The Impact of Liquidity on Profitability of Some Selected Companies: The Financial Statement Analysis (FSA) Approach

Abstract

The major indicators of the financial performance of corporate entities are liquidity and profitability. Liquidity ratio is used to judge the ability of a firm to meet its short term maturing obligations. The higher the ratio the greater the margin of safety for short-term creditors (current ratio). While profitability ratio is concern with relative profitability and efficiency of utilization of resources of a business. Thus, this study seeks to determine the following: (1)The correlation between current  ratio and profitability; as measured by return on assets (ROA), (2) The correlation between Acid-test ratio and profitability; as measured by return on assets (ROA), (3) The correlation between return on capital employed and profitability; as measured by return on assets (ROA). The research design adopted for this study is the “quantitative research design”. The population consists of publicly quoted companies that make up the “industrial/Domestic products” industry. The sampling technique adopted is the “non-probability” sampling technique of four selected companies. The data used for the study was secondary data in the form of the “Annual Reports and Accounts” of the selected companies. Simple correlation analysis was used to test the hypothesis at 10% level of significance. The overall findings of this study indicate that: (1) There is a significant positive correlation between current ratio and profitability, (2) There is no definite significant correlation between Acid-test ratio and profitability. (3) There is no significant positive correlation between return on capital employed and profitability. The researcher recommends that corporate entities should not pursue extreme liquidity policies at the expense of their profitability, i.e. they should strike a balance between the two performance indicators (Liquidity and profitability).