Friday, May 22, 2020
Important For The Survival Of A Firm Finance Essay - Free Essay Example
Sample details Pages: 11 Words: 3393 Downloads: 4 Date added: 2017/06/26 Category Finance Essay Type Narrative essay Did you like this example? The relationship between liquidity and profitability has been investigated by many researchers (Eljelly, 2004; Zainudin, 2006; Rehman and Nasr, 2007; Bhunia, Khan and Mukhuti, 2011). Some of these researchers claimed the inverse relationship between liquidity and profitability of a firm (Eljelly, 2004 and Rehman and Nasr, 2007) and some researchers argued that positive relationship exist between them (Zainudin, 2006; Bhunia, Khan and Mukhuti, 2011 and Bhunia, 2012). The positive relationship shows that firms which have higher liquidity have a propensity to make better profits (Zainudin, 2006). There are two basic measures of liquidity; current ratio and quick (acid test) ratio. I have used current ratio to calculate liquidity as it is a wide measure of liquidity that gives confidence to short-term creditors that current liabilities will pay off by liquidating current assets (Zainudin, 2006) and mostly used by researchers as a proxy of liquidity (Rehman and Nasr, 2007, Bhunia, Khan and Mukhuti, 2011 and Bhunia, 2012). So the liquidity of a firm would be calculated as under: Donââ¬â¢t waste time! Our writers will create an original "Important For The Survival Of A Firm Finance Essay" essay for you Create order Liquidity= Current Ratio = Current assets/Current liabilities 3.3.2.2 Inventory turnover ratio Inventory turnover ratio pointed out how quickly firm sells its inventory, measured as rate of goods movement into the firm from raw material to finished goods and out of the firm in the form of sales (Stickney Weil, 2002). Variability in inventory turnover ratio is caused by segment-wise-effect and when firms work in sales decline state then bigger changes are due to changes in sales (Kolias, Dimelis Filios, 2010). Usama (2012) argued that minimum inventory turnover in days and cash conversion cycle can create higher profit. Capkun, Hameri Weiss (2009) examined the inventory performance by total inventory and the distinct components of inventory such as raw material, work in process and finished goods. They found that inventory performance is positively correlated with financial performance of the firm and association between the performance of distinct components of inventory and financial performance differ across inventory components. Previous researches show various results regarding inventory turnover ratio as Gaur, Fisher Raman (2004), Boute et al. (2007) and Kolias, Dimelis Filios (2010) claimed that inventory turnover and profitability are negatively correlated while Capkun, Hameri Weiss (2009) and Sahari, Tinggi Kadri (2012) argued that inventory turnover ratio and firm performance are positively correlated. The formula to measure inventory turnover ratio is as under: Inventory turnover ratio= Total sales/inventory 3.3.2.3 Debt-to-equity ratio Debt-to-equity ratio is used to evaluate the risk associated with firms financing structure (Wild, Larson Chiappetta, 2007, p. 689). It shows the proportion of equity and debt which the firm is using to finance its assets. A firm adopts suitable mix of sources of finance such as retained earnings, issuance of ordinary and preference shares and debt to maximize shareholders wealth (Afza Hussain, 2011). Debt financing gives a tax shield to a firm therefore they took high level of debt to gain maximum tax benefits and eventually increase profitability. However, the increase of debt financing increases the possibility of bankruptcy (Myers, 2001). A high leverage or a low equity capital ratio causes to reduce the agency cost related to outside equity and raises firm value (Berger Bonaccorsi di Patti, 2003). The level of investment can be increased through the use of borrowed capital and it increased the return of invested capital but it also increased the risk for the firm and for the owners due to fixed expenses of interest (Eriotis, Frangouli Neokosmides, 2011). Elsas, Flannery Garfinkel (2006) argued that debt financing produces negative long run performance more than equity financing whereas financing with internal funds never produce important share underperformance. Amjed (2011) claimed that debt financing is considered to be cheaper than equity financing due to tax benefit and concluded that long term debt has a negative impact on firms performance and short term debt has a positive impact on firms performance. Eriotis, Frangouli Neokosmides (2011) claimed that debt-to-equity ratio has a negative impact on firms performance. The formula of debt-to equity ratio is provided below: Debt-to-equity ratio= Total debt/Total equity 3.3.2.4 Size ownership Size shows the level of firms operations. Larger firms are stronger to face risky situations and have better means to go through these types of situations. Size also brings stronger bargaining power to the firm over its competitors and suppliers and bigger firms have superior technology (Bhattacharyya Sexena, 2009). ). Gibrat(1931) presented a law that growth rate and size of a firm are independent. His law advocated that during a specific period, the probability of change in size is same for all the firms in the given industry. Small firms are more productive but lower survival probability due to two to four times more level of risk as compare to large firms (Dhawan, 2001). Small firms have high profit rate increase as compare to medium or large firms and when these firms become bigger, their profits rate become higher (Ammar et al., 2003). Past studies have different views regarding size and profitability relationship. Some researchers found that profitability of a firm increases as firm size decreases (Dean, Brown Bamford, 1998; Ammar et al., 2003; Ramasamy, Ong, yeung, 2005; Abu-Tapanjeh 2006 and Punnose, 2008) while other claimed that firm size and level of profitability are positively correlated (Treasy1980, Amirkhalkhali Mukhopadhyay, 1993 and Bhattacharyya Sexena, 2009 ). Many proxies are used for size by many researchers according to the requirements of their study. Mostly total sales, total assets or market capitalization is used as proxy of size. In this study, total sales is used as proxy of firm size. Majumdar (1997) and Bhattacharyya and Sexena (2009) also used total sales to measure firm size. For data symmetry, I used natural log of total sales. So the firm size would be: Size= Log (Total Sales) 3.4 Population Population is the concerned group of individuals, data or items from which sample is taken. The concerned population in this study is the Chemical firms listed on the Karachi stock exchange for the period of 2005-2010. The total number of chemical firms listed on Karachi stock exchange is 36. 3.5 Sample and Sampling technique To find out the determinants of firms profitability, this study took the sample of 20 firms from Textile industry of Pakistan which are listed on Karachi Stock Exchange (KSE) during 2005 to 2010 as it is the oldest and largest stock exchange in Pakistan. The firms were selected for the sample by using simple random sampling technique as this technique assures that each component in the population has an equal probability of being selected in the sample ( Zikmund, 2002, p.384). 3.6 Data sources This study took only firm specific factors which affect firms profitability. So, the data for firms specific factors was calculated from the financial statements of the respective firms and report provided by State Bank of Pakistan namely Financial Statement Analysis of Companies (Non-Financial), listed at Karachi Stock Exchange issue 2005-2010. This research is a longitudinal research because same variables were observed repeatedly for the period of six years from 2005 to 2010. 3.7 Hypothesis This study contains one dependent variable i.e. returns on assets (ROA) and four independent variables such as liquidity, inventory turnover ratio, debt-to-equity ratio and size. So, the testable hypotheses (the alternate hypothesis) are hereafter: H11: There may exist a negative relationship between liquidity and profitability of a firm. Firms with higher level of liquidity may possess lower level of profitability and vice versa. H12: There may exist a positive relationship between inventory turnover ratio and profitability of a firm. Firms with higher inventory turnover ratio may possess higher level of profitability and vice versa. H13: There may exist a negative relationship between debt-to-equity ratio and profitability of a firm. Firms with higher level of debt-to-equity ratio may possess lower level of profitability and vice versa. H14: There may exist a negative relationship between size and profitability of a firm. Firms with larger size may possess lower level of profitability and vice versa. Table 3.1 Explanatory variables with their proxy and expected relationship with the profitability (ROA) Variable Name Proxy for the variable Expected relationship Liquidity Current Ratio (CR) Negative Inventory turnover Inventory turnover ratio (INVT) Positive Debt-to-equity ratio Debt-to-equity ratio (DER) Negative Size Log (Total Sales) (SZ) Negative Chapter 4 Analysis and Discussion This chapter includes the statistical analysis of the sample data and gives details regarding empirical findings of the study. 4.1 Analysis This part would indicate the empirical findings of the study. The first table provides the descriptive statistics which quantitatively describe the main characteristics of the data. The second table contains correlation matrix which shows the association between all the variables. The third table entails the OLS regression estimates with fixed effects and fourth table contains the random effects to establish the relationship between dependent and independent variables. 4.1.1 Descriptive Statistics Descriptive statistics portrays summary of the data which is used in the study to clearly understand the range and characteristics of the data. Table 4.1 represents descriptive statistics for 20 Pakistani Chemical firms for a period of 6 years from 2005 to 2010 and for a 120 firms-year observations. Mean shows the average value of the data and median indicates the middle value of the data. In the table 4.1, mean for the dependent variable i.e. return on assets is 15.927 and median is 13.66. Standard deviation Table 4.1 Descriptive Statistics ROA LQ INVT DER SZ Ãâà Mean Ãâà 15.92700 Ãâà 1.736000 Ãâà 12.59517 Ãâà 1.037250 Ãâà 6.539098 Ãâà Median Ãâà 13.66000 Ãâà 1.455000 Ãâà 6.560000 Ãâà 0.945000 Ãâà 6.563317 Ãâà Maximum Ãâà 45.13000 Ãâà 5.130000 Ãâà 222.5300 Ãâà 3.490000 Ãâà 7.945245 Ãâà Minimum -10.98000 Ãâà 0.230000 Ãâà 0.000000 Ãâà 0.190000 Ãâà 5.361393 Ãâà Std. Dev. Ãâà 11.32618 Ãâà 0.972208 Ãâà 22.98619 Ãâà 0.671968 Ãâà 0.618107 Ãâà Skewness Ãâà 0.566959 Ãâà 1.599074 Ãâà 6.861938 Ãâà 1.111136 Ãâà 0.069343 Ãâà Kurtosis Ãâà 2.577047 Ãâà 5.240897 Ãâà 60.02378 Ãâà 4.483081 Ãâà 2.357129 Ãâà Jarque-Bera Ãâà 7.323292 Ãâà 76.24882 Ãâà 17200.28 Ãâà 35.69009 Ãâà 2.162585 Ãâà Probability Ãâà 0.025690 Ãâà 0.000000 Ãâà 0.000000 Ãâà 0.000000 Ãâà 0.339157 Ãâà Sum Ãâà 1911.240 Ãâà 208.3200 Ãâà 1511.420 Ãâà 124.4700 Ãâà 784.6917 Ãâà Sum Sq. Dev. Ãâà 15265.60 Ãâà 112.4775 Ãâà 62875.43 Ãâà 53.73339 Ãâà 45.46468 Ãâà Observations Ãâà 120 Ãâà 120 Ãâà 120 Ãâà 120 Ãâà 120 signifies the distinctive deviation from the mean. The standard deviation of return on assets is 11.32618. The first main independent variable i.e. liquidity (current ratio) has mean value 1.736; median is 1.455 and standard deviation is 0.972208. The second independent variable which is inventory turnover ratio has mean 12.59517; median is 6.56 and standard deviation is 22.98619. The mean, median and standard deviation of third independent variable i.e. debt to equity ratio are 1.03725, 0.945 and 0.671968 respectively. In the case of firm size (natural logarithm of total sales), which is the last independent variable has mean 6.539098; median is 6.563317 and standard deviation is 0.618107. The data of dependent variable which is return on assets and all the independent variables is positively skewed. The kurtosis is also positive among all the variables. The Jarqua-Bera test is used to check the normality of the data rejects the null hypothesis that all the dependent and independent variables are normally distributed because Jarqua-Bera statistic is very high in most of the variables results and the p value is zero in almost all of the cases. Therefore, the data relating to the variables used in the estimation is not normally distributed because the skewness and kurtosis coefficients are not equal to 0 and 3 respectively. 4.1.2 Correlation Analysis The degree of association between the variables is judged by Pearsons correlation coefficient (r). Table 4.2 presents the correlation analysis of all the variables which are used in the analysis. The basic purpose of correlation analysis is to detect the presence of multicollinearity. Gujrati (2008, p.337) recommends that the problem of multicollinearity exist if the correlation coefficient exceeded 0.80. In correlation matrix, no value is greater than or equal to 0.80. So, there is no high correlation among the variables which are used in the analysis. Returns on assets has significant and positively correlation of 42.57% with liquidity, 39.11% with inventory turnover ratio, 42.48% with firms size and negatively correlated with 27.79% with debt to equity ratio. Table 4.2 Correlation Matrix ROA LQ INVT DER SZ ROA Ãâà 1.000000 Ãâà 0.425709 Ãâà 0.391140 -0.277932 Ãâà 0.424855 LQ Ãâà Ãâà 1.000000 -0.175564 -0.648455 Ãâà 0.002791 INVT Ãâà Ãâà 1.000000 Ãâà 0.233890 Ãâà 0.388966 DER Ãâà Ãâà 1.000000 Ãâà 0.227785 SZ Ãâà Ãâà Ãâà Ãâà Ãâà 1.000000 Inventory turnover is positively associated with debt to equity ratio and firms size with 23.39% and 38.90% respectively. Debt to equity ratio is positively associated with 22.78% with firms size. 4.1.3 Regression Analysis (The Fixed Effects Model) Table 4.3 provides the regression analysis to examine the influence of liquidity (LQ), inventory turnover ratio (INVT), debt to equity ratio (DER) and size of a firm (SZ) on its profitability (ROA). In this model, determinants of firms profitability are estimated with fixed effects. The results of regression analysis shows that this model is good fitted having F-statistic 17.5899 and p- value is 0.000. The adjusted R2 value is 0.762270 which predicts that almost 76% variation in the profitability (ROA) uniquely or jointly due to independent variables. Durbin-Watson stat value is 1.641899, points out that no serial correlation is present in the data as the test value is nearly equal to 2 which is the standard value and it is less than the table value dU= 1.663 under 1% level of significance. Table 4.3 Regression Analysis: The fixed effects model (ROAit= ÃÆ'Ã
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½Ãâà ²2 INVTit+ÃÆ'Ã
½Ãâà ²3 DERit+ÃÆ'Ã
½Ãâà ²4 SZit+eit) Variable Coefficient Std. Error t-Statistic Prob.Ãâà Ãâà C 5.868965 21.19104 0.276955 0.7824 LQ 4.596135 0.977998 4.699533 0.0000 INVT 0.063956 0.036370 1.758493 0.0819 DER -3.315956 1.584092 -2.093285 0.0390 SZ 0.720754 3.245100 0.222105 0.8247 Effects Specification Cross-section fixed (dummy variables) R-squared 0.808218 Ãâà Ãâà Ãâà Ãâà Mean dependent var 15.92700 Adjusted R-squared 0.762270 Ãâà Ãâà Ãâà Ãâà S.D. dependent var 11.32618 S.E. of regression 5.522370 Ãâà Ãâà Ãâà Ãâà Akaike info criterion 6.432348 Sum squared resid 2927.671 Ãâà Ãâà Ãâà Ãâà Schwarz criterion 6.989846 Log likelihood -361.9409 Ãâà Ãâà Ãâà Ãâà Hannan-Quinn criter. 6.658750 F-statistic 17.58990 Ãâà Ãâà Ãâà Ãâà Durbin-Watson stat 1.641899 Prob(F-statistic) 0.000000 The relative importance of all independent variables liquidity (LQ), inventory turnover ratio (INVT) debt to equity ratio (DER) and size of a firm (SZ) in the determination of firms profitability (ROA) depends upon the higher coefficient value and t-statistic. Results revealed that liquidity has more influence on the profitability of a firm than other variables. Liquidity, inventory turnover and firms size have positive coefficients of 4.596135, 0.063956 and 0.720754 with t-statistics of 4.649953, 1.758493and 0.222105 respectively while debt to equity ratio has negative coefficient of -3.315956 with t-statistics of -2.093285. Moreover, the variables liquidity, debt to equity ratio and inventory turnover are significant at 1%, 5% and 10% level of significance. 4.1.4 Remarks The aim of this study is to identify the determinants of firms profitability while using the data of Chemical firms in Pakistan which are listed on Karachi Stock Exchange. While analyzing the firm specific factors, liquidity is found to have positive impact on profitability. So, H11 is rejected. Inventory turnover ratio shows the positive impact on profitability according to study findings. So, H12 is accepted in this regard. Moreover, the impact of debt-to-equity ratio is found negative on firms profitability. So, we accept H13. Size of the firm indicated positive impact on firms profitability. So, H14 is rejected with respect to study results. All the variables are found significant determinant of firms profitability except size of the firm which has insignificant result according to the study findings. 4.1.5 Regression Analysis (The Random Effects Model) Table 4.4 entails the regression analysis to examine the influence of liquidity (LQ), inventory turnover ratio (INVT), debt to equity ratio (DER) and size of a firm (SZ) on its profitability (ROA). In this model, determinants of firms profitability are estimated with random effects. In random effects model the intercept shows the mean value or average value of all the intercepts and error term shows the random deviation of single intercept from the mean value. The findings of regression analysis indicates that this model is good fitted having F-statistic 14.92818 and p- value is 0.000. The adjusted R2 value is 0.318882 which predicts that almost 32% variation in the profitability (ROA) randomly due to Table 4.4 Regression Analysis: The random effects model (ROAit= ÃÆ'Ã
½Ãâà ²0+ÃÆ'Ã
½Ãâà ²1 LQit+ÃÆ'Ã
½Ãâà ²2 INVTit+ÃÆ'Ã
½Ãâà ²3 DERit+ÃÆ'Ã
½Ãâà ²4 SZit+eit) Variable Coefficient Std. Error t-Statistic Prob.Ãâà Ãâà C -22.16595 13.27979 -1.669149 0.0978 LQ 4.447065 0.922300 4.821712 0.0000 INVT 0.097785 0.033657 2.905343 0.0044 DER -3.070943 1.450723 -2.116837 0.0364 SZ 4.943581 2.047117 2.414900 0.0173 Effects Specification S.D.Ãâà Ãâà RhoÃâà Ãâà Cross-section random 6.345424 0.5690 Idiosyncratic random 5.522370 0.4310 Weighted Statistics R-squared 0.341777 Ãâà Ãâà Ãâà Ãâà Mean dependent var 5.332229 Adjusted R-squared 0.318882 Ãâà Ãâà Ãâà Ãâà S.D. dependent var 6.785963 S.E. of regression 5.600447 Ãâà Ãâà Ãâà Ãâà Sum squared resid 3606.976 F-statistic 14.92818 Ãâà Ãâà Ãâà Ãâà Durbin-Watson stat 1.382481 Prob(F-statistic) 0.000000 Unweighted Statistics R-squared 0.453175 Ãâà Ãâà Ãâà Ãâà Mean dependent var 15.92700 Sum squared resid 8347.605 Ãâà Ãâà Ãâà Ãâà Durbin-Watson stat 0.597366 independent variables. On the other hand, Durbin-Watson stat value is 1.382481, points out that no serial correlation is present in the data as the test value is less than the table value dU= 1.663 under 1% level of significance. Coefficient value and t-statistic indicates the relative importance of all independent variables liquidity (LQ), inventory turnover ratio (INVT) debt to equity ratio (DER) and size of a firm (SZ) in the determination of firms profitability (ROA). Results revealed that liquidity has more influence on the profitability of a firm than other variables. Liquidity, inventory turnover and firms size have positive coefficients of 4.447065, 0.097785 and 4.943581 with t-statistics of 4.821712, 2.905343 and 2.414900 respectively while debt to equity ratio has negative coefficient of -3.070943with t-statistics of -2.116837. Moreover, the variables liquidity and inventory turnover ratio are significant at 1% and debt-to-equity ratio and size are significant at 5% level of significance. 4.1.6 Remarks The basic purpose of this study is to find out those factors which affect firms profitability. The above model is used to find out the relationship between the dependent and independent variable with the random effects model. The model exhibits that liquidity is significantly positively correlated with profitability. So, H11 is rejected. Inventory turnover ratio shows the significantly positive impact on profitability. So, H12 is accepted in this regard. On the other hand, the impact of debt-to-equity ratio is found to be significantly negatively associated with the firms profitability. So, we accept H13. Size of the firm indicated significantly positive impact on firms profitability. So, H14 is rejected with respect to study results. All the variables are found significant determinant of firms profitability in random effects model. 4.2 Discussion The basic purpose of this study is to identify the determinants of firms profitability while using the data of Chemical firms in Pakistan which are listed on Karachi Stock Exchange. The research findings show that liquidity is significantly positively correlated with profitability which satisfies the findings of (Zainudin, 2006, Bhunia, Khan Mukhuti, 2011 and Bhunia, 2012) but it opposes the results of (Eljelly, 2004 and Rehman and Nasr, 2007). Inventory turnover ratio shows the significantly positive impact on profitability according to study findings which is consistent with the finding of (Sahari, Tinggi Kadri, 2012). On the other hand, the impact of debt-to-equity ratio is found to be significantly negatively associated with the firms profitability which supported the conclusion of (Eriotis, Frangouli Neokosmides, 2011). Size of the firm indicated significantly positive impact on firms profitability according to the findings of (Treacy, 1980; Bhattacharyya Sexena, 2009 and Am irkhalkhali Mukhopadhyay, 1993) and the findings rejected the arguments of (Ramasamy, Ong yeung, 2005, Ammar et al., 2003 and Dean, Brown Bamford, 1998). On the whole, the selected variables are strongly associated with the profitability of the firm. Liquidity is the most important factor to affect profitability. Although size and debt-to equity ratio reveal strong power to affect profitability, but their explanatory power is less than liquidity. On the other hand, inventory turnover ratio has a significant positive relationship with profitability but its explanatory power is less than other independent variables. Chapter 5 Conclusion and Implications This chapter provides conclusion, limitations and of the study further directions for future research. 5.1 Conclusion The primary objective of this study was to find out the factors which determine the profitability of the firm while analyzing the financial data of Chemical industry of Pakistan which are listed on Karachi Stock Exchange for the period of 2005 to 2010. The findings revealed that the selected variables have significant relationship with the profitability and they strongly affect the profitability of the firm. The findings suggested that liquidity has a strong positive impact on profitability. Firms should maintain optimal level of liquidity to meet short term obligations. The results also show that inventory turnover ratio is positively associated with firms profitability. It means that firm gets higher profit by quickly converting its inventory into cash. The findings reject the pecking order theory as debt-to-equity ratio has inverse relationship with profitability as debt-to-equity ratio increases, the firms profitability decreases. It shows that firm should not rely on heavy debt financing. The findings confirm the trade-off theory that firms should focus on trade-off of costs and benefits while selecting how much equity and debt to use as financing sources. Lastly, the findings reject the Gibrats law and claimed that firm size and profitability are positively related. The results indicated that profitability goes up as firms size become larger. 5.2 Limitations of the research This study is carried out in Pakistan which has developing economy so there are many problems with respect to availability of data as many manipulations and misrepresentations are existed in publically available data. Many sources were used for data collection. So, the quality of results of this study depends upon the available data of selected companies. Due to limitations of time and scope of the research required to focus only on limited number of firms. Due to available resources, only internal factors which affect profitability are included in the study. 5.3 Directions for the future research This research was first time conducted in Pakistan to explore the determinants of firms profitability in Karachi Stock Exchange. Further studies should be carried out in Pakistan to explore this phenomenon on different sectors or in other developing economies to evaluate whether the factors have same effect in different economies. Comparative research on this topic could be employed while taking different sectors of the economy. Moreover, external factors could be used to analyze their affect on profitability in developing economy. Different models could be employed for further in-depth analysis.
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