Faculty of Commerce

Tanta university
Business Administration Dept.

The impact of Liquidity on the Profitability of companies

An empirical study on listed companies listed on the Egyptian stock
exchange

Prepared by
Tuqa Abd Al-Majeed Yassin Ammar

Under Supervision of

Prof. Dr.

El-Sayed El-Badawy Abdel-Hafez Ibrahim

Professor of investment and Finance.
Faculty of commerce – Tanta University

A Graduation Research Project Submitted to the Business Administration

Department in Partial Fulfillment of the Requirements for the Award of the
Degree of Executive MBA in Business Administration (Finance).

2022
 Abstract
The aim of this study is to test the relationship between liquidity and
profitability to determine the effect of liquidity on profitability. A purposive
sample of 30 listed companies on the Egyptian Stock Exchange was selected based
on data availability at the end of fiscal year for the period (2018-2020), Data was
analyzed using E-views software and running a Panel data regression. Results
revealed that there is a positive significant relationship between liquidity measured
by current assets and profitability measured by return on assets (ROA).

ii
 Oral examination and approval committee

Prof.Dr: El-Sayed El-Badawy Abdel-Hafez

Chairman
Signature: __________________

Prof. Dr: Mohamed Saad Shahen

Internal examiner
Signature: ____________________

Prof. Dr: Bassam Samir Barouma

Internal examiner
Signature: _____________________

iii
 Acknowledgement
Although this research is completed by one individual it takes the support of
many to complete the process and I acknowledge them for all the support they
have provided to me in this rewarding journey.

I would like to express my sincere gratitude and great thanks to my supervisor

Prof. Dr. / El-Sayed El-Badawy Abdel-Hafez Ibrahim, Professor of investment
and Finance, for his sustained unlimited help, patience and support throughout my
research project process, without his support this research could not be completed.

I deeply value and appreciate the efforts of the two members of discussion
committee, Prof. Dr. Mohamed Saad Shahen and Dr. Bassam Samir
Barouma who approved to participate in this discussion. I am sure that they
will enrich this discussion.

I also must acknowledge my family for the support they have provided for
me during this study at the expense of my companionship to which they were
entitle.

Finally, I am grateful to all professors who have taught me throughout more

than two years and helped me in every possible way to make this work easier and
enjoyable.

iv
 Dedication
This study is wholeheartedly dedicated to my beloved parents, who
have been a source of inspiration and gave us strength when we thought
of giving up, who continually provide their moral, spiritual, emotional,
and financial support.

v
 Table of contents
- Abstract ii
- Oral examination and approval committee iii
- Acknowledgement iv
- Dedication v
- List of Tables viii
- List of Appendices ix

Chapter one: Introduction 1

1-1. Background……………………………………………………………….…...1
1-2. Research Problem…………………………………………………………..….2
1-3. Research Goals………………………………………………………………...3
1-4. Research Importance……………………………………………………….….3

Chapter 2: Previous Empirical Studies 5

Chapter 3: Theoretical Framework 10

3-1. Definition of Liquidity……………………………………………………….10

3-2. Theories of Liquidity…………………………………………………………12
3-3. Importance of Maintaining Appropriate Liquidity
Ratios…………………….14
3-4. Sources of Liquidity
Risk……………………………………………………..15
3-5. Measures of
Liquidity………………………………………………………...16
3-6. Definition of
Profitability……………………………………………………..18
3-7. Factors affecting profitability of
companies…………………………………..19

vi
3-8. Measures of
profitability……………………………………………………...20

Chapter 4: Research Methodology 22

4-1. Research
hypothesis…………………………………………………………..22
4-2. Research variables and measures…………………………………………….22
4-3. Research population and sample selection…………………………………..22
4-4. Research Limitation………………………………………………………….23
4-5. Data collection……………………………………………………………….23
4-6. Data analysis…………………………………………………………………23

Chapter 5: Research results 24

Chapter 6: Conclusions and Recommendations 27

References………………………………………………………………………...29

Appendices………………………………………………………………………..33

vii
 List of tables

Table (5-1): The results of Correlated Random effects-Hausman test……………24

Table (5-2): The results of random effects model………………………………...25

viii
 List of Appendices

Appendix (1): Results of statistical analysis………………………………………33

Appendix (2): Names of companies included in the sample……………………...35

ix
 Chapter One
Research introduction
1-1. Background
Liquidity management is a concept that is receiving serious attention all over
the world especially with the current financial situations and the state of the world
economy. The concern of business owners and managers all over the world is to
devise a strategy of managing their day-to-day operations in order to meet their
obligations as they fall due and increase profitability and shareholder’s wealth.
Liquidity management is considered from the perspective of working capital
management as most of the indices used for measuring corporate liquidity is a
function of the components of working capital (Eljelly, 2014).

Liquidity is a precondition to ensure that firms are able to meet its short-term
obligations. The liquidity position in a company is measured based on the 'current
ratio' and the 'quick ratio'. The current ratio establishes the relationship between
current assets and current liabilities. Normally, a high current ratio is considered to
be an indicator of the firm's ability to promptly meet its short term liabilities (Berk,
2009).

Liquidity is a prerequisite for a firm as it shows its ability for meeting its
short-term obligations. Quick ratio and current ratio are considered to be the
common measures of liquidity position of a company. Current ratio sets the
association between short term assets and short term liabilities. Generally, when
current ratio is high it can be said that the firm’s ability to pay back its short term
obligations is good, whereas quick ratio sets the correlation between current
liabilities and current assets. When assets are liquid it means that they can be
converted into cash quickly without loss. Low current ratio means that a company

1
cannot pay its obligations on time to creditors, services and goods suppliers
(Owolabi, et al., 2011).

Liquidity and profitability are two very important and vital aspects of
corporate business life. No firm can survive without liquidity. A firm not making
profit may be considered as sick but, one having no liquidity may soon meet its
downfall and ultimately die. Liquidity management has thus, become a basic and
broad aspect of judging the performance of a corporate entity (Bardia 2017).

Wang (2002) found that aggressive liquidity management boosts the

operating performance of a firm and usually results in higher values for a firm.
Managing liquidity efficiently results in eliminating the risk of inability of meeting
short-term liabilities when it is due, on one hand. On the other hand, it helps in
avoiding excessive investment in these assets (Priya & Nimalathasan, 2013)

Thus, it is essential to maintain as adequate degree of liquidity of smooth

running of the business operations. The liquidity should be neither excessive nor
inadequate. Excessive liquidity indicates accumulated idle funds, which do not
earn any profit for the firm, and inadequate liquidity not only adversely affect the
credit worthiness of the firm, but also interrupts the production process and
hampers its earning capacity to a great extent. Thus, the need for efficient liquidity
management in corporate businesses has always been significant for smooth
running of the business, (Valrshney, 2018).

Based on the above, this study attempts to examine the impact of Liquidity
on profitability of a sample of 30 companies listed in Egyptian Stock exchange.

1-2. Research problem

The importance of liquidity is not new in the literature of finance. Many
researchers have been studying liquidity and its impact on firms’ profitability using

2
different types of measures. Number of scholars has analyzed the impact of
liquidity on profitability using traditional measures for measuring firm’s liquidity.
Some studies were consistent with each other in their findings, and some were
contradicted.
Based on the above, this research attempts to determine the relationship
between liquidity and profitability by answering this important question:
“What is the impact of liquidity on profitability of companies listed on
the Egyptian stock exchange?”

1-3. Research Goals

The main objective of this research is to examine the relationship between

liquidity management and profitability to identify the impact of liquidity on
profitability of a sample of 30 companies listed in the Egyptian stock exchange.

1-4. Research importance

1-4.1. Scientific importance

The importance of this study stems from being an update on the impact of
liquidity on profitability of a number of listed companies in the Egyptian stock
exchange, therefore it is a modest addition to the body of knowledge.
1-4.2. Practical importance
This study determines the effects of having an adequate liquidity within
companies, thus providing guidance to companies on how to employ liquid assets
effectively given the enormous problems these companies face in case of having
insufficient cash to finance their daily operations.
Liquidity management and profitability are two important concepts in every
company regardless of its business model. In order for a company to ensure that it
is a going concern sound liquidity management and profit realization are in

3
indispensable, as a result this study will be a practical framework on how to use
liquid assets efficiently to increase the profitability of companies under
investigation.

Creditors analyze liquidity ratios when deciding whether or not they should
extend credit to a company. They want to be sure that the company they lend to has
the ability to pay them back. Any hint of financial instability may disqualify a
company from obtaining loans.
For investors, they will analyze a company using liquidity ratios to ensure that
a company is financially healthy and worthy of their investment. Working capital
issues will put restraints on the rest of the business as well.

4
 Chapter 2
Previous empirical studies
The importance of liquidity is not new in the literature of finance. Many
researchers have been studying liquidity and its impact on firms’ profitability using
different types of measures. Number of scholars has analyzed the impact of
liquidity on profitability using traditional measures for measuring firm’s liquidity.
Some studies were consisted with each other in their findings, and some were
contradicted.

On one hand, (Elangkumaran & Karthika, 2013; Khidmat & Rehman, 2014;
Mushtaq, et al., 2015; Saleem & Rehman, 2011) conducted their studies in
different sectors with different sample size for the purpose of finding out the
relationship between liquidity and profitability, all of them measured liquidity by
liquidity ratios whereas profitability by different measures.

Owolabi et al. (2011) used operating profit-turnover ratio, whereas Khidmat

(2014) used return on equity and return on assets, while Elangkumaran & Karthika,
2013 used earnings per share and return on assets. However, Saleem & Rehman
(2011) used three measures; ROA, ROE and ROI; Mushtaq et al. (2015) used
return on assets. All studies consisted and reveal positive correlation between
liquidity and profitability.

On the other hand, (Bhunia, et al., 2011; Krishnakumar, 2010; Panigrahi,

2013) applied their research in Indian software, cement and steel sectors
respectively using traditional indices for measuring liquidity and different
measures for profitability such as return on Investment, gross Profit ratio, return on
assets and earning per share, findings of these three studies found a negative
association between liquidity and profitability.

5
 Niresh (2012) aimed to understand the cause and effect of the relationship
between profitability and liquidity, his study showed that there is mixed (positive
and negative) relationship between the independent and dependent variables used
in the study; current ratio has negative association with net profit and return on
capital employed ratio and positive association with return on equity. Quick ratio
has a positive correlation with net profit and return on equity and has a negative
correlation with return on capital employed.

Lyroudi & Lazaridis (2013) aimed to examine the relationship between

liquidity measured by cash conversion cycle and profitability of food industry in
Greece measured by return on investment, return on equity and net profit margin.
By applying regression and correlation analysis, as well as t-tests of two
independent samples. This study identified that cash conversion cycle has positive
correlation with return on assets, return on equity and net profit margin.

Bibi & Amjad (2017) decided to explore the relationship between liquidity
and companies’ profitability and finding out the impact of all components of
liquidity on profitability in Karachi Stock Exchange using cash gap in days and
current ratio for measuring liquidity. In their research, they showed that traditional
measures have a significant positive correlation with profitability measures
whereas modern indices of liquidity have a significant negative correlation with
profitability.

Yameen, et al., (2019) also conducted their study to investigate the impact of
liquidity on the profitability of pharmaceutical companies listed on Bombay Stock
Exchange (BSE). Data are extracted from ProwessIQ database. The analysis is
done using a balanced panel data of 82 pharmaceutical companies for the period of
10 years from 2008 to 2017. Findings reveal that current liquidity ratio and quick
ratio have a positive and significant impact on the profitability of pharmaceutical
6
companies measured by return on assets, while control variables leverage, firms’
size, and age have a negative impact on the profitability of pharmaceutical
companies. The study used recent literature to explore the gap in the existing
literature.

The study of Priya, K. & Nimalathasan, B. (2013) aimed at finding the effect
of changes in liquidity levels on profitability of manufacturing companies in Sri
Lanka. The study covered listed manufacturing companies in Sri Lanka over a
period of past 5 years from 2008 to 2012. Correlation and regression analysis were
used in the analysis and findings suggest that there is a significant relationship
exists between liquidity and profitability among the listed manufacturing
companies in Sri Lanka. Suggested that Inventory Sales Period (ISP), Current
Ratio (CR) and are significantly correlated with Return on Asset (ROA), Operating
Cash Flow Ratio (OCFR)are significantly correlated with Return on Equity (ROE)
5 percent level of significance.

Lartey, V. et al., (2013) sought to find out the relationship between the
liquidity and the profitability of banks listed on the Ghana Stock Exchange. Seven
out of the nine listed banks were involved in the study. The financial reports of the
seven listed banks were studied and relevant liquidity and profitability ratios were
computed. The trend in liquidity and profitability were determined by the use of
time series analysis. The main liquidity ratio was regressed on the profitability
ratio. It was found that for the period 2005-2010, both the liquidity and the
profitability of the listed banks were declining. Again, it was also found that there
was a very weak positive relationship between the liquidity and the profitability of
the listed banks in Ghana.

Bordeleau, Crawford and Graham (2009) reviewed the impact of liquidity on

bank profitability for 55 US banks and 10 Canadian banks between the period of
7
1997 and 2009. The study employed quantitative measures to assess the impact of
liquidity on bank profitability. Results from the study suggested that a nonlinear
relationship exists, whereby profitability is improved for banks that hold some
liquid assets, however, there is a point beyond which holding further liquid assets
diminishes a banks’ profitability, all else equal.

In an attempt to measure the impact of liquidity on profitability Lanberg

(2013) conducted a study using a sample of companies listed on Shochholm Stock
Exchange. Their focus was on impact of active liquidity strategies on company’s
profitability in and out of financial turbulence or economic downturn. Relevant
data were financial ratios which generated from financial statements. Their
findings suggested that the adaptation of liquidity strategies do not have a
significant impact on return on assets (ROA). Only increased use of liquidity
forecasting and short-term financing during financial crisis had a positive impact
on ROA. They found also that the importance of key ratios monitoring companies’
liquidity has not changed between the studied time points.

Njihia (2005), in a study to identify determinants of commercial banks

profitability in Kenya identified liquidity as one of the factors affecting
profitability. The study involved 35 commercial banks operating in Kenya over a
period of 5 years. The study employed descriptive statistics and multiple regression
analysis to estimate the determinants of commercial banks profitability. The study
concluded that in one of the years under study liquid assets significantly
determined the profit of the commercial banks especially in the period after
political instability after the elections. The ratio of deposits held, loans and
advances held by the commercial banks influenced the profitability.

The above analysis of the previous studies revealed that findings are mixed,
that is some of studies proved that there is positive relationship and impact
8
between liquidity and profitability, while other studies concluded that there is a
negative relationship between liquidity and profitability. Other studies showed a
weak relationship between liquidity and profitability.

This study differs from previous studies in that it will be applied on 30

Egyptian companies listed in stock exchange to see in what direction liquidity will
affect profitability in the Egyptian firms.

9
 Chapter 3
Theoretical Framework
3-1. Definition of Liquidity
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 (Rochet, 2008).

Liquidity defines the ability, and the ease with which current assets other
than cash and cash equivalent could be converted into cash. Liquid assets are
mostly current assets, which can quickly be converted to cash when the need
comes in order to meet financial and debt obligations (Okaro and Nwacoby, 2016)

The term liquidity is basically a technique or procedure which is adopted by

a firm or an organization or any financial institution to convert its assets into 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 its operations, on the other hand if the amount of currents
assets is too high, this shows that the return on investment for the organization is
not in unspoiled state. Anyanwu, (1993) also defined liquidity as the ability of a
firm to convert its asset into cash within the short time and without the loss of
value. Liquidity is generally defined as the ability of a financial firm to meet its
debt obligations without incurring unacceptably large losses (Maness & Zietlow
2005).

Maness & Zietlow (2005) summarizes 3 components to define liquidity,

which is amount, time and cost. Amount means how many resources the company
10
has to fulfil its financial obligations; time means how long the company takes to
transfer assets into cash; cost means if the company can transfer assets into cash
without much costs. While Campbell et al., defines liquidity as “the ability of a
firm to augment its future cash flows to cover any unforeseen needs or to take
advantage of any unexpected opportunities” (Maness & Zietlow 2005).

Liquidity administration is an idea that is accepting genuine consideration

everywhere throughout the world, particularly with the current money related
circumstances and the condition of the world economy. A portion of the striking
corporate objectives, incorporates the need to augment benefit, keep up an
abnormal state of liquidity to ensure security, accomplish the largest amount of
proprietor's total assets combined with the fulfillment of other corporate targets.
The significance of the liquidity administrator as it influences corporate benefit in
today's business can't be overemphasized. The urgent part in overseeing working
capital has required the upkeep of its liquidity in everyday operation to guarantee
its smooth running and meets its commitment. Liquidity assumes a huge part in the
effective working of a business firm (Priya, & Nimalathasan, 2013).

Normally, a high liquidity ratio is a sign of financial strength, but according

to some researches, too high liquidity ratio also reveals mismanagement problems
of a company, which means companies didn’t make best use of assets to maximize
the companies’ profit because of less profitability of current assets compared with
fixed assets (Marozva, 2015). Liquidity necessitates pulling out of funds that can
be invested to generate profits for the need to ensure stability in operations. On the
other hand, reducing the liquidity by an increase in working capital which when
invested can potentially result in higher rates of profitability (Raykov, 2017).

Crockett (2008) indicates that liquidity is much easier to be recognized than

be defined, as there are 3 concepts of understanding liquidity. Financial Instrument
11
liquidity refers to the availability of change current assets into cash without value
loss. Market liquidity refers to the capability to trade certain securities or assets
without influencing their price. The third concept of liquidity deals with monetary
liquidity concerned with quantity of fully liquid assets in the financial world.

3-2. Theories of Liquidity

There are various theories underpinning liquidity management, namely

liquidity preference theory, shiftability theory, commercial loan theory,
Schumpeter’s theory of profitability (Chinweoda, et al., 2020).

3.2.1 Liquidity Preference Theory

The liquidity preference theory was postulated by John Maynard Keynes in

his book “Money “in (1936) to explain determination of the interest rate by the
supply and demand for money. The theory highlights three motives namely
transanctionary, speculative and precautionary behind holding cash. The demand
for money as an asset was theorized to depend on the interest foregone by not
holding bonds and other less liquid assets. Interest rates, he argues, cannot be a
reward for saving as such because, if a person hoards his savings in cash, keeping
it under his mattress say, he will receive no interest, although he has nevertheless
refrained from consuming all his current income. Instead of a reward for saving,
interest, in the Keynesian analysis, is a reward for parting with liquidity.

3.2.2. Shiftability Theory

This theory was developed by Harold G, Moulton in 1915. This theory states
that, for an asset to be perfectly shiftable, it must be directly transferable without
any capital loss when there is a need for liquidity. This is specifically used for
short term market investments, like treasury bills and bills of exchange which can
be directly sold whenever there is a need to raise funds by banks. But in general
12
circumstances when all banks require liquidity, the shiftability theory need all
banks to acquire such assets which can be shifted on to the central bank which is
the lender of the last resort. This theory maintains that banks could effectively
protect themselves against massive deposit withdrawals by holding, as a form of
liquidity reserve, credit instruments for which there existed a ready secondary
market. Included in this liquidity reserve were commercial paper, prime bankers
acceptances and, most importantly as it turned out, treasury bills. Under normal
conditions all these instruments met the tests of marketability because of their short
terms to maturity.

3.2.3. Commercial Loan Theory or Real Bills Doctrine

Adam Smith was among the scholars that propounded the theory of real bills
doctrine or the commercial loan theory. He propounded this theory in 1776 in his
book entitled “Wealth of Nations”. The commercial loan or the real bills doctrine
theory states that a commercial bank should forward only short-term self-
liquidating productive loans to business organizations. Loans meant to finance the
production, and evolution of goods through the successive phases of production,
storage, transportation, and distribution are considered as self-liquidating loans.
This theory also states that whenever commercial banks make short term self-
liquidating productive loans, the central bank should lend to the banks on the
security of such short-term loans. This principle assures the appropriate degree of
liquidity for each bank and appropriate money supply for the whole economy.

3.2.4. Schumpeter Theory of Profitability

Schumpeter developed the “circular flow model” in which a profit-less

economy is described where perfect competition extinguishes surpluses of
monopoly and friction. The analyses of the “circular flow” economy differ in detail

13
from the “static state” model of Clark. So departures between an ideally
competitive environment and actual economies yield the causes of profit.
Schumpeter identifies the single notion of innovation as paramount, so that
changes based upon innovation are the cause of profit. Gradual changes in
population and capital would easily be anticipated by the market and hence present
no opportunity for the entrepreneur.

3-3. Importance of Maintaining Appropriate Liquidity Ratios

Keeping up the right level of liquidity is vital for guaranteed development

and profit. Three points below by Mebounou, et al. (2015) explain the importance
of liquidity ratios:
1. Determine the ability to cover short-term obligations
Liquidity ratios are important to investors and creditors to determine if a
company can cover their short-term obligations, and to what degree. A ratio of 1 is
better than a ratio of less than 1, but it isn’t ideal. Creditors and investors like to
see higher liquidity ratios, such as 2 or 3. The higher the ratio is, the more likely a
company is able to pay its short-term bills. A ratio of less than 1 means the
company faces a negative working capital and can be experiencing a liquidity
crisis.
2- Determine creditworthiness
Creditors analyze liquidity ratios when deciding whether or not they should
extend credit to a company. They want to be sure that the company they lend to has
the ability to pay them back. Any hint of financial instability may disqualify a
company from obtaining loans.
3- Determine investment worthiness
For investors, they will analyze a company using liquidity ratios to ensure that
a company is financially healthy and worthy of their investment. Working capital

14
issues will put restraints on the rest of the business as well. A company needs to be
able to pay its short-term bills with some leeway. Low liquidity ratios raise a red
flag, but “the higher, the better” is only true to a certain extent. At some point,
investors will question why a company’s liquidity ratios are so high. Yes, a
company with a liquidity ratio of 8.5 will be able to confidently pay its short-term
bills, but investors may deem such a ratio excessive. An abnormally high ratio
means the company holds a large amount of liquid assets.

3-4. Sources of Liquidity Risk

Liquidity risk is the risk that a business will not have sufficient cash to meet
its financial commitments in a timely manner. Without proper cash flow
management and sound liquidity risk management, a business will face a liquidity
crisis and ultimately become insolvent. As businesses go about the process of
measuring and managing liquidity risk, they need to be on alert for common
sources of that risk. Those sources include:
(i) Lack of Cash Flow Management
Cash flow management gives a business good visibility into potential
liquidity challenges and opportunities. Cash is king, and cash flow is the bloodline
of all businesses. Without proper management of cash flow, a business will
increase its exposure to unnecessary liquidity risks. Moreover, a business without
healthy and well-managed cash flow will face an uphill battle to remain profitable,
secure favorable financing terms, attract potential inventors and be viable in the
long run.
(ii) Inability to Obtain Financing

A history of late debt repayment and/or non-compliance with loan covenant

requirements may translate into additional challenges when attempting to secure
financing. Therefore, it is imperative that businesses have good capital structure
15
management, match debt maturity profiles to assets, and maintain a good
relationship and regular communication with lenders. The inability to obtain
funding at all or to obtain it at competitive rates and acceptable terms increases
liquidity risk.
(iii) Unexpected Economic Disruption
At the start of 2020, the stock market was at its all-time high, and few people
expected the world would be so hard hit by COVID-19. The adverse economic
impact of this global pandemic was swift and relentless. Lockdowns created an
unexpected economic disruption, and many businesses saw sales dwindle to a
catastrophically low level and liquidity risk drastically increase.
(iv) Unplanned Capital Expenditures
Having proper fixed asset management is extremely important, particularly
for a business that operates in a capital-intensive industry such as energy,
telecommunications or transportation. A capital-intensive business is often highly
leveraged with a high fixed to variable costs ratio. For businesses like these, a
single unplanned capital expenditure, such as a new purchase or major equipment
repairs, may exacerbate existing budget constraints. This, in turn, further increases
operating leverage and heightens liquidity risk.
(v) Profit Crisis
A business in a profit crisis will not only see a decline in its profitability
margins but also a decline in its top-line revenue. Consequently, to combat
negative profitability margins and remain in operation, it will need to start dipping
into cash reserves. Failure to stop a continuous cash burn will eventually deplete
cash reserves, with the business inevitably facing a liquidity crisis.

3-5. Measures of Liquidity

16
 Liquidity can be quantitatively measured by several indicators, one of them
is discussing liquidity by concerning working capital first, as working capital is
crucial in measuring liquidity. Working capital can simply means the cash one
company needs to support its daily operation.

Net working capital = Current assets-current liabilities

The normal terms of working capital for companies when considering

working capital include cash, short-term financing, receivables, inventory,
payables, prepaid expenses and so on. (Sagner, 2010).

As one factor to measure liquidity, theoretically, high net working capital

means high liquidity for a company. But one thing to mention is that, although all
the terms mentioned in the category of working capital can account for working
capital, they have different level while considering their liquidity. For example, the
risk-bearing securities and treasury bills have different levels in terms of liquidity,
although they all belong to current assets. Thus, pay attention to the detained
category of working capital is needed when measuring liquidity (Sagner, 2010).

Another indicator to measure liquidity is CCE (cash conversion efficiency),

which shows the companies’ efficiency to transfer revenues into cash flow from
operations.

Cash conversion efficiency (CCE)= Cash flow from operations / Sales

CCC (Cash Conversion Cycle) could also be used as an indicator of

measuring liquidity, the concept of CCC (Cash Conversion Cycle) is introduced by
Gitman (1974) .which measures the time period between inventory purchase and
money collection from selling goods. The formula of calculation is DSO (Days
sales outstanding) plus DIO (Days Inventory Outstanding, then minus DPO (Days
payable outstanding). CCC is regarded as a comprehensive factor including DSO,
17
DIO and DPO, thus, it’s often widely used by some research to act as the
representing factor to measure liquidity. Normally high CCC shows the company
has high liquidity.

CCC= Days Sales Outstanding + Days Inventory Outstanding – Days

payable Outstanding

However the most commonly used ratios to measure liquidity are current
ratio and quick ratio (Nyabate, 2015; Chinweoda, et al., 2020; Niresh, 2012):

a) Current ratio: is the first developed ratio to measure liquidity, it was

first put forward in early 20th centuries. Current ratio measures the capacity of
owning current assets to cover up existing current liability obligations. It can be
calculated as the current assets divided by current liabilities. Historically, current
ratio was taken as the benchmark for companies to ensure its liquidity, but recently
the ratio tends to decline due to managerial decision of decrease of current assets.

Current ratio= Current Assets / Current liabilities

b) Quick ratio: which is also called acid-test ratio, is another ratio

measuring liquidity, the difference between current ratio and quick ratio is that it
deletes inventory from current assets because of the less liquidity of inventory
compared with other current assets.

Quick ratio = (Current assets – Inventories) / Current liabilities

The researcher will use the most common measures of liquidity in this
research which are current ratio and quick ratio.

3-6. Definition of Profitability

Profitability has many uses, from being a performance measure for the
economic effectiveness of the facility to being a standard for making some general
18
decisions, and therefore it is a tool in the decision maker's hand to measure the
impact of indebtedness and lending on profitability. It is an important indicator of
the success of the company's business, and the main concern of all stakeholders
such as creditors, investors, owners, and management. (Gitman, & Zutter, 2012)

Profitability is a commonly used indicator of firm performance.

Consequently, it is in the best interest of every organization to maximize their
return rate to satisfy shareholders, attract new capital and to ensure continued
operations (Yazdanfar, 2013), There are various definitions of profitability, the
most important of which are the following:-

The profitability of a company shows a company's ability to generate

earnings for a certain period (Margaretha, & Supartika, 2016). Profitability is an
indicator of institutions’ efficiency in managing their assets and making more
profits from them. It also refers to the facility's ability to meet the risks it is
exposed to and the possibility of achieving continuity and growth, in addition to
increasing the wealth of shareholders and owners, enhancing confidence in the
facility and thus facilitating the process of obtaining capital (Beryawy, 2015).

Profitability is a measure of an organization’s profit relative to its expenses.

Organizations that are more efficient will realize more profit as a percentage of its
expenses than a less-efficient organization, which must spend more to generate the
same profit (Yazdanfar & Ohman, 2019).

3-7. Factors affecting profitability of companies

Profitability is affected by a number of factors, at the forefront of these factors

are the following as mentioned by Knaan & Saoud (2018):-

19
1) The amount of profit is mainly related to the amount of results and revenues
generated by sales or commercial activities practiced by the facility, so when
sales increase, profitability can increase and vice versa.

2) Market share: having a bigger market share is a blessing companies strive to

achieve, however increased competition intensity as well as and technological
developments pushing firms to rely more on efficient and effective marketing
mix in order to create and increase their market share which eventually will
increase in profitability.

3) Tax rate imposed on profits: higher taxes mean deducting large premiums, and
this leads to a reduction in the remaining net profit

4) Management style: management style practiced by managers have a significant

impact in achieving high rates of profits, as far as the administration is serious
and relies on sound scientific estimates of its revenues and expenses, and as
much as it can reduce the administrative cost as much as it is able to achieve
good profits.

3-8. Measures of profitability

One of the most frequently used tools of financial ratio analysis is

profitability ratios which are used to determine the company's bottom line and its
return to its investors. Every firm is most concerned with its profit. Profitability
ratios show a company's overall efficiency and performance. So it will helps to
provide feedback for the management decision for the long term success of the
company (Margaretha, F. & Supartika, N. 2016).

Two basic measures of profitability are:-

(i) Return on Assets (ROA)

20
 ROA Refers to a financial ratio that indicates how profitable a company is in
relation to its total assets. Corporate management, analysts, and investors can use
ROA to determine how efficiently a company uses its assets to generate a profit, a
higher ROA means a company is more efficient and productive at managing its
balance sheet to generate profits while a lower ROA indicates there is room for
improvement. (Belhag, N. 2017; Ebrahim, A. & Ali, S. 2020)

Return on Assets (ROA) = Net income / total assets

(ii) Return on equity (ROE)

ROE is a gauge of a corporation's profitability and how efficiently it

generates those profits, it calculated by dividing net income by shareholders'
equity, it measures the efficiency of administration in exploiting the owners'
money and the ability of these funds to generate profits (Belhag, 2017; Ebrahim, &
Ali, 2020)

Return on Equity (ROE) = Net income / average common stockholders’ equity

21
 Chapter 4
Research Methodology
4-1. Research Hypothesis

Based on previous studies and theoretical framework, and by using the

deductive approach, the research hypothesis can be formulated as follows:

H1: There is a positive impact of liquidity on profitability.

4-2. Research variables and measures

1- The above-mentioned hypothesis indicates that there are two variables

(liquidity) as the independent variable which is measured by:

Current Assets
Current ratio (CR) = Current Liabilities

2- And profitability of companies which is measured by return on assets

(ROA) as the dependent variable.

Net Income
Return on assets (ROA) = Total ssets

The following figure (4-1) shows research hypothesis and variables

Figure (4-1): Research variables and proposed relationships

+ Ve
Liquidity Profitability
H1
4-3. Research population and sample selection

The population of this research consists of all companies listed on the

Egyptian stock exchange. A purposive sample of 30 listed companies was selected
based on data availability at the end of the fiscal year for the period 2018-2020.
Appendix (2) indicates the names of these companies.

22
4-4. Research Limitation

The findings of this research are constrained by some limitations:

- Place limitation: the study is limited to investigating the impact of

liquidity on profitability of 30 listed companies in Egyptian stock
exchange only.
- Time limitation: this study is conducted only for 3 years during the
period 2018 to 2020.
- Subject limitation, this study is limited to investigating the impact of
liquidity on profitability leaving other variables that might affect the
profitability of companies such as size, age, number of employees,… Etc.
4-5. Data collection

The data that were used in this research are return on assets (ROA) and the
liquidity measured by current ratio for 30 firms included in the sample. These data
have been obtained from the annual financial statements of firms listed in the
Egyptian stock exchange on a yearly basis.

4-6.Data analysis
To analyze the data set and test the research hypothesis, a random effect
model was used for the panel data using E-Views software to estimate the
following regression equation:

ROAit = αi + bi (liquidity)it + eit

Where,

ROA: return on assets of the company at time (t)

Current Assets
Liquidity ratio which is measured by Current Liabilities

23
 Chapter 5

Research results

Before initiating in analyzing the research results, the researcher will use
Correlated Random effects-Hausman test to determine the right model between the
fixed and random effects model based on the following hypotheses:
Null hypothesis (H0): Random effects model is appropriate
Alternative hypothesis (HA): Fixed effects model is appropriate
Choosing the appropriate model among the 2 models will be based on this
Decision Criterion:
-Reject H0 if probability value is less than 5%,
-Accept H0 if probability value is greater than 5%.
Table (5-1)
The results of Correlated Random effects-Hausman test

Since the probability value here is 0.1073, which is greater than 5% thereby we
accept null hypothesis and conclude that the random effects model is the
appropriate model for testing research variables.

24
25
 Table (5-2)
The results of random effects model using fixed assets turnover and roe

Dependent Variable: ROA

Method: Panel EGLS (Cross-section random effects)
Date: 11/23/22 Time: 14:02
Sample: 2018 2020
Periods included: 3
Cross-sections included: 30
Total panel (balanced) observations: 90
Swamy and Arora estimator of component variances

Variable Coefficient Std. Error t-Statistic Prob.

C -0.005303 0.018713 -0.283373 0.7776

CURRENT_RATIO 0.034748 0.009576 3.628815 0.0005

Effects Specification
S.D. Rho

Cross-section random 0.051389 0.5789

Idiosyncratic random 0.043827 0.4211

Weighted Statistics

R-squared 0.128143 Mean dependent var 0.022533

Adjusted R-squared 0.118236 S.D. dependent var 0.047094
S.E. of regression 0.044223 Sum squared resid 0.172096
F-statistic 12.93403 Durbin-Watson stat 1.224953
Prob(F-statistic) 0.000532

Unweighted Statistics

R-squared 0.266938 Mean dependent var 0.051008

Sum squared resid 0.398424 Durbin-Watson stat 0.529107

Table (5-2) shows the impact of liquidity (measured by current ratio) on

profitability of companies measured by Return on assets (ROA), The table also
shows the significance of the relationship between liquidity and the profitability,
results also indicated that there is a positive significant impact of liquidity on
profitability, as 12.814 % of the change in ROA is due to liquidity management as
shown by the value of R-squared and the rest of the change in profitability is due to
factors other than liquidity such as financial leverage, firm size and age.

26
 These results are consistent with other studies (Owolabi et al. 2011; Khidmat,
2014; Elangkumaran & Karthika, 2013; Saleem & Rehman, 2011, Mushtaq et al.
2015), which proved a positive relationship between liquidity and profitability.

An explanation for this positive relationship is that increasing financial

liquidity level means that companies can quickly, without any delays, settle their
liabilities in cash thus granting some discounts from their suppliers and clients,
enjoy greater trust of loan-providers who analyze liquidity before granting loans,
and most of all, it diminishes the risk of insolvency (Szczepaniak, 1996).

On the other hand, maintaining too big share of current assets may be
disadvantageous for the company profitability. This is especially true about the
excess cash in relation to expected expenses and this part of products or material
inventory which does not participate in the current turnover, and thus do not
contribute to generating profit and are only some kind of security for unexpected
events, such as sudden boost of demand or problems with supplies (Bolek, &
Wiliński, 2011).

27
 Chapter 6
Conclusions and Recommendations

6.1. Conclusion

The results of the research showed that there is a positive relationship and a
positive effect of liquidity and companies’ profitability, measured by return on
assets. This positive and significant effect of liquidity on ROA is consistent with
the other results (Owolabi et al. 2011; Khidmat, 2014; Elangkumaran & Karthika,
2013; Saleem & Rehman, 2011, Mushtaq et al. 2015), this is because 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.

Despite the positive impact of liquidity on the profitability of companies,

having excess liquidity levels will lead to counterproductive results because the
surplus of cash, inventories and receivables generate the cost of lost opportunities.
The cost of lost opportunities is the loss of potential profit which would be earned
if some resources frozen in current assets were allocated for the undertakings
increasing company profitability. The resources frozen in the excess current assets
could be allocated for investment in fixed assets, such as buildings, machines,
equipment and vehicles, which, if used appropriately, account for the company
production potential and thus its income possibilities (Bolek, & Wiliński, 2011).

Therefore, managers have to be careful and manage their current assets in a

ways that increases their profitability and, not holding excessive amounts of liquid
assets so their profitability would be affected negatively

28
6.2. Recommendations

The significant influence of liquidity on profitability guides managers to focus

on managing liquidity to the optimal level as well as paying business’ obligations
in a reasonable period to ensure smooth functions and credit benefits, this will
enhance their performance and revenues in the future.

It is also recommended that managers develop policies and guidelines

regarding the allocation of cash by avoiding investments that could harm the
financial strength of the company, thus keeping liquidity position at good levels.

Also, It would be interesting if this study would be replicated with a focus on

some other variables that may affect profitability such as leverage and firm size
and age.

It would also be interesting to extend this study to other sectors taking into
account a longer period of analysis to capture a more comprehensive causal effects
of liquidity on profitability.

29
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33
 List of Appendices
Appendix (1)
Results of statistical analysis
Correlated Random effects-Hausman test

Correlated Random Effects - Hausman Test

Equation: Untitled
Test cross-section random effects

Chi-Sq.
Test Summary Statistic Chi-Sq. d.f. Prob.

Cross-section random 2.593926 1 0.1073

Cross-section random effects test comparisons:

Variable Fixed Random Var(Diff.) Prob.

CURRENT_RATIO 0.005604 0.034748 0.000327 0.1073

Cross-section random effects test equation:

Dependent Variable: ROA
Method: Panel Least Squares
Date: 11/23/22 Time: 16:22
Sample: 2018 2020
Periods included: 3
Cross-sections included: 30
Total panel (balanced) observations: 90

Variable Coefficient Std. Error t-Statistic Prob.

C 0.041927 0.033498 1.251641 0.2156

CURRENT_RATIO 0.005604 0.020473 0.273713 0.7853

Effects Specification

Cross-section fixed (dummy variables)

R-squared 0.791485 Mean dependent var 0.051008

Adjusted R-squared 0.685460 S.D. dependent var 0.078146
S.E. of regression 0.043827 Akaike info criterion -3.150499
Sum squared resid 0.113330 Schwarz criterion -2.289454
Log likelihood 172.7725 Hannan-Quinn criter. -2.803275
F-statistic 7.465103 Durbin-Watson stat 1.738354
Prob(F-statistic) 0.000000

34
Random effect results

Dependent Variable: ROA

Method: Panel EGLS (Cross-section random effects)
Date: 11/23/22 Time: 14:02
Sample: 2018 2020
Periods included: 3
Cross-sections included: 30
Total panel (balanced) observations: 90
Swamy and Arora estimator of component variances

Variable Coefficient Std. Error t-Statistic Prob.

C -0.005303 0.018713 -0.283373 0.7776

CURRENT_RATIO 0.034748 0.009576 3.628815 0.0005

Effects Specification
S.D. Rho

Cross-section random 0.051389 0.5789

Idiosyncratic random 0.043827 0.4211

Weighted Statistics

R-squared 0.128143 Mean dependent var 0.022533

Adjusted R-squared 0.118236 S.D. dependent var 0.047094
S.E. of regression 0.044223 Sum squared resid 0.172096
F-statistic 12.93403 Durbin-Watson stat 1.224953
Prob(F-statistic) 0.000532

Unweighted Statistics

R-squared 0.266938 Mean dependent var 0.051008

Sum squared resid 0.398424 Durbin-Watson stat 0.529107

35
 ‫‪Appendix (2): Names of companies included in the sample‬‬
‫اسم الشركة‬ ‫رقم‬
‫مجموعة عامر جروب القابضة‬ ‫‪-1‬‬
‫ابن سينا فارما‬ ‫‪-2‬‬
‫بالم هيلز‬ ‫‪-3‬‬
‫اعمار مصر‬ ‫‪-4‬‬
‫اكرو مصر للشدات والسقاالت المعدنية‬ ‫‪-5‬‬
‫التوفيق للتأجير التمويلي‬ ‫‪-6‬‬
‫الشركة المتحدة لالسكان‬ ‫‪-7‬‬
‫العربية لالسمنت‬ ‫‪-8‬‬
‫العربية لاللمونيوم‬ ‫‪-9‬‬
‫العز الدخيلة للحديد والصلب‬ ‫‪-10‬‬
‫المنصورة للدواجن‬ ‫‪-11‬‬
‫النصر لتصنيع الحاصالت الزراعية‬ ‫‪-12‬‬
‫ام ام جروب للصناعة والتجارة العالمية‬ ‫‪-13‬‬
‫أي بي ام للهندسة‬ ‫‪-14‬‬
‫الشركة المصرية الدولية للصناعات الدوائية (ايبيكو)‬ ‫‪-15‬‬
‫شركة الصناعات الهندسية المعمارية لإلنشاء والتعمير (إيكون)‬ ‫‪-16‬‬
‫بورتو جروب‬ ‫‪-17‬‬
‫بيراميزا للفنادق والقري السياحية‬ ‫‪-18‬‬
‫ثروة كابيتال القابضة لالستثمار‬ ‫‪-19‬‬
‫دلتا للطباعة والتغليف‬ ‫‪-20‬‬
‫شركة رایة لخدمات مراكز االتصاالت‬ ‫‪-21‬‬
‫شركة ريكاب لالستثمارات المالية‬ ‫‪-22‬‬
‫شركة الكابالت الكهربائية‬ ‫‪-23‬‬

‫‪36‬‬
 ‫عبور الند للصناعات الغذائية‬ ‫‪-24‬‬
‫العز للسيراميك والبورسلين (الجوهرة)‬ ‫‪-25‬‬
‫ليسيكو مصر‬ ‫‪-26‬‬
‫مارسيليا المصرية الخليجية لالستثمار العقاري‬ ‫‪-27‬‬
‫مجموعة طلعت مصطفي‬ ‫‪-28‬‬
‫مدينة اإلنتاج اإلعالمي‬ ‫‪-29‬‬
‫مصر لالسمنت‬ ‫‪30‬‬

‫‪37‬‬