Liquidity-Profitability Trade-Off: A Panel Study of Listed Non-Financial Firms in Ghana

Abstract

Copyright © 2019 by author(s) and International Journal of Trend in Scientific Research and Development Journal. This is an Open Access article distributed under the terms of the Creative Commons Attribution License (CC BY 4.0) (http://creativecommons.org/licenses/ by/4.0) ABSTRACT This study sought to explore the trade-off between liquidity and the profitability of non-financial firms listed on the Ghana Stock Exchange (GSE). A panel data extracted from the audited and published annual reports of fifteen (15) selected firms for the period 2008 to 2017 was used for the study. In the study, liquidity was surrogated by the Cash Flow Ratio (CFR) and the Cash Ratio (CaR), whilst profitability was proxied by Return on Capital Employed (ROCE). After undertaken some diagnostic and specification tests to address the basic assumptions of the Classical Linear Regression Model (CLRM), the study uncovered that, cash flow ratio had a significantly positive effect on the firms’ profitability as measured by ROCE [β=0.1050416, (p=0.038)<0.05], but the cash ratio had an insignificantly negative influence on the firms’ profitability as measured by ROCE [β= -0.0805403, (p=0.306)>0.05]. It was further discovered that, the cash flow ratio and the cash ratio had a combined significant effect on the firms’ profitability as measured by ROCE [Wald chi2(1)=7.43, (p=0.0244)<0.05]. In order to ensure continuous survival and success, the firms should not play with the issue of liquidity management. The entities are expected to maintain an optimal liquidity level that will be capable of performing the ‘twin’ role of meeting their financial obligations and at the same time maximizing their shareholders’ wealth. This optimal liquidity level could be obtained if the establishments are to meet the standards set by the Ghana Stock Exchange (GSE). Adhering to these standards will help the firms to reduce the cases of financial distress. In other words, the firms should keep an adequate level of liquidity that will not portend their going concern status, and yet allow them to make ample returns on their investments. Thus, the firms should strike a balance (trade-off) between their liquidity and profitability. Also, surplus liquidity and inadequate liquidity are two financial ailments that can simply wear down the firms’ profitability. Therefore, the establishments must embrace liquidity management in their attempt to optimize profitability. This could be attained if the firms lessen the amounts they hold in cash and focus more on investments so that, they could gain higher returns rather than tying them down in idle cash. From the perspective of theory, the outcome of this study is in tandem with that of prior studies by bringing to light the effect of liquidity on firms’ financial performance as measured by ROCE. The firms should therefore inculcate into their decisions the findings of this study so as to meet their operational and expansion needs, as well as the desires of their shareholders.