Advances in Environmental Biology

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1 Advances in Environmenal Biology, 8(19) Special 2014, Pages: AENSI Journals Advances in Environmenal Biology ISSN EISSN Journal home page: hp:// Invesigaing he Relaionship beween Liquidiy and Profiabiliy in Lised Companies in Tehran Sock Exchange Adeleh Azadzadeh Deparmen Of Accouning, Faculy of Managemen saveh Science and Research Branch Islamic Azad Universiy Saveh Iran ARTICLE I N F O Aricle hisory: Received 10 Sepember 2014 Received in revised form 23 Ocober 2014 Acceped 27 November 2014 Keywords: Working capial managemen, profiabiliy, liquidiy, Indusry A B S T R A C T The major indicaors of he financial performance of corporae eniies are liquidiy and profiabiliy. The sudy aims o invesigae he relaionship beween profiabiliy and liquidiy, as measured by curren raio and cash gap (cash conversion cycle) for 84 indusrial companies lised a he Tehran Sock Exchange for a period of Using correlaion and regression analysis he sudy found significan posiive relaion beween he firm s profiabiliy and liquidiy.a he indusry level, however, The size variable is also found o have significan effec on profiabiliy. Also i was observed ha here was grea variaion among indusries wih respec o he significan measure of liquidiy. Finally, he resuls are sable over he period under sudy AENSI Publisher All righs reserved. To Cie This Aricle: Adeleh Azadzadeh., Invesigaing he Relaionship beween Liquidiy and Profiabiliy in Lised Companies in Tehran Sock Exchange. Adv. Environ. Biol., 8(19), , 2014 INTRODUCTION Currenly, one of he mos imporan issues in financial managemen is working capial managemen ha is discussed on he ypes of curren asses and liabiliies. For efficien working capial managemen in a company, anicipae and mee he cash required by he company is as a fundamenal objecive. In general, managemen of working capial means ha cash, accouns receivable and goods invenory are mainained a a level o can be adequae o pay shor-erm bills and ongoing obligaion. Liquidiy and profiabiliy are wo very imporan and vial aspecs of corporae business life. No firm can survive wihou liquidiy. A firm no making profi may be considered as sick bu, one having no liquidiy may soon mee is downfall and ulimaely die. Liquidiy managemen has hus, become a basic and broad aspec of judging he performance of a corporae eniy [1]. I is hus, essenial o mainain as adequae degree of liquidiy of smooh running of he business operaions. The liquidiy should be neiher excessive nor inadequae. Excessive liquidiy indicaes accumulaed idle funds, which do no earn any profi for he firm, and inadequae liquidiy no only adversely affec he credi worhiness of he firm, bu also inerrups he producion process and hampers is earning capaciy o a grea exen. Thus, he need for efficien liquidiy managemen in corporae businesses has always been significan for smooh running of he business [9] Lieraure Review: Working capial managemen is an imporan componen of managemen of corporae finance; since i direcly influences firm s profiabiliy as well as liquidiy in everyday aciviies. In any business organizaion, i is obvious ha here mus be sufficien working capial o run day o day operaion. Therefore, o operae he business aciviies smoohly, working capial of firms mus be sufficien. In his regard, he concern of working capial managemen is seing sufficien (opimal) level of working capial and managing shor erm asses and liabiliies of firms wihin a specified period of ime, usually one year. I is obvious ha, he imporance of efficien working capial managemen is unquesionable o all business aciviies given he fac ha business capabiliy relies on is abiliy o effecively use (manage) receivables, invenories and payables[3]. Generally, working capial managemen is simple and accurae means of ensuring an organizaion's abiliy o find he difference beween shor erm asses and liabiliies [6]. In pracice, working capial managemen has become one of he mos imporan issues in organizaions ha many financial managers are compeing o idenify he main componens of working capial and an appropriae level of working capial [7]. Corresponding Auhor: Adeleh Azadzadeh, Deparmen Of Accouning, Faculy of Managemen saveh Science and Research Branch Islamic Azad Universiy Saveh Iran

2 164 Adeleh Azadzadeh, 2014 Advances in Environmenal Biology, 8(19) Special 2014, Pages: Garcia and Marinez [4] had examined he effec of working capial managemen on profiabiliy of he small and medium enerprises and conclude ha managers can wih reducing urnover of accouns receivable and goods invenory creae value on he company and wih shoren up he cash conversion cycle and improve corporae profiabiliy. Gill and colleagues [5] chose a 88 sample of companies lised on he New York Sock Exchange and wih examinaion of he level of working capial on profiabiliy concluded ha a here are a significan relaionship beween cash conversion cycle and corporaes profiabiliy. Eljelly [2] examined he relaion beween liquidiy and profiabiliy measured by curren raio and cash gap (cash conversion cycle) on a sample of join sock companies in Saudi Arabia using correlaion and regression analysis. They found a negaive relaionship beween profiabiliy and liquidiy indicaors, and i was found ha cash conversion cycle had a bigger impac over profiabiliy hen curren raio. Garcia-Teruel and Solano [6] sudied he effecs of working capial managemen over companies ROA. They observed 8872 enerprises and found ou ha shorening cash conversion cycle had significan effec over companies profiabiliy. Raheman and Nasr [9] sudied he relaionship beween working capial managemen and profiabiliy for 94 Pakisanian companies lised on Karachi Sock Exchange. beween heir finding, i was observed a significan negaive relaionship beween companies liquidiy and profiabiliy. Daa And Mehodology: Since he aim of his sudy is o examine he relaion beween profiabiliy and liquidiy, he sudy makes a se of esable hypoheses. Firs, his sudy assumes ha here may be a relaionship beween profiabiliy of he company and is liquidiy profile, since he laer effecs he former in a direc way, as a resul of he exernal financing coss or saving hereof. Due o hese elemens of coss and cos saving his relaionship is mos likely be negaive. Thus, he firs hypohesis of his sudy can be saed as follows: Hypohesis 1: There is a possible negaive relaion beween liquidiy of a company and is profiabiliy. Companies wih relaively high levels of liquidiy are expeced o pos low levels of profiabiliy and vise versa. Secondly, profiabiliy, on he oher hand, may be a funcion of he size of companies (measured in erms of sales or oal asses).the company size may affec liquidiy, cash gaps and, hence, profiabiliy in differen ways. On he one hand, large companies may be able o buy invenory in large quaniies in order o ge quaniy discouns. Furher, because of heir size, large companies may qualify for discouns from suppliers wih relaively small invenory levels. On he oher hand, large companies may be able o ge favorable credi erms from heir suppliers in erms of longer credi periods. Moreover, large companies may have more success in heir receivables collecion effors relaive o small companies. All hese facors may push liquidiy levels and cash gaps of large companies o levels lower han ha of small companies. On he conrary, small companies are usually no able o obain as much invenory o qualify for quaniy discouns as heir large counerpars do. Addiionally, small companies make effors o pay wihin discoun periods in order o benefi from cash discouns and o avoid severing heir relaions wih heir suppliers. These facors may force small companies o have higher liquidiy levels and larger cash gaps. Accordingly, his sudy saes he following hypohesis: Hypohesis 2: A posiive relaion may exis beween he company size and is profiabiliy. This may be due o he abiliy of large companies o reduce liquidiy levels and cash gaps. Third, liquidiy and cash gaps may differ among indusries and among counries and may depend on he prevailing economic condiions. Someimes radiions and he naure of business se he ypical working capial requiremens and he cash gap in a given indusry. Some indusries have inherenly high levels of working capial requiremens and large cash gaps han ohers, while some may require low levels of working capial and shorer or even negaive cash gaps, which indicae heir abiliy o obain cos-free capial from heir cusomers. Thus, his sudy saes he following hypohesis: Hypohesis 3: Need for working capial and liquidiy is influenced by he indusry in which he company operaes. Capial inensive indusries require low levels of working capial and end o have smaller cash gaps han heir labor-inensive counerpars. Accordingly, liquidiy requiremen is expeced o have no significan negaive impac on profiabiliy of capial- inensive indusries. To es hese hypoheses his sudy uses he following mehodology : 1. The sudy firs esimaes he cash gap for each company and for each year of he sample period as follows: Cash Gap = Days in Invenory (DII) + Days in Accouns Receivable (DIR) Days in Accouns Payable (DIP)

3 165 Adeleh Azadzadeh, 2014 Advances in Environmenal Biology, 8(19) Special 2014, Pages: The componens of he cash gap are calculaed as follows: - Invenory urnover = cos of goods sold/ average invenory - Number of days in invenory= 365/ invenory urnover - Number of days in Receivables= Receivables/ average daily sales - Number of days in Payables = Payables / average daily purchases 2. Correlaion analysis o idenify he associaion beween profiabiliy and liquidiy indicaors and oher relaed variables 3. Regression analysis o esimae he causal relaionship beween profiabiliy variable, liquidiy and oher chosen variables. Populaion And Sample: The populaion of his sudy is all lised companies in Tehran Sock Exchange during he period 2003 o Companies surveyed are seleced by he sysemaic eliminaion or argeed based on he following crieria: Their fiscal year be ending March 29 of each year. Surveyed companies have been joined sock before 2003.Sample companies have an operaional losses during he period under he review. These companies should have informaion such as iems of curren asses, oal asses and curren liabiliies during he period 2003 o 2010.I was no among invesmen firms and financial inermediaion. According o sudies conduced, 84 companies which are eligible above condiions has been invesigaed in he period 2003 o RESULTS AND ANALYSIS The following noaions are used hroughou his sudy: S= ne sales TA= Toal asses CG= Cash gap in days CR= Curren raio LOGS= Logarihm of ne sales LOGTA= Logarihm of oal asses CGS= Cash gap in days/100 NOI= Ne operaing income + depreciaion / ne sales Tab.1 shows he measures of cenral endency and dispersion for he basic variables used in his sudy; NOI,CR, CG, and S. The able shows wide variaion for hese variables, especially sales (S) and cash gap(cg). Thus hese wo variables are ransformed in he analysis ha follows, by aking he logarihm of sales (o saisfy normaliy) and divide CG by 100,o ge a new scaled variable CGS. Table 1: Descripive Saisics (n =672). NOI CG CR LOGS LOGTA CGS Number of observaions Average Median Sd. Deviaion skewness Kurosis Range Minimum Maximum The sudy firs examines he relaionship ha exiss beween he variables of profiabiliy and liquidiy. Table 2 shows he Pearson correlaion coefficiens beween NOI, CGS, LOGTA, LOGS, CR, CG, and TA for he whole sample of 672 company-year observaions. In Table 2 he correlaion coefficiens indicae a significan posiive relaionship beween curren raio (CR) and cash gap (CG/CGP) and Ne Operaing Income (NOI). One should no overlook he posiive significan associaion ha exiss beween NOI and he wo measure of size, LOGS and LOGTA, which in urn indicaes a posiive relaion beween size and profiabiliy. This has o be viewed in ligh of he highly significan negaive correlaion ha exiss beween hese wo variable and he CR. Similarly, a negaive relaion exiss beween LOGS and LOGTA and CG. Finally, one should observe he srong highly posiive relaion ha exiss beween sales and oal asses which show ha hey are subsiue measures of size. To invesigae he associaion beween profiabiliy and liquidiy furher, he sudy esimaes he following regression equaion for he whole sample and for four equaion for he whole sample and four sub-samples. The sub-samples are by producs of dividing he sample ino four sub-samples, based on CR and CG.

4 166 Adeleh Azadzadeh, 2014 Advances in Environmenal Biology, 8(19) Special 2014, Pages: Table 2: Pearson Correlaion Coefficiens Marix. TA CG CR LOGS LOGTA CGS LNNOI S.977 ** **.185 ** ** TA **.202 ** ** CG ** ** ** **.197 ** **.104 **.164 ** 1 CR ** ** LOGS **.031 LOGTA CGS **. Correlaion is significan a he 0.01 level (2-ailed). The firs wo sub- samples are creaed by dividing he sample ino wo sub- samples, one wih CR 2 and he oher wih CR>2. The reason for his spli is o examine wheher he effec on profiabiliy is a funcion of he level of liquidiy. The oher wo samples are creaed by dividing he sample ino wo sub- samples, one wih CG 150 days and he oher wih CG >150 days. The purpose in his case is o examine wheher he relaion beween profiabiliy, liquidiy level and cash gap is a funcion and cash gap is a funcion of he efficiency of managing cash cycle. for he sample and each of he sub-samples he following regression equaion is esimaed: NOI= B0+B1 CR+B2CGS+B3LOGS+e Where: B0, B1, B2 B3, he coefficiens of he regression equaion; and he oher variables are as defined before. Table 3: NOI= B0+B1 CR+B2CGS+B3LOGS+eRegression (1): The general regressions. Inercep CR CGS LOGS Pooled.057* * (4.281) (-1.774) * (3.865) (-4.960) Sub- sample CR 2 Sub- sample CR> 2 Sub- sample CG 150 Sub- sample CG> * (-4.608) * (-4.789) * (-7.088) -.875* (-2.175).158 (3.189) (.985) * (3.968) (-1.075) * (4.042) * (3.763) * (7.292) * (2.129) (-1.625) (.758) * (2.584) * (-2.127) = Variance Inflaion Facor. (*) indicaes significance a all levels R F * * * N Table 3 shows he resuls of esimaing he regression equaion for he pooled sample and for each of he four sub-sample. The resuls of he pooled regression and he sub- samples, in general, show ha he model fis he daa very well shown by he high R2 and F saisics. However, he pooled regression shows ha he curren raio wih a posiive and very significan slop coefficien confirming he resuls of he earlier correlaion analysis. Similarly, he coefficien for he CGS is posiive and significan. The size variable LOGS is negaive, bu also no significan. The sub- sample regression, however, show differen resuls. For he sub-sample wih CR 2 he coefficiens of CR and CGS are boh posiive, bu are for CGS is significan and he coefficiens of LOGS is negaive, bu is insignifican.

5 167 Adeleh Azadzadeh, 2014 Advances in Environmenal Biology, 8(19) Special 2014, Pages: This indicaes ha when liquidiy levels are low, denoed by low curren raios, he effec on profiabiliy is no significan. However, when CR>2,he effec on profiabiliy is no significan. Similarly, when he sample is divided on he basis of cash gap, he resuls for he subsamples where CG 150 show ha CR has a posiive, bu significan coefficiens indicaing significan effec on profiabiliy. This means ha when he cash conversion cycle is shor he curren raio increase is imporance and impac on profiabiliy. However, since he cash conversion cycle (cash gap) replaces he curren raio as a liquidiy parameer, he cash gap coefficien is posiive and highly significan poining o he posiive impac of relaively shor cash gaps on profiabiliy. When he cash gap is greaer han 150 days he CR coefficien is negaive insignifican. This indicaes ha when he cash conversion cycle is long, hen he liquidiy level (as measured by curren raio) becomes a insignifican parameer and impacs profiabiliy in a insignificanly negaive way. However, i is highly possible ha he independen variables, CR, CGS, and LOGS are highly relaed o each oher, and inclusion of all of hem will hus be unjusified. To es for his possibiliy he sudy used wo mehods recommended by economericians, which are and Variance Inflaion Facor () ess [6].The olerance is a saisical measure used o deermine how much he independen variables are linearly relaed o each oher. A variable wih very low olerance conribues lile informaion o he model. I is measured as (1-r2) for he variable, or simply as a reciprocal of he Variable Inflaion facor, 1/. When he variable is highly collinear he olerance level is zero or close o zero. If, on he oher hand, i is no relaed o oher variables he olerance level is 1. The, on he oher hand, is a measure ha is used o deermine collineariy. Large value is an indicaion of mulicollineariy. As a rule of humb, if of a variable exceeds 10 ha variable is said o be highly collinear. I is eviden from Table 3 ha he independen variables are independen and here is no collineariy among hem. Thus, he regression resuls ogeher wih he correlaion resuls suppor he firs hypohesis of his sudy on he overall posiive relaion beween profiabiliy and liquidiy. I is eviden, however, ha his effec depends on he level of liquidiy and he size of cash gap. On he oher hand, he secor regressions show differen paerns han he pooled regression. For he Chemical and Food excep sugar and Auomobile secors boh CGS and CR coefficiens are posiive and highly significan, while he LOGS coefficien is no significan. This may explain he relaive imporance of he cash gap and curren raio as a measure of liquidiy, in he capial inensive indusries such as Chemical and Food excep sugar and Auomobile. he resuls confirm hypohesis II and III on he influence of boh indusry and size on profiabiliy wihin economic secors. Table 4: NOI= B0+B1 CR+B2CGS+B3LOGS+eRegression (2): Secor Regressions. Inercep CR CGS LOGS Chemical.380 *.128 * * )3.840( )2.050( )1.615( )-4.543( Pharmaceuical Auomobile Ceramic &Tiles Cemen Basic meal Food excep sugar * )-6.368( * )-6.583( )-1.689( ) ( )-.514( * (-2.087).070 )1.447( * )2.9( * )2.011( ).976( )1.896( * (2.087) * )8.088( * )1.632( ).509( )-.466( )-1.324( * ) 3.349( * )2.377( )1.992( ).407( ).755( )-1.053( ).834( R * = Variance Inflaion Facor, (*) indicaes significance a.05 level F * * * * N

6 168 Adeleh Azadzadeh, 2014 Advances in Environmenal Biology, 8(19) Special 2014, Pages: There is an imporan quesion concerning he sabiliy of he regression resuls over ime. To examine his issue a regression is conduced for each individual year in he sample period. The resuls shown in Table 5 for he individual years furher suppor he assumed relaions of his sudy and heir sabiliy over ime. Firs, he high R2 shows ha a large variaion of he dependen variable is explained by he model. The size coefficien for all years is no significan indicaing ha size maers when considered wihin secors or indusries. The CR coefficiens for mos of he years are posiive as expeced and insignifican for mos of he ime period, while CGS coefficiens are posiive for mos of he years bu significan. Table 5: NOI= B0+B1 CR+B2CGS+B3LOGS+e Regression (2): Secor Regressions. Inercep CR CGS * ).608( )1.140( )-2.719( * )-2.206( * )-3.215( * )-2.550( )-1.852( )-1.996( )-1.352( )-1.913( * )-2.572( * )3.132( )1.484( ).977( )1.566( )1.964( * )3.166( * )3.045( )1.142( * )2.480( * )2.030( )1.770( (*) indicaes significance a.05 level LOGS.061 ).983( ).656( )-.483( )-.042( )-.781( )-.384( R F * * * * * * N Conclusions: The resuls of his sudy have imporan implicaions for liquidiy managemen in various Iranian companies. This sudy has aemped o empirically examine he relaion beween profiabiliy and liquidiy in a sample of 84 join sock companies ha represen he major economic secors in Tehran Sock Exchange over he period The sudy reveals ha here exiss a significan and posiive relaion beween profiabiliy and liquidiy measures such as curren raio and cash gap. Size is also found o bear some influence over profiabiliy wihin economic secors, bu no in he overall sample. These wo influences are more profound in capial- inensive secors, such as manufacuring. The sudy also revealed ha here is grea variaion among indusries wih respec o he significan measure of liquidiy. Alhough cerain liquidiy levels are desirable and someimes unavoidable, he sudy poins o he los profis and he unnecessary coss ha are borne by companies as a resul of holding excessive liquidiy. These losses or coss could be reduced or eliminaed by adoping acive liquidiy managemen sraegies.

7 169 Adeleh Azadzadeh, 2014 Advances in Environmenal Biology, 8(19) Special 2014, Pages: Furhermore, he sudy highlighs and reviews briefly he imporance of using he various measures and echniques ha measures and echniques ha conribue owards an efficien managemen of liquidiy and, hence, improve profiabiliy. These echniques include he JIT sysem, and facoring of receivables, o menion a few. REFERENCES [1] Bardia, S.C., 2004.Liquidiy Managemen: A case Sudy of Seel Auhoriy of India Ld, The Managemen Accounan, ICWAI, Kolkaa, [2] Eljelly, A., Liquidiy profiabiliy radeoff: an empirical invesigaion in an emerging marke. IJCM, 14(2): [3] Filbeck, G., T. Krueger, An Analysis of Working Capial Managemen Resuls Across Indusries. American Journal of Business, 20(2): [4] Garcia-Truel, P.J. and Marinez-Solano, Effec Of working capial managemen on SME profiabiliy. Inernaional journal of managerial of finance, 3: [5] Gill, A., N. Biger and N. Mahur, The relaionship beween working capial managemen and profiabiliy: evidence from he Unied Saes. And economics Business Journal, 10: 1-9. [6] Gujarai, N., Damodar, Basic economerics. McGraw-Hill, inernaional Ediion, Economic series. [7] Harrris, A., Working capial managemen: Difficul, bu Rewarding. Financial Execuive, 21(4): [8] Lamberson, M., Changes in Working Capial of Small Firms in Relaion o Changes in Economic Aciviy. Mid-American Journal of Business, 10(2): [9] Rahman, Abdul, Nasr, Mahamed, Working capial managemen and profiabiliy - Case of Pakisani Firms. Inernaional Review of Business Research papers, 3: [10] Valshney, Safish Chandra, Trade credi and company liquidiy, The Managemen Accounan, 36(10):