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Project

Research Proposal
Topic:
"Impact off liquidity on profitability"
Submitted to:
Mam sundas
Submitted by:
Maha Riasat. 14-154
Ambreen Tariq. 14-111
Momina sultan. 14-121
Semester :
BBA 7th( S.S)

Department of Business Administration


Impact of Liquidity on Profitability; An
Analysis on Banking Sector
1. Introduction

1.1 Introduction to the Problem


In this world the banks are the most powerful financial institutions/sectors that
play the significant role in economic development. We can define bank as an
organization for raising the fund for the public and giving customer goods and
securities on credit. It also discounts the bills for the important financial
institutions. The liquidity of an organization is considered as most important
element for it to pay its current liabilities. It includes payment of duties and
the other financial expenses which are considered as short term. There is an
inverse relationship between profitability and liquidity ratio. If we want to
increase profitability then we have to sacrifice liquidity. At the same time
increased liquidity will be on the cost of profitability. According to (Amengor,
2010) in commercial banks the liquidity basically represents the capacity to
settle its commitments at maturity time. These commitments include lending and
investment commitments, any kind of withdrawals, deposits made by account
holders, and accrued liabilities. (Eljelly, 2004) described liquidity as the ability
of a deposit money bank to pay its short term obligation to its depositors and
creditors on demand or at maturity. On the other hand profitability is the
measure of the difference between income and the bank operating expenses. It
can be concluded by the work of (Eljelly, 2004) that liquidity ratio and
profitability can be like two forces having differing objectives which at all
times exert pressure to pull the bank apart. It has been explained by (Olagunju,
David, & Samuel, 2012) that profitability and liquidity are very important to
the main tax authorities, creditors and shareholders. The business men are
interested to become the shareholders in the bank. Investors gain the
profitability by their investment done in bank and this can be determined by
their return on investment. While the liquidity is the ability to fulfill the
customer’s or depositor’s withdrawal needs, which is usually on demand or on
a short notice as the case may be. The tax authorities are interested in
profitability of the banks in order to determine the appropriate tax obligation.
(Soenen, 1993) described that liquidity ratio work with cash and near cash
assets of a business on one side, and the payment obligation on the other side
payment. The near cash assets normally include receivables from customers and
inventories of complete goods and natural materials. Operating cash flows
produced by assets will affect firm liquidity position.

1.2 Importance of the Problem


The impact of Liquidity on the Profitability is to rationalize the assets or
investments of the firm or financial institution in such a way that the firm or
institution may be able to pay the quick obligations due upon it with out any
heavy loss. The arrangement of investments will lead to reap an economical
profit and in no phase will have to face any sort of slump. The main objective
of this study is to find the impact of liquidity on profitability.
1.3 Relevant Scholarship
1.3.1 Liquidity
The term liquidity is basically a technique which is used by an organization
to convert its assets (current) into cash. Whenever a firm/organization needed to
meet its financial obligations, it converts its current assets into cash form to
pay the due liabilities at maturity date. As and when the bank needed to pay
its short term obligations to its debtors and creditors/suppliers, it must have an
ability to satisfy it’s creditors for this purpose, and this ability is named as
“Liquidity” of a bank. This can be defined in simple words as under: A
technique or procedure which is adopted by a firm or an organization or any
financial institution to convert its assets into to cash for payment of near term
obligation livid upon. (Van Horne & Wachowicz, 2008) described that
organizations having current assets in less quantity will face problems in
continuing it’s operations on the other hand if the number of currents assets is
too high, this shows that the return on investment for the organization is not in
unspoiled state. (Anyanwu, 1993) defined liquidity as the ability of a firm to
convert it’s asset into cash within the short time and without the loss of value.
Liquidity ratio plays a very important role in every business because banks
usually operate with large funds borrowed from depositors in form of demand
deposits and time deposits. (Olagunju et al., 2012) explained that liquidity
means the ability of a bank to meet financial commitments at a reasonable
price at all times. Banks having money when they need to satisfy the
withdrawal needs of their customers. (Carlin, Kogan, & Lowery, 2013)
considers that liquid assets should be marketable securities. Liquidity of assets
means that they are expected to be converted to cash easily and pay out the
liability. Another quality of liquid assets is price stability. Based on the
characteristic, bank deposits and short term securities are more liquid than
equity investments due to the fact that the prices of the former are fixed than
the prices of short term securities.
1.3.2 Profitability
The issue of profitability is a contentious subject that a bank has to
consistently face. (Heibati, Seid Noorani, & Dadkhah, 2009) explained profit as
the difference among expenditures and returns during a fixed period of time,
normally comprised of one year. They argued that a business behaves like
living i.e. it stay alive and grows. Therefore, it is significant that a bank
produces income for its continuous survival and growth. It is also essential that
sufficient income must be produced to sustain the operations of the
organization that will lead towards further expansion and growth. (Agbada &
Osuji, 2013) consider planning for corporate profit as one of the most
challenging and extensive aspect performed by bank management just because
of the involvement of numerous variables in the decision making process,
which are generally not in the control of the bank. They also argued that
profit planning can be even more complex if it is done in highly challenging
economic environment. It has been described by (Tabari, Ahmadi, & Emami,
2013) that profitability is measured by two substitute measures. First is the
return on asset (ROA) as measured by the ratio of profits to total assets, and
the second is return on equity (ROE). It is generally believed that return on
assets ROA reveals the capacity of the assets of the banks to produce profit,
though this estimate can be biased due to off-balance-sheet activities. According
to (Saleem & Rehman, 2011) profitability can also be measured using return on
investment (ROI)

1.3.3 Theories of the Relationship between Liquidity and Profitability


Various theories have been presented to provide awareness for the association
between liquidity and profitability of banks. The straightforward query which
the underlying theories tried to respond is how does liquidity affect profitability
in banking? (Osborne, Fuertes, & Milne, 2009) suggested that greater liquidity
is usually expensive for banks, suggesting that greater liquidity decreases
profitability. However, according to the trade-off theory, Bank’s risk can be
reduced due to higher liquidity and in future the premium required
compensating investors for the costs of reducing bankruptcy risk (Osborne,
Fuertes, & Milne, 2012). They also argued that during business cycle bank’s
optimal liquidity level vary, naturally increasing when expected costs of distress
are expected to be higher, the association between profitability and liquidity is
possible to be extremely recurring, showing more positive results through the
stages of distress as banks that try to increase their liquidity position also
increase their profitability. So, there can be a negative or positive relationship
between liquidity and profitability in the short-run which depends on bank’s
current liquidity position in comparison to its optimal liquidity level. According
to (Flannery & Rangan, 2008) proclaim that if it is possible for banks to
attain their optimal liquidity level then certainly there will not exist any short-
run relationship. As any change in liquidity has no impact on profitability.
However, in the long run, regulatory requirements for liquidity may be a
requisite. This suggests that greater liquidity position only decreases profitability
in case if banks are beyond their optimal liquidity level, for example due to
regulatory requirements imposed by regulatory authorities or unanticipated
events. In support of the above study, (Osborne et al., 2012) discoursed that
banks’ optimal liquidity level raises through phases of distress in banking
sector. As the cost of bankruptcy rises during such phases of distress. (Agbada
& Osuji, 2013) clarified the relationship between liquidity and profitability
more briefly. They argued that it is more safe for banks to maintain high
amount of cash reserves against the deposits held by the bank. As this reserve
is an idle money they will not be earning any profit on it. At the same time if
they adopt the policy of investing all to increase the profit they may face
illiquidity problem if customers demand much cash in a particular time. It can
be concluded that good banker must have to maintain a harmony between
these two conflicting objectives by investing in a very well diversified good
portfolio mix.

1.4 Objective of study


1. To determine the relationship between current ratio and profitability.
2. To determine the relationship between quick ratio and profitability.
3. To determine the relationship between cash ratio and profitability.

1.5 Variables

DEPEDENT
DEPEDENTVARIABLES
INDEPENDENT VARIABLES
VARIABLES INDEPENDENT VARIABLES
Current
Return
Returnononasset
asset Currentratio
ratio
Return Quick ratio
Returnononequity
equity Quick ratio
Cash
Cashratio
ratio
1.5.1 Dependent variables

Return on asset (roa) = net profit before tax /total asset


Return on equity (roe) = net profit before tax /share holder equity

1.5.2 Independent variables

Current ratio = Current asset / current laibilities


Quick ratio = Current asset-inventories / current laibilities
Cash ratio = Cash + Cash Equivalents/Current Liabilities
2. Literature Review
Liquidity plays vital role in determining the effectiveness of firms. Thus it is
necessary for firms to maintain a balanced liquidity ratio in order to meet their
short term liabilities. Due to its relationship with the day to day operations it
is imperative for both internal and external analysts to study liquidity.
Literature review consist on the study of person who studied previous research
papersand provide their reviews.

Khan and Mutahhar Ali (2016) state that there is positive relationship between the
liquidity and profitability.
The current ratio and quick ratio was consider as measure of liquidity and Gross profit
margin and Net profit margin ratios were consider as measure of profitability.

Ibe (2013) discusses that the liquidity management is an important problem in the
Nigeria.The data is collect from three banks which is selected randomly represent the
whole banking sector of Nigeria.
Profitability represents the after tax profit dependent variable and the liquidity
management is independent variable which include the Bank cash assets , Bank
Balance, Treasury Bills and certificate. Regression is used to analysis the data.

According to Eljelly ( 2004 ) efficient working capital management involves planning


and controlling current assets and current liabilities in a manner that eliminates the
risk of inability to meet short term obligations on one hand and avoides excessive
investment in these assets.

Waleed,pasha and akhtar(2016)they discusses that there is a significant relationship


among liquidity and profitability but ROI and EPS has insignificant relationship with
liquidity they search data from PSE during time period(2010-2015).
The model that they used is yhe regression model to determining the relationship
between variables.
Ibrahim (2017) discisses the relationship of liquidity and profitability by taking the
data of five banking sector.dependent and independent variables(quick ratio, current
ratio, ROA, ROE ,ROI) were used. He states any lead in liquidity will increase the
ROA and for calculation use OSL model.

Macharia(2013)state that liquid asset are less profitable as compare to long yerm
asset and most of the firm manager try to invest in profitable projects and he study
on 44 banks among time period of(2008-2012).he study the secondary data on
determining thr profitability and liquidity .used regression model to establishing the
relation between variables.The study recommends that the finance managers of
commercial banks maintain a balance between the level of liquid assets and long term
assets to reinforce each of the
conflicting objectives of maintaining adequate liquidity and sustainable profitability.

Maqsoid, Anwar and Raza(2016)show that the banking sector


of Pakistan is chose as sector and country is Pakistan and there is a significant
relationship between liquidity and profitability eight 8 banks financial reports are
taken and 8 years data is taken from 2004 to
2015 for this research paper and the banks are selected bank of Punjab.

Sulieman alshatti(2014) shows that there is a significant relationship between


liquidity and profitability while in defining the model they used t -test by using
regression analysis and shows the relationship that if liquidity increase or decrease
what will be the imapct on profit.he state there is a need of utilization to increase the
bank profitability.

Ismail(2016) firstly discuss the financial crisis that they can also effect the
profitability of a firm they gathered the data by examining the non financial firm and
take data from KSE after this discuss the profitability and liquidity ratio variable and
state that high conversion ratio increase in current ration leads/increase the firm
profitability.
3.Data and sample selection
The purpose of this study is to analyze the impact of the liquidity on the profitability
of the Pakistani banking sector(HBL,UBL,MCB and ABL) constituting KSE 100
Index.The dependant variables that we used for studying
profitability(ROA,ROE,ROI).Here three ratios are consider in calculating the"
imapact of liquidity on profitability of banking sector " independent variables are
(quick ratio,current ratio and capital ratio). While the whole data that we collect is
secondary.

3.1 ROA
Profitability is assessed relative to costs and expenses, and it is analyzed in
comparison to assets to see how effective a banking sector is. The term return in the
ROA ratio customarily refers to net profit or net income, the amount of earnings from
sales after all costs, expenses and taxes.
3.2 ROE
It is a ratio that concerns a company's equity holders the most, since it measures their
ability of earning return on their equity investments. ROE may increase dramatically
without any equity addition when it can simply benefit from a higher return helped by
a larger asset base

4. Research methodology

The method of analysis used is the regression analysis.


This paper shows the impact of the liquidity on profitability in the pakistan
commercial banks during the time period (2009-2015)

Research Models
The following two models represent the research models:

ROA= a0 + a1CR + a2QR+ a3CAR


ROE = b0 + b1CR + b2QR + b3CAR

CR: current ratio = Current asset / current laibilities


QR:Quick- Acid ratio = (Current assets- Inventory) / Current liabilities.
CAR: Cash ratio = Cash+cash equivalents/Total liabilities
a1, a2, and a3, : are the variables coefficients of the first model.
Where b1, b2,and b3: are the the variables coefficients of the second model.

The first and second model measures the effect of the liquidity on profitability in the
pakistani commercial banks, where return on equity (ROE) and return on
assets(ROA) was the proxy for profitability.
OLS(operating least square) and sample Statistics are used in evaliating the result that
is regression and coefficient Mean,S.D,and standard error or t-test were also used.
5. Results and discussion

5.1 Bank Alfalah:


Major factors like global financial turmoil, economic slowdown and contractionary
monetary policy were compounded by an unusual liquidity stress during October-
November 2008.
Due to relatively higher growth in advances, the liquidity profiles of the bank alfalah
had already been burdened.To manage the liquidity stress resulted in a significant
decline in cash and treasury bank balances by the end of Dec-08 quarter but that is
balanced due to proportionate increase in operating expense.
5.2 MCB:
MCB shows that their profit during 2006-2008 increase that there is a little bit
decreasr on ratio but earn profit but tgeey face decline in 2010 on ROAand ROE due
to some fluctuations. Their net interest income and non interest income increase by
8%.
The liquidity position of MCB over the year seems to have fared very mixed results
over the year. smaller proportion of its deposits as advances, indicating that it wished
to improve its cash position.
Reduction in CRR (cash reserve ratio) and SLR ( statutory liquidity ratio) that result
in decline in cash and bank balance.
5.3 HBL:
HBL overall position shows that there is changes in ROA and ROE due to liquidity
effect. in 2010 the bank increases their profit by reducing their advances and their
income before tax are greater. In 2009 their profit decreases due to fluctuations in
economy
markets in Pakistan faced various episodes of liquidity stress run.The year kicked
started with the build-up of liquidity pressure in the money market which peaked
during October November 2009.The overall liquidity profile of the banking system
was strained due to high public sector demand for bank credit and pick up in credit to
private sector.

As overall results of all banks shows each bank phase decline in their profit due to
the element of liquidity and economy fluctuations.so liquidity have significant
effect on profitability of banking sector.

Discussion and ResultsThis study has examined the impact of the liquidity
management on the performance of the Pakistani Firms constituting KSE 100
Index. The results of regression analysis have been discovered in Table 3. The
regression analysis results indicate that high current ratio and longer CCC lead
firms towards better performance in terms of return on assets. The study found
that current ratio has a significant positive impact on ROA of the sampled
firms. This result is consistent with the studies of Ahmed (2013); Bolek (2013);
Alavinasab and Davoudi (2013); Ajanthan (2013); Manyo and Ogakwu (2013);
Ajao and Small (2012); Azam and Haider (2011); Haq et al. (2011); Rahman
(2011) and Zainudin (2006). Current assets are useful for firms to withstand
and survive in a financial distress situation. Additionally, business expansion
programs require enough cash assets to maintain day-to-day operations alongside
the long-term external financing. Cash and quick ratios show insignificant
association with the performance of sampled firms. Further, the results of a
regression show that there is a significant positive relationship exists between
cash cycle and return on assets. The result of study is consistent with the
study Bagchi et al. (2012) based on Spearman’s correlation coefficient and
regression analysis. A significant positive relationship between CCC and ROA
tells that a longer cash conversion process will result an increase in sales and
profits. The longer cash cycle can make the firms approachable for a large
number of customers; which can in turn increase the volume of revenue
generated during the period. This study suggests sampled firms to relax their
credit sales policies, and devise inventory & collection turnover system in a
wise manner to be more accessible to a large number of customers. This study
also suggests managers to pay business’ obligations in a reasonable period to
ensure smooth functions and credit benefits. This measure will enhance their
performance and revenues in the future. The availability of historical data was
an issue to extend the study area. It is a recommendation for further research
to consider an increased number of the companies listed on Karachi Stock
Exchange with some different variables of liquidity and profitability and recent
statistics of companies. results of fours models show positive impact and two
models shows a negative effect. The empirical consequences deliver also the
conclusion that the profitability of banking sector can be increased together
with the growth of the number of accounts payables days. From the analysis,
we conclude that for banks to resolve the liquidity/profitability trade-off, there
is need for each bank to determine its optimal liquidity position. Recommendation
There is need for banks to engage competent and qualified personThis research
paper is examined on the impact of liquidity on profitability of the banking sector of
Pakistan constituting 8 years of eight banks. And the Liquidity have much money in
cash.Based on the research findings, the researcher concluded that, there is an
effect of the liquidity management on profitability in the Jordanian commercial
banks as measured by ROE or ROA, where the effect of the investment ratio and
quick ratios on the profitability is positive when measured by ROE, and the effect
of capital ratio on profitability is positive as measured by ROA, and the effect of
the other independent variables on the two measures of profitability (ROE and
ROA) is negative, the researcher thinks that this negative effect is due to the
increased volume of untapped deposits at the Jordanian commercial banks.

6. Conclusion
This research paper shows the impact of liquidity on profitability on banking sector
of pakistan for period of 2006-2010.The analysis in this paper show the relation of
dependent to independent variables and the variables relationship show that there is
a negative impact of liquidity on profitability if its not determine its position.From
the analysis, we conclude that for banks to resolve the liquidity/profitability trade-off,
there is need for each bank to determine its optimal liquidity position and the role of
SBP to take timely corrective measures. Measures include relaxation of CRR and SLR
in phases

7. References
1: Khan, R.,Ali,M.(2016):impact of liquidity on profitability of commercial banks in
pakistan:An analysi of banking sector in Pakistan.

2: Obilor Ibe, S. (2013)impact of liquidity on profitability of bank in nigeria.

3: Waleed,A.,pasha, A.and Akhtar, A. (2016):the impact of liquidity on


profitability:Evidance from banking sector of Pakistan

4: Eljelly, A.(2004):liquidity profitability trade-off: An emprical investigation


emerging market.

5: Naberl, M.,Muhammad Hussain, S. (2015):Liquidity management and its impact


on banks profitability :A perspective of Pakistan

6: Maqsood, T., Anwar, M., Riaz, A., ijaz, M. and shouqat, U. (2016):impact of
liquidity management on profitability in banking sector of pakistan.

7; Sulieman Alshatti, A. (2014):the effect of liquidity management on profitability


in the Jordanian commercial banks.

8: Ismail, R. (2016):impact of liquidity management on profitability of pakistani


firms:A case of KSE-100.

9: Ibrahim,S.S.(2017):the impact of liquidity on profitability in banking sector of


iraq:A case of irqi commercial banks.
10: Macharia, W. T. (2013):the relationship between profitability and liquidity of
commercial banks in kenya.