Originality/value – This study differs than previous studies in many ways: first, it focuses on non-financial
listed companies in Malaysia. Previous studies have concentrated on companies in the financial sector, such
as banking and financial institutions or on industrial organizations. Second, this study analyzes the data in
companies’ annual reports for a three-year period from 2012 to 2014. During this period, the economy in
Malaysia was fluctuating due to currency depreciation. Third, the study used both return on equity and
earnings per share as indicators of profitability. Fourth, the results of the study provide empirical evidence
that large size firms with efficiently managed assets can improve operating income and ultimately enhance
profitability. Last but not least, this study applies the resource-based theory and the trade-off theory.
Keywords Profitability, Malaysia, Efficiency, Leverage, Liquidity, Working capital
Paper type Research paper
1. Introduction
One of the main goals of any company is to be sustainable in any competitive environment.
To do so, it is important for the company to develop, implement and maintain strategies that
can enhance its performance. This can be done by investigating the internal and external
factors that may have an impact on the company’s profitability. The quality and efficiency
Journal of Economic Studies of managers depend on their ability to identify those elements that can lead to increased
Vol. 45 No. 3, 2018
pp. 442-458
© Emerald Publishing Limited The authors of this paper has not made the authors research data set openly available. Any enquiries
0144-3585
DOI 10.1108/JES-05-2017-0124 regarding the data set can be directed to the corresponding author.
profitability. In general, profitability is defined as the earnings of a company that are Profitability in
generated from revenue after deducting all expenses incurred during a given period. It is one Malaysia
of the most important factors that signal management’s success, shareholders’ satisfaction,
attraction for investors and the company’s sustainability (Bekmezci, 2015). Undoubtedly,
the ultimate goal of any firm is to maximize the wealth of its shareholders by increasing the
value of its stocks. Previous studies have found a positive relationship between earnings
and stock values (Kalama, 2013). In other words, if earnings announcements come as 443
expected or are better, stock prices will increase, but if earnings announcements fall short of
expectations, the stock prices will decline.
A majority of companies, if not all, realize the concept and the importance of
profitability but they may not know how to enhance it and what the factors affecting
profitability are. This is more obvious during a time of crisis; some companies attempt to
preserve their financial status by undertaking risky measures, but due to limited
experience and high risks, these kinds of actions more often than not result in worsening
their financial status.
Identifying the factors which determine profitability is still one of the major concerns of
researchers. A number of previous studies have investigated the factors that influence
profitability of firms, including size (Stierwald, 2010a, b; Yazdanfar, 2013; Mohd Zaid et al.,
2014); working capital (WC) management (Goddard et al., 2005; Chowdhury and Amin, 2007;
Alipour, 2011; Charumathi, 2012); age of the firm (Geroski and Jacquemin, 1988; Bhayani,
2010; Agiomirgianakis et al., 2013); and leverage (Burja, 2011; Mistry, 2012; Boadi et al.,
2013). However, previous studies have shown inconsistent findings that make
generalization questionable. Based on this, this study is concerned with profitability in
Malaysia. Malaysia is widely recognized as an emerging market.
The Malaysian economy showed strong signs of recovery in 2010 from the global
economic crisis (Datamonitor, 2010; Watanabe et al., 2011). The profitability persistency of
individual firms exists in seven developing nations, including Malaysia (Glen et al., 2003).
This puts Malaysian companies in competition with others and has increased the challenges
they have to face. The main challenge Malaysian companies are facing is how to achieve
stability and sustainability. In order for a company to achieve this, it is crucial that the
company has a good knowledge of specific internal and external conditions within which
the company operates. The quality and efficiency of managers depend on their ability to
identify those elements that can enhance company performance and profitability (Burja,
2011). This is also applicable for Malaysian companies if they wish to continuously compete
in the emerging market. The Malaysian currency started began depreciating during the
Asian Financial Crisis of 1997–1998 and dropped to almost 50 percent of its value.
Companies have less incentive to reduce costs because they can rely on devaluation to boost
competitiveness. The recession over the long term can lead to lower productivity due to a
decrease in incentives and inflation (Todorović and Veličković, 2010). This creates an
ambiguous picture about companies’ profitability in Malaysia.
Generally, very few studies, such as Ahmad Farid (1980), Mohd Zaid et al. (2014) and the
latest study by Ulfana Nisa (2015), have investigated the factors affecting profitability in
Malaysia. However, this study differs from the previous studies in a number of aspects: first,
it examines different independent variables (IVs), including company efficiency and WC.
Second, the study covers the period during the depreciation of the Malaysian currency
(Ringgit). Third, the study uses two measurements for profitability, i.e. earnings per share
(EPS) and return on equity (ROE), which can produce more realistic results that are
beneficial to stakeholders of these firms, specifically, creditors, investors, management
and shareholders. Therefore, based on previous studies, this study examines the impact of
five factors on companies’ profitability by using six financial indicators, namely, total
sales, WC, assets turnover ratio, current ratio, debt equity ratio and leverage ratio.
JES The profitability factor is measured by using ROE and EPS. This study intends to achieve
45,3 the following objectives:
(1) to examine the relationship between firm size and profitability;
(2) to examine the relationship between WC and profitability;
(3) to examine the relationship between company efficiency and profitability;
444 (4) to examine the relationship between company liquidity and profitability; and
(5) to examine the relationship between company leverage and profitability.
This study is organized into five sections as follows: Section 2 displays briefly previous
studies. Section 3 explains the source of data, the hypotheses under investigation and the
research model. Results of the tested hypotheses are included in Section 4. Finally, Section 5
concludes the study.
2. Literature review
2.1 Previous empirical studies
It has been proven that a business will not survive if it is not profitable, and a business that is
highly profitable has the ability to reward its owners with high returns on their investment.
Thus, companies that want to achieve stable profitability need to know internal and external
factors that may have a significant effect on profitability. Earlier and recent studies have
attempted to determine the financial indicators for profitability by empirically examining
different factors that have theoretical relationships with profitability, like size (Mehta, 1955;
Comanor and Wilson, 1969); net operating profitability (Ito and Fukao, 2006; Rahman et al.,
2010; Burja, 2011); liquid ratio, receivables turnover ratio and WC to total assets (Singh and
Pandey, 2008); debt ratio (Burja, 2011); return on total assets (Padachi, 2006); return on invested
capital and return on assets (ROA) (Narware, 2010); financial leverage (Burja, 2011); equity
ratio (Burja, 2011); market share (Nagarajan and Barthwal, 1990); current assets ratio (Singh
and Pandey, 2008; Burja, 2011); and R&D (Fenny and Rogers, 1999). Some related studies have
examined these aspects in different countries, like Huang and Song (2006) and Chakraborty
(2010) in China; Akintoye (2008) in Nigeria; Pirtea et al., Burja (2011), Moldovan et al. (2013) and
Vătavu (2014) in Romania; Sivathaasan et al. (2013) in Sri Lanka; Kaen and Baumann (2003),
Hoffmann (2011) and Growe et al. (2014) in the USA; Raza et al. (2012) and Bhutta and Hasan
(2013) in Pakistan; Dencic-Mihajlov (2014) in Serbia; Geroski et al. (1997) in the UK; Fenny and
Rogers (1999) in Australia; Claver et al. (2006) in Spain; Ito and Fukao (2006) in Japan; Chander
and Priyanka (2008) in India; Asimakopoulos et al. (2009) in Greece; and Goddard et al. (2009) in
11 European countries. Some of these studies are descriptive and others are empirical, which
show the relationship between profitability and its determinants.
The findings of previous studies have broadly highlighted a number of variables that have
a significant impact on companies’ profitability. All these variables, namely, company size,
age, risk, liquidity, leverage, industry type, capital intensity, skill, concentration ratio, capacity
utilization, market share, advertising intensity, R&D intensity, retention ratio, growth in
revenue, long-term financing, turnover ratios, ownership characteristics, exports, working
assets, indebtedness level, etc., are equally popular among researchers. However, previous
studies differ from each other because of the period the study was undertaken, ranging from
one year (as seen in Jones et al., 1973; Barthwal, 1984) to 20 years (Kaur, 1997), or because of
focusing on country-specific and firm-specific factors (Kaur, 1997; Glancey, 1998; Ito and
Fukao, 2006); and inter-industry-specific factors (Barthwal, 1984; Nagarajan and Barthwal,
1990; Grinyer and McKiernan, 1991). In addition, the review also shows that most of the
research work relating to inter-industry profitability has been conducted in developed
countries. Vătavu (2014) examined the determinants of financial performance in 126 Romanian
companies listed on the Bucharest Stock Exchange over a period of ten years (2003–2012). The Profitability in
analysis was based on cross-sectional regressions, performance was measured by ROA, while Malaysia
the IVs were debt, asset tangibility, size, liquidity, taxation, risk, inflation and crisis. The
outcomes of regression analysis indicate that profitable companies operate with limited
borrowings. Tangibility, business risk and the level of taxation have a negative impact on
ROA. Although earnings are sustained by significant sales turnover, performance is affected
by high levels of liquidity. Periods of unstable economic conditions, reflected by high inflation 445
rates and the financial crisis, have a strong negative impact on corporate performance.
Several financial indicators, such as current ratio, liquidity ratio, receivables turnover
ratio and WC to total assets, have been examined in other studies (Singh and Pandey, 2008);
while some studies have considered performance assessment expressed by earnings before
interest and taxes and the associated risks resulting from the influence of using a certain
financing structure (Akintoye, 2008), or expressing it through economic value added, ROE,
operating profit margin (OPM) and EPS (Rayan, 2008).
Profitability is the main concern of Malaysian-listed companies as it is the concern of other
related parties. However, the studies done in Malaysia are very few and the focus has been
mostly on two sectors, i.e. the construction and banking sectors. Examples of these studies
include Ramasamy et al. (2005), Narware (2010), San and Heng (2011), Razak et al. (2008) and
Salim Yadav (2012). Nevertheless, all of these studies have highlighted the importance of
profitability at the microeconomic level. Mohd Zaid et al. (2014) examined the determinants of
profitability based on construction companies in Malaysia. The data were collected for the
period of 2000–2012. This study used ROE to measure the profitability of companies; debt
equity ratio to measure capital structure; quick ratio to measure liquidity; sales to measure the
size of companies; and term premium to measure the economic cycle. The result shows that
liquidity and size have significant relationships with profitability. A negative and insignificant
relationship is found between capital structure and profitability. Another study (unpublished)
by Ulfana Nisa (2015) examined factors that affected profitability during the financial crisis of
2008. The ROA was used as a measurement for company profitability, while size, liquidity,
leverage, sales growth and gross domestic product were examined as IVs. The data of
161 listed companies for the period of 2001–2012 were analyzed using ordinary least squares
(OLS) and fixed-effects estimation. The findings show that leverage has a negative and
significant relationship with ROA; and size, liquidity and sales growth have a positive and
significant relationship with ROA. However, gross domestic product does not have a
significant relationship with ROA. In general, in today’s economy, where strong competition
dominates and where all processes are highly dependent on information (Alarussi et al., 2009),
the success of a company requires specific measurements and management systems.
To comply with the principle of rational economics, a company must systematically analyze its
financial result, or in other words, analyze profitability. Parkitna and Sadowska (2011)
affirmed that when determining the profitability index of a business entity, it is important to
use many variants of the numerator and denominator to gain more information about a
company. This paper is concerned with the profitability of companies in Malaysia and chooses
the most common variables in order to check whether the determinants of profitability for
developed countries are applicable in Malaysia’s case as a developing country following the
depreciation of the Malaysian Ringgit. The results of the study will be useful for related
parties, including management, shareholders, financial analysts and investors.
(Model 2):
449
EPS ¼ aþb1LTS þb2WC þb3CRIO þb4ASTRIO þb5LEVRIO þb6DTERIO þe;
Here, α and β1–β6 are coefficients, Log of Total Sales (LTS), WC, Current Ratio, Assets
Turnover Ratio, Leverage Ratio and Debt to Equity Ratio are the explanatory variables, and
ε is the error term.
Table II shows the descriptive statistics for the sample. The mean (median) of
absolute value is ROE 6.7 (6.64) whereas the minimum value is negative, showing loss.
In addition, the mean (median) of EPS is 12.61772 (8.305); however, the minimum
value is negative 75. In terms of WC, the mean (median) is 4.15 (1.01); the mean (median)
company efficiency (assets turnover ratio) is 0.5790497 (0.686061); the mean (median)
of liquidity (current ratio) is 3.03802 (1.858931); and, lastly, the mean (median) of
leverage (debt equity ratio and leverage ratio) is 0.4262042 (0.3894299) and 0.6138858
(0.8631349), respectively.
Table III shows the correlation between the IVs and the DV in this study. Total sales and
WC are positively correlated with EPS. However, leverage is negatively correlated with EPS.
These results are similar to the studies of Malik (2011), Burja (2011), Stierwald (2010a, b),
Warrad and Al Omari (2015) and Al-Jafari and Alchami (2014). Total sales, WC and assets
turnover are positively related with ROE. However, within the IVs, the maximum correlation
1 Profitability (1) Returning on equity Yasser et al. (2011), Nawafly and Alarussi
(2) Earnings per share (2016)
2 Firm size Total sales Kajüter (2006)
3 Working capital Current asset − current Diakomihalis (2012)
liabilities
4 Company efficiency Assets turnover ratio Lesáková (2007)
5 Liquidity Current ratio Gurbuz et al. (2010) Table I.
6 Leverage (1) Debt equity ratio Alarussi and Shamki (2016) Variables’
(2) Leverage ratio measurements
EPS 1.0000
ROE 0.6232* 1.0000
INS 0.5765* 0.3584* 1.0000
WC 0.3065* 0.0871* 0.3130* 1.0000
CRIO −0.0355 −0.0198 −0.2227* 0.0418 1.0000
ASTRIO 0.1406 0.2819* 0.2551* −0.0047 −0.1651 1.0000
Table III. LEVRIO −0.1792* −0.1339 0.0727 −0.0854 −0.4243* 0.0296 1.0000
Correlation between DTERIO −0.0301 −0.1342 0.1776* −0.1724* −0.2579* 0.0085 0.3437* 1.0000
DV and IVs Note: *Significant in less than 5 percent
4. Discussion of results
This study focuses on financial indicators of profitability, i.e. firm size (total sales), WC,
company efficiency (assets turnover ratio), liquidity (current ratio) and leverage (debt equity
ratio and leverage ratio). These are the IVs and profitability is the DV, measured by ROE
and EPS. The results are elaborated on as follows.
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Further reading
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