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INFLUENCE OF LIQUIDITY ON

PROFITABILITY: A CASE OF
NEPALESE MANUFACTURING
FIRMS

Antovna Gyawali
Roll Number: 11450241
P.U. Registration Number: 2010-02-45-0005

Introduction
Liquidity and profitability management are crucial
aspects of a business.
Working capital requirement decides the liquidity and
profitability of a firm
WCM is a managerial accounting strategy focusing on
maintaining efficient levels of both components of
working capital, current assets and current liabilities,
in respect to each other

Problem Statement

Issues raised
The outcome of the research clearly pinpoint a
negative relationship of profitability with
liquidity and receivable conversion period.
Positive relationship was established between
profitability and inventory conversion period,
payment deferral period and cash conversion
period which expresses the efficiency of
working capital.
The financial leverage correlated positively
with profitability.

Objectives
To analyze the relationship between Working
Capital Efficiency and Profitability of
manufacturing companies of Nepal.
To analyze the relationship between Liquidity
and Profitability
To examine the relationship between leverage
and profitability

Literature Review
Topic/Issue

Findings

S.N

Year Author

2004

Mukhopadhya
y

Working Capital

Working capital is the most crucial factor for


maintaining liquidity, survival, solvency and
profitability of business

2010

Dong and Su

There is strong negative relationship


between cash conversion cycle and
profitability.

2004

Eljelly

the relationship
between
profitability, the
cash conversion
cycle and its
component
The
relationship
between liquidity
and
working
capital
management

2006

Atrill

The crucial part in managing working capital


is required maintaining its liquidity in day-today operation to ensure its smooth running
and meets its obligation.

The importance of Working capital directly affects the liquidity,


WCM
profitability and growth of a business and is
important to the financial health of
businesses as the amounts invested in
working capital are often high in proportion to
the total assets employed.

Data Collection and Methodology


Population: 18 manufacturing companies listed in the Nepal
Stock Exchange(NEPSE) market
Sample: 2 sample companies
Observation: 12
Study Period: 2007-2012 (6 years)
Data Extraction: Use of many secondary data, mainly the
Annual Reports
Balance Sheets
Income Statements
Techniques: Descriptive Statistics, Correlation Analysis and
Regression Analysis
Tools: MS - Excel

Variables
Return on Assets (ROA) = Net Profit/ Total Assets
Return on Equity (ROE) = Net Profit/ Total Equity
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = (Current Assets Inventories) / Current
Liabilities
Receivable Conversion Period (RCP)= Account Receivables
*365/ Sales
Inventories Turnover Period (ITP) = (Inventories x 365) /
Cost of sales
Payment Deferral Period (PDP) = Accounts Payable*365/ Cost
of sales
Cash Conversion Cycle (CCC) = ICP+RCP-PDP
Debt Ratio (DER) = Total Debt/ Total equity
Size of the Firm = ln (Total Sales)

Study Models [Y = +1X1+ 2X2+e]


ICP

DER

ROE

ROE

Current
Ratio

Model I

LR

Model II

Size of
the
Firm

ROE
PDP

RCP

ROE
Model III

CCC

Model IV

Data Analysis and Presentation

Performance of
Nepalese
Manufacturing Firms

Return on Equity
ROE
53.48%

60.00%

53.00%

50.00%

47.96%

40.00%

32.07%

30.00%
20.00%

18.95%

23.38%

ROE

10.00%
0.00%

2007

2008

2009

2010

2011

2012

Return on Assets
ROA
22.08%

25.00%

21.49%

20.00%

17.31%

15.94%

15.00%

13.23%
10.00%

ROA

12.23%

5.00%

0.00%

2007

2008

2009

2010

2011

2012

Current Ratio
Current Ratio
Current Ratio

2.57
1.95
1.86

1.53

1.25
1.12

2007

2008

2009

2010

2011

2012

Size
Size
17.2

17

16.8

16.6

Size

16.4

16.2

16

15.8

2007

2008

2009

2010

2011

2012

Debt Equity Ratio


Debt-equity
Debt-equity

0.58
0.43
0.55
0.37

0.34
0.26

2007

2008

2009

2010

2011

2012

Cash Conversion Cycle


135.79

127.89

140.00

130.73
112.76

107.39

117.43

120.00

100.00

80.00

60.00

40.00

20.00

0.00

2007

2008

2009

2010

Cash Conversion Cycle

2011

2012

Liquidity risk
Liquidity Risk
0.25
0.2
0.15
0.1
0.05
0

Liquidity Risk

2007

2008

2009

2010

2011

2012

Descriptive Analysis

Correlation

MODEL I
ROE is dependent variable. ICP and
CR are independent variables.

Regression Statistics
Multiple R
R Square

0.8999

The adjusted R^2 of this model is


76.75%. This means that 77%
(approx) change in the dependent
variable is explained by the change
in the other 2 independent
variables.

0.8098

Adjusted R Square 0.7675


Standard Error
0.1826
Observations

12

Coefficie Standard
nts
Error
Intercept
ICP
Current
Ratio

t Stat

P-value

-0.51

0.29

-1.75

0.11

0.01

0.00

5.42

0.00

-0.08

0.09

-0.84

0.42

The standard error of the model is


0.18 which is at a level of 18% is the
adjustment factor for the accuracy
of the data.
In this model, ROE has significantly
positive relationship with ICP where
as insignificantly negative
relationship with CR.

MODEL II
ROE is again taken as
dependent variable and leverage
ratio (debt-equity) and RCP are
dependent variables in this
model.

Regression Statistics
Multiple R

0.8795

R Square

0.7734

Adjusted R
Square
Standard Error

0.7231

Adjusted R2 is 72.31%, which


implies that 72.31% of the total
variation in the ROE is explained
by the independent variables
that are identified.

0.1994

Observations

12

Coeffici
ents

Standard
Error

Intercept

0.49

0.22

2.19

0.06

Debtequity

0.60

0.44

1.36

0.21

-0.02

0.00

-4.86

0.00

RCP

t Stat

P-value

Standard Error of the


regression is 0.1994 which
means other factors have very
less effect on the dependent
variable ROE.
ROE has statically significant
positive relation with debtequity ratio whereas significant
but negative relation with RCP.

MODEL III
ROE is the dependent
variable and the other
independent variables are
PDP and Liquidity Risk.

Regression Statistics
Multiple R

R Square
Adjusted R
Square
Standard
Error
Observations

0.9264
0.8582

The R square of the model


is 0.8267. This means that
82.67% change in the
dependent variables is
explained by the change in
the independent variables.

0.8267

0.1577
12

Coefficie Standard
nts
Error

t Stat

P-value

Intercept

-0.29

0.10

-2.79

0.02

PDP
Liquidity
risk

0.01

0.00

7.16

0.00

-0.30

0.36

-0.85

0.42

PDP is positively correlated


and found significant with
ROE. Liquidity Risk is
negatively related but
found insignificant with
ROE.

MODEL IV
ROE is the dependent
variable and the other
independent variables are
CCC and Size(log of sales).

Regression Statistics
Multiple R

0.8701

R Square

0.7570

Adjusted R
Square
Standard Error

0.7031

Observations

Coefficie Standard
nts
Error

0.2064
12

t Stat

P-value

Intercept -0.3188

0.4913

-0.6489

0.5326

Size

0.0530

0.0101

5.2582

0.0005

CCC

-0.0015

0.0037

-0.4049

0.6950

In this model it was found


that Cash Conversion Cycle
and profitability (ROA) are
positively co-related. So,
longer the duration between
making payments and
receiving cash flows, the
profitability of the firm
tends to increase.
Adjusted R2 of
manufacturing firms is
0.7031 which means that
71.31% of the total
variation in the ROE is
explained by the given
independent variables.

Conclusion
There exists a negative relationship between liquidity and
profitability and CCC and profitability.

There is positive relationship between leverage and profitability. An


average DER of 0.42 means that majority of the assets of
manufacturing companies are financed through equity.
ROE is in increasing trend which is a good sign for investors.
ROA seem decelerating from 2010 and main reason behind this may
be the strikes of unions, fire on the factories and so on.
As in 2007 CR is higher than 2, which means manufacturing
companies had problems in managing WC whereas in rest of the
years it less than 2 but greater than 1. This shows that companies
are more likely to meet its liabilities.

Quick Ratio has an average of 0.94 which is minutely less than one.
So manufacturing firms have very less difficulties in paying their
short term obligations.
Average NWPS of 933.90 shows that manufacturing companies in
Nepal are good investment areas.
RCP[23.6] is less than PDP[61.52] and manufacturing companies have
CCC of days in an average.

The longer ICP is due to the bulk purchase of inventory and large
quantity of inventory.
The study found out positive relationship between CCC, PDP and ICP
with profitability but negative with RCP.
Manufacturing firms in Nepal have a high scope so the investment
in these may be fruitful.

Recommendations to future researchers


Future research with more companies and
detail financial data will be more fruitful.
A broader sample size would have been a
better indicator of the market scenario of
Manufacturing firms in Nepal.

Take a longer period of data observation