A STUDY OF VIETNAM’S LEATHER AND FOOTWEAR COMPANIES: FOCUS ON THE RELATIONSHIP BETWEEN LIQUIDITY AND FIRMS’ PROFITABILITY45488

Key words: Liquidity; profitability; current ratio; quick ratio; net working capital 1.. Some studies indicated a positive link between liquidity and profitability variables, while there

A STUDY OF VIETNAM’S LEATHER AND FOOTWEAR COMPANIES: FOCUS ON THE RELATIONSHIP BETWEEN LIQUIDITY AND FIRMS’

PROFITABILITY

Tran Thi Thu Trang, Le Thanh Huyen

Thuong Mai University - Vietnam

ABSTRACT

This study examines relationship between two ratios of the financial statements i.e profitability and liquidity in twelve listed leather and footwear companies in Vietnam between 2014 and 2018 The relation is measured by current ratio, quick ratio, and net-working capital Results revealed that there is weak negative relation between liquidity and profitability Quantitative research design is used

as tool for the study To find the relation and strength of the relation correlation and regression are used

Key words: Liquidity; profitability; current ratio; quick ratio; net working capital

1 INTRODUCTION

Working capital management is an important tool of enterprise finance because it directly affects the liquidity and profitability of the company Every enterprise pay attention to their profitability; therefore, they have to find out the factors affecting the profitability And Liquidity is one of the factors Every company is trying to promote their profits and they always want to bring their Liquidity at optimum level to raise their profitability

Many studies on the relationship have been conducted in past and had a huge variation in the results Vietnam’s economy is different from other economies and leather and footwear industry have its own characteristic This study will put light

on the relation of these two variables in context of leather and footwear sector in Vietnam

In Vietnam, leather and footwear is one of the key industries The industry contributes 10% to Vietnam’s GDP and Vietnam is among the top 10 countries producing footwear

* Corresponding author

Email address: tranthithutrang.tm@gmail.com

in the world With the aim to maximize their profit, the companies are interested in financial aspects There are many studies on different financial aspects However, no studies have been conducted on the relationship between liquidity and profitability

in the industry This study aim to measure the role of liquidity in explaining the variations in the profitability of Vietnam’s leather and footwear Companies

2 THEORETICAL BASIS AND ANALYSIS FRAMEWORK

In finance literature the researchers approached the relationship between the liquidity and profitability on different aspects as follow:

2.1 Concept of profitability

Profit and profitability are different While profit is considered as an absolute measure

of earning capacity, profitability is used as relative measure of earning capacity According Iyer (1995) and Nimalathasan (2009), profit is “excess of return over outlay”.Meanwhile, the definition of profitability is “the ability of given investment to earn a return from its use” (Nimalathasan, 2009)

According to Osiegbu and Nwakanma (2008), profitability plays an important role in making decisions and constructing policies In fact, profitability ratios can evaluate the firm’s capability to create profits Therefore, profitability is the major solution for the overall success of enterprise Besides, analyzing profitability ratios is integral activity

of the Shareholders, creditors, prospective investors, bankers and government alike Nimalathasan (2009) It is profit that is the primary purpose of a business, which measures both the success of a product and the growth of the market for it

Although Weidenfeld and Nicholson (1970) thought that the profit is a reward

to owner of the capital, the return to capital is an aim of a company’s activities Velnamby and Pandy (1979) showed that it is probably right in emphasizing the role of profitability as a criterion for the efficient operation of a company In 2009, Nimalathasan (2009) highlighted that the profitability will lead to more accurate view

of the firm’s performance

According to Vishnani and Shah (2007), profitability is commonly measured by ROA However, in 2004, correlation and regression study of Eljelly indicated that Current ratio is more important to measure profitability

2.2 Concept of liquidity

A good liquidity is a necessary element in the success of a firm A firm had better to ensure that it has not to face a lack of liquidity to meet its short-term compulsions Shim and Siegel (2000) Liquidity is business ability to pay short-term debts that have maturity less than one year

According to Ibenta (2005), liquidity demonstrates the firm’s capacity to meet short-term need of funds In 2003, Matarazzo indicated that liquidity reveals the firm’s degree of independence against the creditors In addition, it also shows the difficulties and crises that the company has to face Chandra (2001) states that

financial strength of a business is measured by its liquidity.Maness & Zietlow (2005) declare that high financial cost and business’s inability to fullfill its obligations are the results of low liquidity

In 2010, Bhunia gave a study where author asserts thatliquidity is one of major elements to both the internal and the external analysts because of its close relationship with daily operations of a business

In point of view of Vishnani and Shah (2007), liquidity is commonly measured by current ratio.Eljelly (2004) proved that cash conversion cycle is more important to measure liquidity

2.3 The relationship between liquidity and profitability

There have been some researches about the association between liquidity and profitability, both in single firm or in industries as a whole Surprisingly, there are diverse results in different industries and different country as well Some studies indicated a positive link between liquidity and profitability variables, while there are also researches showing a negative relationship between liquidity and profitability, in line with the risk and return theory

In 1996, by carrying out his study, Jose et al illustrated the integral role of management

of a firm’s short-term assets and liabilities in the success of the firm In order to have long term prospects and healthy bottom lines, firms should not remain solvent without good liquidity management

Bhunia (2010) As liquidity has a significant relation with day to day activities so the study of liquidity plays an important role im the internal analysts as well as external analysis

In the point of view of Walt (2009), profitability should have a more important position, because profit can usually be changed into a liquid asset Author opined that liquidity is also important but a good liquidity does not mean that the company

is profitable

According to Don (2009), liquidity is more important because it is necessary for the immediate survival of the company

Mahmood and Qayyum, (2010) argue that both liquidity and profitabilityare important

in helping company to achieve two major objectives Profitability is associated strictly

to the wealth maximization purpose of the shareholders and liquidity is integral for the continuity of business

Based on their research on strategic management of liquidity and its link with profitability from the cement industry in Nigeria,Nworji and Alayemi (2014)concluded that there are significant association between liquidity and profitability In this study, variables consist of current assets (that is divided into current operating asset and current financing asset) and current liability (that is divided into current operating liabilities) and current financing liability

According to Marques and Braga (1995) and Renato Schwambach Vieira (2010), the relationship between profitability and liquidity is inverse

Similarly,Abuzarand Eljelly (2004) took current ratio as tool to find the association between profitability and liquidity, author concludes that there is negative link between the firm’s liquidity and its profitability

Eljelly (2004) His study about liquidity and profitability tradeoff: an empirical investigation in an emerging market, showed an inverse relationship between profitability and liquidity indicators In this research, current ratio and cash gap (cash conversion cycle) are used as liquidity indicator and net operating income

is considered as a profitability indicator Those variables are tested using person correlation analysis and regression analysis Studyalso indicates that current ratio is more important as liquidity measure that affect profitability Meanwhile, within sector, cash gap seems to be more important than current ratio in influencing profitability With the aim of measuring the effect of working capital management on the net operating profitability and liquidity, Raheman and Nasr (2007) used a sample of

94 Pakistani firms listed on Karachi Stock Exchange for a 6-year period Finally, authors conclude that there is a strong negative link between variables of working capital management and profitability of the firms Similarly, a significant negative relationship between liquidity and profitability is indicated Also, debt used by the firm negatively impacts firm’s profitability By contrast, there is a positive link existing between size of the firm and its profitability Authors used average collection period, inventory turnover in days, average payment period, cash conversion cycle, current ratio, debt ratio, size of the firm and financial assets to total assets ratio as variables

in their analysis

Through multivariate working capital analysis, the study of Shah in 2012 about evaluation of link between profitability and liquidity, shows that liquidity and profitability are vital and contradictory aspect of business life The research also indicates that analysts should spend more attention onvariable named “operating cycle period” than the current ratio and quick ratio in measuring the firm’s liquidity

On the contrary, in the point of view of Sur et al (2001), Bardia (2007), Bardia (2004) and Sur and Ganguly (2001), the relationship between profitability and liquidity is positive

Vieira (2010) carried out a research on airline companies from 2005 to 2008

He found a significant positive correlation between liquidity and profitability on the short run, contradicting the main literature about association between liquidity and profitability For the medium run, the relationship was showed to be positive

According to the risk and return theory, risk and return have a positive relationship It means that the higher the return, the higher the risk as well By contrast, when the risk

is lower, the return will be lower Linking the risk and return theory to the association between liquidity and profitability, it can also lead to the similar behavior When a firm maintains a higher liquidity of a company, it will have lower chance to beunable

to fulfill its short-term debt and become bankrupt In the point of view of Gitman & Zutter given in 2012,the tradeoff between profitability and risk exists In this context, profitability is revenues and cost generated relationship While risk that a company will be unable to fulfill its obligation as they come due and become insolvent has the relationship with the firm probability

Similarly, by using data collected from listed banks in Ghana, Lartey, Antwi, and Boadi (2013), also found a positive association between liquidity and profitability, even though the relationship was weak The profitability indicator used in this study was return on asset (ROA), while the temporary investment ratio (TIR) is used as the liquidity indicator

In his study on NFL, Narware (2004) concluded that there is both negative and positive associations between profitability and liquidity

In 2014, in a study about the influence of liquidity management on profitability in the Jordanian Commercial Banks between 2005 and 2012, Alshatti used investment ratio, quick ratio, capital ratio, and liquid assets ratio as liquidity indicators, while return on equity and return on asset were used as the tool to measure the firm’s profitability Author concluded that the rise in quick ratio and the investment ratio impact profitability positively However, negative effect of capital ratio and liquid assets ratio on Jordanian commercial banks profitability was indicated

Meanwhile, Amit et al (2005) argues that there is no any relation between profitability and liquidity

Lambery and Valming (2009) Decisions related to liquidity have no effect on profitability Nevertheless, the use of forecasting of liquidity and short-term financing during crisis impacts positively profitability

Niresh (2012) studied about the tradeoff between liquidity and profitability based

on the data collected from selected manufacturing firms in Sri Lanka during period from 2007 to 2011 The variables used in this study was current ratio, quick ratio, and liquid ratio for liquidity indicators, whereasnet profit, return on capital employed, and return on equity (ROE) were used to evaluate the firm’s profitability Using correlation analysis and descriptive statistics, he did not find any significant relationship between liquidity and profitability among the listed 31 manufacturing firms in Sri Lanka from

2007 to 2011

3 METHODOLOGY

3.1 Measurement of Variables

The study takes Return on Assets as measure of Profitability to represent dependent variables and Quick ratio, Current ratio and Net working capital as measures of Liquidity to represent independent The studied variables are calculated as follows:

Table 1 Caculations of Liquidity and Profitability ratios

Quick ratio = Current Assets - Current Liability

Current ratio = (Current Assets - Inventory)/Current Liability

Liquidity ratio = (Cash in hand + Short Term Investment)/Current Liability

Net working capital = Current Assets - Current Liability

Return on investment = Profit after Interest and Tax/Total Assets × 100

Source Authors

3.2 Population & Sampling

For the purpose of the study on the relationship between liquidity and profitability our reserch group selected sample size according to the formula proposed by Tabacknick and Fidell (2007) n > = 50 + 8p (n is the minimum sample size, p is the number

of factors or independent variables) using for regression model Therefore, financial data of twelve leather and footwear companies in five years are selected as below:

Table 2 Some leather and footwear companies selected

No Type of enterprise The number of enterprise

1 Small and medium sized enterprise 6

Source Authors

3.3 Period of Study

The study collected 5 years financial statements data starting from 2014 to 2018

3.4 Data Collection

Secondary data is collected through five years financial statements data of leather and footwear companies

3.5 Hypotheses

For the study seven hypotheses have been constructed:

Ho: No relation exists between the liquidity and profitability

H1: There is significant relationship between liquidity and profitability

H2: There is a positive relation between current ratio andprofitability

H3: There is a negative relation between current ratio and profitability

H4: There is a positive relation between quick ratio and profitability

H5: There is a negative relation between quick ratio and profitability

H6: There is a positive relation between Net-working capital and profitability

H7: There is a negative relation between Net-working capital and profitability

3.6 Conceptual Framework

Figure 1 Author constructed

Current ratio

Quick ratio

Net working capital

Profitability Liquidity

Return on Assets

4 DATA ANALYSIS AND DISCUSSION

4.1 Descriptive statistics

Table 3 Descriptive Statistics

N Minimum Maximum Mean Std Deviation

NWC 60 -55958.00 7738082.00 335373.6667 1315480.05783 Valid N

The table 3 shows the mean value of the variable liquidity ratio, quick ratio and current ratio is around 0.4, 0.42 and 1.82 with standard deviation of 0.45, 0.45 and 0.79 respectively; the mean value of net working capital of all the companies together is about 335,373 million dong Moreover, the mean value of the variable return on investment is about 32.67%

4.2 Correlation

Table 4 Correlations

ROA

Pearson Correlation 1 020 -.062 -.026

CR

Pearson Correlation 020 1 582 ** 211

QR

Pearson Correlation -.062 582 ** 1 -.177

NWC

Pearson Correlation -.026 211 -.177 1

Sig (2-tailed) 843 105 175

** Correlation is significant at the 0.01 level (2-tailed).

Table 5 Correlations between ROA and Liquidity

a Dependent Variable: profitability

The Sig.(2-tailed) value tells if there is a statistically significant correlation between two variables.In comparing liquidity from firm’s profitability, research compares

current ratio, quick ratio, net working capitalas the liquidity, returns on assets (ROA)

as firm’s profitability As can be seen from the table 4 and 5, the sig.(2-tailed) value between current ratio and ROA is 878, the value between quick ratioand ROA is .640, and the value between net working capitaland ROA is 843 That result means that there is no statistically significant correlation between current ratio, quick ratio, net working capital and ROA Moreover, the sig.(2-tailed) value between Liquidity and ROA is 0.708 In other words, different from main litteratures, there is no statistically significant correlation between those ratios and profitability of Vietnamese leather and footware companies from 2014 to 2018

5 CONCLUSION

From the findings and results of the study we can conclude that there is no statistically significant correlation between those ratios and profitability of Vietnamese leather and footware companies.So the null hypothesis is accepted and alternate hypothesis

1 is rejected

6 LIMITATIONS

Due to limited research time and data accessibility, the sample size of the research sample was minimal In addition, the research has only been conducted for joint stock companies in the footwear industry We hope that the following studies can expand the scope of research and collect more data for other types of enterprises

in this industry

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