Relationship between the liquidity and profitability of oil companies in Kenya

Abstract

Liquidity management is undoubtedly one of the most crucial aspects of financial management since an efficient and effective liquidity management is crucial if the survival and prosperity of organizations firms is to be assured. The main objective of liquidity management is to maintain an optimal balance between current assets and current liabilities between each of the working capital components. A business success heavily depends on the financial executives’ ability to effectively manage current assets and current liabilities elements. This study examined the relationship between liquidity management and profitability of the Oil companies Kenya and covered the period 2007- 2010. A regression model was developed to determine the relationship between the dependent variable (Profitability of the firms) and independent variables (liquidity position). The independent variable used in the model consisted of Current ration, quick ratio, cash conversion cycle, while leverage and the age of the firm were used as control variables. Towards the achievement of the study objective, secondary data was used in the analysis that was obtained from the firm’s financial statements. Pearson’s correlation and regression analysis were used for the analysis and tests of significance were carried out for all variables using t-test at the 95% level of significance. The results indicate that the relationship between liquidity and profitability is weak with an adjusted R2 of 13.2% and also that all the independent variables had a significant relationship with ROA except the quick ratio and cash conversion cycle. The results further show that there is a strong negative relationship between a firms leverage and quick ratio with its ROA. This might be explained with the view that with inadequate cash position, then the firm will borrow at possible high interest rate and also not being able to meet supply the required fuel on time to meet customer demands. The study concluded that liquidity management is not a significant contributor alone of the firm’s profitability and there exist other variable that will influence ROA. However, it is important for a firm to understand the effect of each of the liquidity components on the firm’s profitability and also undertake deliberate measures to optimize its liquidity level. The study also recommends a further study on the role of liquidity on a firm’s profitability by incorporating more liquidity variables and control variables.