Beruflich Dokumente
Kultur Dokumente
Profitability Ratio
&
Liquidity Ratio
Sheikh Nasir Uddin
H. M. T. Tarikul Kamrul
Sadia
Abstract
Financial ratios often act as a yardstick for the board of directors or shareholders (present
and would-be as well) to measure a company’s performance. These ratios also serve as a
means to examine and establish new propositions and hypotheses. These ratios can be
obtained or derived from the corresponding organization’s financial statements. Likewise,
to find out a relationship (or no-relationship, at all) between two important ratios, namely,
profitability and liquidity ratio, we used and dissected financial statements of three
organizations. We focused on a particular industry to avoid confusion and interruption of
too many unaccounted factors. We took data of three financial institutions to judge the
hypothesis that profitability and liquidity ratios indeed do have a relationship.
Objective
The main objective of this paper is to examine and observe the relationship between two
important types of financial ratios, liquidity and profitability ratios in context of financial
organizations. A trend analysis has also been done of these two through this process.
Introduction
The information required to prepare the report was obtained from the annual reports of
the three financial institutes, Delta Brac Housing Finance Corporation Ltd., Premier Bank
and Union Capital Limited. Since we cannot avail more, we took 5 year’s data from each
of these companies. Among various methods of profitability ratios we chose 5, Operating
Income Ratio, Net Income Ratio, Return on Asset Ratio, Return on Equity Ratio and
Earning per Share (EPS). And we compare each of these ratios with 3 types of liquidity
ratio, Current Ratio, Quick Ratio and Debt-Equity Ratio.
We used the Spearman's Rank Correlation* to establish whether there is any relationship
between Profitability ratio and Liquidity ratio.
* Spearman's Rank Correlation is a technique used to test the direction and strength of the relationship
between two variables. In other words, it’s a device to show whether any one set of numbers has an effect
on another set of numbers. It uses the statistic Rs which falls between -1 and +1.
Brief descriptions of the samples considered
A. Delta Brac Housing Finance Corporation Limited (DBH):
(DBH) is the pioneer, the largest and the specialist Housing Finance Institution in the
private sector of the country. After commencing operation in the early 1997, the company
has registered commendable growth in creating home ownership among more than 7,500
families in Dhaka and other major cities of the country. At the same time, the company
has been playing an active role in promoting the real estate sector to the large cross
sections of prospective clients who had but yet unfulfilled dream of owning a sweet
home.
Among all Banks and Financial Institutions of Bangladesh only DBH has been rated the
highest 'AAA' credit rating. The level of credit rating provides a very important indication
of the financial safety, security and strength of the concerned Bank or Financial
Institution and is particularly relevant to its depositors and other investors such as
shareholders and lenders.
Local Promoters
Delta Life Insurance Company Limited-The leading life insurance company in the
private sector of the country.
BRAC- The largest national NGO of the world, having deep presence in the country and
contributing in the socio-economic development of the country.
Green Delta Insurance Company- The leading and pioneer general insurance company
in the private sector of the country
International partners
HDFC: A pioneer in the area of private sector housing finance in India and the most
successful housing finance institution in the South Asia bring to DBH technological and
business expertise making the proper recommendations in relation to products, policies,
systems and procedures
IFC: The private sector arm of the World Bank Group. Both local and foreign
shareholders come together with an objective to channel resources into providing finance
for the people’ basic need for shelter, enhance housing stock of the country and promote
affordable home ownership.
Union Capital is an entrepreneurial company that prides itself on its speed of through and
action. Its ability to make decisions quickly and efficiently and to generate value as an
agent and executor sets it apart from all other investment banks and financial institutions
in Bangladesh. The company's strategy is to focus on Bangladesh and to develop a truly
global distribution network through the major investment institutions abroad. SES
Company Limited, which is wholly owned by Union Capital, has seats in both the Dhaka
and Chittagong stock exchanges. This provides Union Capital with unmatched local
distribution capabilities to retail and institutional investors throughout the world in
relation to securities originating in Bangladesh.
Union Capital is the only institution having three unique advantages in common, which
no other institutions can match in the capital market of Bangladesh. Union Capital is –
>> Central Bank (the Bangladesh Bank) licensed Financial Institution, and
>> On-the-ground access to the Stock Exchanges through wholly owned
subsidiary company, which has Corporate Memberships both at Dhaka and
Chittagong stock exchanges.
Union Capital is a public limited company having a profitable and dividend payment
track record.
Theories behind the Analysis at a glance
Liquidity Ratios
Profitability Ratios
Operating Income Ratio, Net Income Ratio, Return on Asset Ratio, Return on Equity
Ratio and Earning per Share (EPS)
Net Income
Average stockholders’ equity
From the stockholder’s point of view, an important measure of the income producing
ability of a company is the relationship of net income to average common stockholder’s
equity also called the return on equity (ROE).
The earning per share is the most widely used measure of a company’s operational
success. It is very important to the investors since it indicates how much they can earn on
each share. The EPS usually plays a major role in determining the market price of a
share.
Procedure for using Spearman's Rank Correlation
1. State the null hypothesis i.e. "There is no relationship between the two sets of
data."
2. Rank both sets of data from the highest to the lowest. Make sure to check for tied
ranks.
3. Subtract the two sets of ranks to get the difference d.
4. Square the values of d.
5. Add the squared values of d to get Sigma d2.
6. Use the formula Rs = 1-(6Sigma d2/n3-n) where n is the number of ranks you have.
7. If the Rs value...
... is -1, there is a perfect negative correlation.
...falls between -1 and -0.5, there is a strong negative correlation.
...falls between -0.5 and 0, there is a weak negative correlation.
... is 0, there is no correlation
...falls between 0 and 0.5, there is a weak positive correlation.
...falls between 0.5 and 1, there is a strong positive correlation
...is 1, there is a perfect positive correlation
between the 2 sets of data.
8. If the Rs value is 0, state that null hypothesis is accepted. Otherwise, say it is
rejected.
The following hypotheses have been tested while we applied the Spearman’s Rank
Correlation.
H0: There is no significant relationship between the Profitability and the Liquidity.
H1: There is a significant relationship between the Profitability and the Liquidity.
Interpretation of the Financial Ratios
A. DBH:
Company’s current ratio is in increasing trend. It implies that the company is managing
its assets efficiently. Quick ratio of the company is also in rapid growing trend. It shows
that the company’s liquidity situation is very good. But still the point is below 2 for both
current and quick ratio. The company still has more potential improve the liquidity
situation. Debt to equity ratio of the company is in a steady situation. It shows that the
investors can continue to invest in this company.
2
1.3
1.2 1.5
1
1.1
1
0.5
0
0.9
2002- 2003- 2004- 2005- 2006- 2002- 2003- 2004- 2005- 2006-
2003 2004 2005 2006 2007 2003 2004 2005 2006 2007
year year
Debt-Equity Ratio
15
10
5
0
Operating ratios and Net income ratios are in decreasing trend for the company. The
company needs to continue its current profitability growth in the future to retain the
investors’ confidence on the company.
Operating Income Ratio Net Income Ratio
40 20
30 15
20 10
5
10
0 0
2002- 2003- 2004- 2005- 2006- 2002- 2003- 2004- 2005- 2006-
2003 2004 2005 2006 2007 2003 2004 2005 2006 2007
Year Year
Return on equity and asset both are in growing situation. It shows the company
management is managing the company asset effectively and efficiently to have more
return on investment of the stakeholders. Also EPS for the stakeholders are growing
rapidly for the company.
RETURN ON ASSET RATIO: DBH RETURN ON ASSET RATIO: DBH EPS: DBH
3.4 50 60
3.2 40 50
3 30 40
30
2.8 20
20
2.6 10 10
2.4 0 0
2002- 2003- 2004- 2005- 2006- 2002- 2003- 2004- 2005- 2006- 2002- 2003- 2004- 2005- 2006-
2003 2004 2005 2006 2007 2003 2004 2005 2006 2007 2003 2004 2005 2006 2007
Year Year Year
B. Premiere Bank:
Current and quick ratio is in decreasing trend for the company. It shows that company is
not in a good condition to re-pay its debt in the short term. Also the debt to equity ratio is
in increasing trend, which shows the debt situation is worsening for the company.
Quick Ratio: Premiere
2.5
1.5
0.5
0
2001 2002 2003 2004 2005 2006
Year
Current Ratio
2.5
2
1.5
1
0.5
0
Year
25
20
15
10
0
2001 2002 2003 2004 2005 2006
Year
Company’s net income and operating income ratio both are in decreasing trend. Also the
Return on Asset and Return on Equity of the company is not in a good trend. EPS is also
decreased in the recent years for the company. It shows that company‘s profitability
situation is not in a very good shape. Company needs turn around the current profitability
situation immediately to regain and sustain the investors’ confidence and reliability on the
company.
Operating Ratio
120
100
80
60
40
20
0
Year
40
30
20
10
Year
ROA
6
5
4
3
2
1
0
Year
ROE
35
30
25
20
15
10
5
0
Year
EPS
100
80
60
40
20
0
Year
Current/Quick Ratio
2.5
2
1.5
1
0.5
0
Year
10
8
Year
(ii) Profitability Ratio:
Company’s net income and operating income scenario at its peak in 2005, but the
company lose its growing trend in 2006. Also Return on Asset and Return on equity are
not stable for the company. EPS is in decreasing trend for the company for last 6 years. It
shows, the company is heavily investing in the company.
Operating Ratio: Union Net Income Ratio: Union
35 35
30 30
25 25
20 20
15 15
10 10
5 5
0 0
2001 2002 2003 2004 2005 2006 2001 2002 2003 2004 2005 2006
Year Year
ROA: Union
6
5
4
3
2
1
0
2001 2002 2003 2004 2005 2006
Year
25 7
6
20
5
15 4
10 3
2
5
1
0 0
2001 2002 2003 2004 2005 2006 2001 2002 2003 2004 2005 2006
Year Year
A. DBH:
Calculating the last 5 years ratio, rank correlation coefficient of the above two ratio is 0.5.
It shows a weak positive correlation between the two.
From the rank correlation findings, we can see that Current ratio and Quick ratio are
correlated with the company’s operating and net income and also with the Return on asset
and Return on Equity. The ratios are highly correlated with EPS of the company.
Moreover company’s operating income is negatively correlated with the current and
quick ratio. The fact shows that when you better manage or pay your interest and debts to
the creditors, your operating profit goes down. It implies that the firm’s asset
management system will highly impact on its profitability. Company’s debt-equity ratio
highly correlated with net income, return on equity and EPS. On the other hand debt-
equity ratio has no correlation with net income and return on asset. It shows that
company’s debt paying status is highly correlated with its net income and shareholder’s
earnings.
B. Premiere Bank:
(i) Current Ratio and Operating Income Ratio:
Calculating the last 6 years ratio, rank correlation coefficient of the above two ratio is
0.54. It shows a Strong positive correlation between the two.
From the rank correlation findings, both Current and quick ratio are positively correlated
with the entire profitability ratio. Among the profitability ratio, the liquidity ratios has
strong correlation with the Operating income and Return on Equity of the Shareholders.
On the other hand the profitability ratios have strong negative correlation with the debt-
equity ratio. It implies that as the company debt-equity ratio gone high, the company’s
profitability will hamper.
Null hypothesis is rejected. Profitability and Liquidity are closely related with one
another.
Calculating the last 6 years ratio, rank correlation coefficient of the above two ratio is
-0.03. It shows a weak negative correlation between the two.
From the rank correlation findings, we can see that current and quick ratio both have
strong positive correlation with the company’s operating income and net income and
negative correlation with company’s ROA, ROE and EPS. On the other hand debt-equity
ratio has strong negative correlation with operating income, net income, ROA of the
company and positive correlation with Shareholder’s earnings.
A. DBH:
Total rank correlation coefficient of Profitability Ratios and Liquidity Ratio are 0.8. This
shows a very strong positive correlation between the two.
So, the null hypothesis is rejected.
B. Premiere Bank:
Total rank correlation coefficient of Profitability Ratios and Liquidity Ratio are 0.64. This
shows a very strong positive correlation between the two.
So, the null hypothesis is rejected.
45 40
40
35 29
30
25
Profit
Profit (Mill)
20 14
13 11 11
15
10
5
0
2001 2002 2003 2004 2005 2006
Year
300 267
237
250 225
200
150
Current Asset (Mill)
100
50
0
2001
-9 2002
-7 2003
-7 2004 2005 2006
-50
B. Premiere Bank
Premiere Banks profitability and current asset was correlated in last couple of years. As
we can see, Premiere bank earn the highest profit in 2004 when company’s current asset
increase by huge margin. We can see negative correlation between profitability and
current asset of the company in last two years. Though company’s current asset increase,
but profit falls in back to back two years. It is due to failure of efficient banking operation
of the bank managements, as they are unable to give required loans and creditors to the
customer.
Profitability (Mill)
500
400
300
Profit (Mill)
Profit
200
100
0
2001 2002 2003 2004 2005 2006
Year
30000
25000
20000
Asset Value
10000
5000
0
2001 2002 2003 2004 2005 2006
Year
C. DBH:
DBH’s profitability and liquidity situation is fully related with one another as one grows
another follows and vice versa. The company is growing in a consistent way in last five
years and profitability is highest in the last year when liquidity condition is also at it
peaks.
Profitability (Mill)
160
140
120
100
80 Profit (Mill)
Profit
60
40
20
0
2001 2002 2003 2004 2005
Year
3000
2500
2000
1000
500
0
2001 2002 2003 2004 2005
Year
From the above analysis we can strongly say that, Profitability and liquidity of the above
company is strongly correlated with one another, which is also supported by the rank
coefficient correlation analysis earlier. So, report Null hypothesis is strongly rejected.
Conclusion
Bibliography
Both the Accounting books of our course.