Assessing Liquidity Impact On Profitability Of Australian Banks: A Ratio-Based Approach

Profitability measures: Profit margin, return on assets, return on equity

The investors who generally invests in equity are apprehensive about the ability of the company to create, preserve and raise the amount of income. The extent of profitability can be assessed various interconnected dimensions. Primarily there is a relationship of the profit of the company in accordance to the revenue, which is even known as the residual return on per sales dollar of the company (Atoom et al., 2017). The other measure is the return on investment that associates to the profits to the investment that is needed to create them. The assessment of the income is of significant issue to the stockholders as they create revenue in the form of dividends. Additionally, the rise in the level of profit can lead to the rise in the price in the market that would lead to capital gains.

The ability of an organization to endure their short term ability of debt payment is vital to the financial report users. In case the company is not able to maintain their long term ability of debt payment, then they would not be able to satiate their shareholders (Salim et al., 2016). A profitable organization may even face bankruptcy if it is unable to meet their responsibilities to the short term creditors. The capability of paying out present obligations when they are due is even associated to the ability of cash generation of the organization. The evaluation of the debt payment capability of the organization which is short term in nature discloses a close relationship among the current liabilities and current assets. The profitability of an organization does not ascertain the ability to pay out the short term debt (Al Nimer et al., 2015). It can even be said that by making use of the accrual accounting, the organization may disclose high amount of profits but may not have the capability to pay for their current bills and expenses as it does not have the fund that is required. If the firm reports a loss, it may still be able to pay for their obligations that are short term in nature. Liquidity acting as a factor of profitability is comparable to the one that is taken under consideration in the researches that are associated with discovering the profitability of the banks which is even known as the internal determinants that can be controlled by the management (Alshatti, 2014). This research paper would therefore look to assess whether quick ratio has key amount of impact on the profitability of the Australian banks with the help of return on asset (ROA).

Liquidity measures: Capital ratio, quick ratio, current ratio, cash ratio, investment ratio

The research based on this topic has been undertaken in order to address how liquidity has an effect in the profitability of the Australian banks. The banks that are functioning in Australia have their precise objectives and goals and thereby is able to understand the process that would be taken in order to gain profit for the banks. Profit for any bank is the ultimate goal as a bank will not be able to operate in the economy if they do not earn profit (Hesse, & Poghosyan 2016). Therefore, it is essential for the banks to maintain their liquidity position at an optimum level and thereby understand how liquidity affects profitability. This is the problem statement and therefore assessment of several ratios would be influential in understanding the liquidity impact on profitability.

The objectives and the aim of the research paper looks to assess the degree of profitability of the Australian banks by understanding the concerned ratios of the banks. The aims and objectives of the research paper are as follows:

• Determine the scenario of profitability of the Australian banks
• Assess the position of liquidity of the Australian banks
• Determine the impact of liquidity on the degree of profitability of the Australian banks

The research question is constructed in order to take the research paper forward and thereby construct the aspects in accordance to which the issues related to the research can be understood and the research result can be ascertained. The research questions are as follows:

Q1. What is the degree of profitability of the Australian banks?

Q2. What is the position of liquidity of the Australian banks that are functioning in the economy?

Q3. Is there any impact of liquidity on the profitability of the Australian banks? 

This research paper explains certain past papers and studies about the impact of management of liquidity on the profitability of the banks and an understanding about the economy of Australia. This section of the paper explains certain theoretical elements associated to the liquidity concepts of the banks and the requirement of liquidity, the theories associated with the management of the liquidity, profitability of the banks and their measures.  

The liquidity of the banks explains the capability to satisfy their financial responsibilities as they become due (Alalaya, & Al Khattab 2015). The liquidity in the commercial banks addresses the capability of the banks to finance their contractual responsibilities when they are due and these responsibilities can be inclusive of investments, lending and deposit withdrawal and the maturity of the liabilities which occurs in the general course of the actions taken by the banks.

There are several theories of liquidity management and each one of them has been explained as follows:

Liquidity management theories: Anticipated income theory, asset transfer theory, balance sheet aspects theory, self-liquidation of loans theory

This theory encourages the bankers to assess their portfolio of the loans which acts a source of liquidity. The theory of anticipated income has influenced the bankers to treat the long term loans as the probable liquidity sources (Duraj, & Moci 2015). By making use of the anticipated income theory, the loans are specifically paid off by the borrower in various instalments. In this manner, the loan portfolio of the banks gives the banks with sustainable flow of cash that gets added to the liquidity of the banks (Mustafa, & Datta 2017). Furthermore, even though the loans are long term in nature, in case of crisis of liquidity, the banks can sell off their loans in order to gather the required cash in the secondary markets.

This theory is a measure to maintain the liquidity of the banks by assisting the transferring of the assets. When the bank does not have ready money, then it is capable of selling the assets to a bank that is more liquid (Ghosh, 2016). This process assists the banking process to function in an effective manner: with less number of reserves and even investing in the long term assets. In accordance to this theory, the banking process looks to avoid the crisis related to liquidity by assisting the banks to sell or repo at effective prices.

This theory explains that the banks can fulfil the demand for liquidity by borrowing from the capital and the money markets (Chronopoulos et al., 2015). The principle contribution of this theory looks to assess both aspects of the balance sheet of the banks as a source of liquidity.

This theory explains that liquidity in the commercial banks are attained automatically with the assistance of self-liquidation of the loan which is being given for a shorter time frame in order to finance the working capital in which the borrowers refund the amount that has been borrowed after completing the trade cycle in a successful manner (Ndoka et al., 2016). In accordance to this theory, the banks do not loan money for the intention of buying real estates and consumer goods and even investing in the bonds and stocks because of the tenure of the anticipated payback period for these investments in which this theory is effective for the traders who requires finance for their distinct transactions associated with trading and for the shorter time frame (Narwal, & Jindal 2015). 

The profitability of the banks is the capability of the banks to create revenue over the expenses in association to the capital base of the bank. An effective and profitable banking sector is effectively able to endure the negative shocks and contribute to the sustenance of the financial process (Rahman et al., 2015).

Past studies: Hussanie et al. (2017), Tran et al. (2016), Chen et al. (2017)

Profitability in the general sense is an association among the profit that is created by the organizations and the investments that have contributed to the attainment of the profits and the profitability ratios computes the effectiveness with which an organization transforms their business operations into profits (Tan, 2016). The profit margin evaluates the capability to transform the extent of revenue to profits. The return on assets computes the capability to utilise the assets to manufacture net income (Borio et al., 2017). The return on equity makes a comparison of the net income to the equity of the shareholders.

Liquidity acts as a measure of the capability and the easiness with which the assets can be transformed into cash. The liquid assets are those that can be converted into cash in order to satisfy the financial obligations (Marozva, 2016). In order to remain viable, a financial organization needs to have adequate liquid assets in order to fulfil their close obligations like the withdrawals undertaken by the depositors. The key measures of liquidity are capital ratio, quick ratio, current ratio, cash ratio and investment ratio. 

In order to ascertain the degree of the capability of the banks in order to make profits from the money that has been invested, there are various financial ratios associated to both the depositors and owners (Madhou et al., 2015).

The impact of management of liquidity on the profitability of the banks has been assessed by various researchers. Hussanie et al., (2017) assessed the liquidity management and the profitability of the commercial banks in Nigeria. The results of this assessment explains that there is a key relationship among the profitability and liquidity. This explains that profitability in the commercial banks is vitally influenced by liquidity and vice versa.

Tran et al., (2016) looked to explain the association among the profitability and liquidity. The key outcome of the research explains that each of the ratios has a vital impact on the financial scenario of the organizations with variable amounts along with the liquidity ratios in the initial phase. The profitability ratios have a key role to play in the financial scenarios of the organizations.

Chen et al., (2017) examined the factors of liquidity risk and evaluated their effect on the Pakistani banks. The outcome of the paper explains that there is a key effect in the factors of liquidity risks on the profitability of the banks in which a rise in the deposits leads to the rise in the profitability of the banks in accordance to lowering the reliance on the central banks in satisfying the obligations of the customers and the profitability is impacted negatively by the assignment of the liquidity gaps and non-performing loans.

Research questions: Q1. What is the degree of profitability of Australian banks? Q2. What is the position of liquidity of the Australian banks functioning in the economy? Q3. Is there any impact of liquidity on the profitability of Australian banks?

Tan et al., (2017) assessed the effect of the performance of the liquidity in commercial banks and the results indicate that there is a positive relationship among the management of liquidity and presence of any banks.

Chaudhary, & Abbas (2017) investigated empirically the impact of effective liquidity management on the performance of banking in Nigeria. The results from the assessment have been clear and robust and explains that there is a key relationship among effective management of liquidity and the performance of the banks and explains that efficient management of liquidity develops the effectiveness of the banks. These results have been influential in providing an understanding of the impact of liquidity in order to have an understanding of profitability in the Australian banks and accordingly proceed with the research paper in order to gain effective results. 

The data gathering aim and objective of the paper has been to have an understanding about the effect of liquidity on the profitability of the Australian banks. The research undertakes descriptive research design and the paper looks to gather data through secondary sources and the secondary information have been gathered from the annual report of the banks that have been chosen in order to gain the return on assets and quick ratio of the banks (Al-Jafari, & Al Samman 2015). Data has been collected for the year 2016-17 and 2015-16 in order to have an understanding about the changes and the effect of liquidity on the profitability of the Australian banks. Secondary data has been collected even through internet websites, journals and books with the help of which the analysis of the paper can be taken forward. The results from the past researches of similar researches have even taken into consideration with the help of which effective results have been obtained and use of these researches have been found to be reasonable and cost effective (Gyamerah, & Amoah 2015). This kind of data is helpful in addressing the current issues and can thereby gain the results that is desired. The information that is collected are quantitative and this is effective in having an understanding of the future mechanisms that would be used.

This research paper has gathered quantitative data and this kind of information can be processed with the help of the process of quantitative data analysis. Ariyadasa et al., (2017) have expressed that the process of quantitative data process is a methodical process for the assessment of the data with the help of which the data that are numerical data can be used to have an understanding about the results that is desired. The paper would look to assess the independent and dependent variables so that an idea about how liquidity has an effect in the Australian bank’s profitability. The information has gone through assessments through different tools which aids in providing outcomes that is required in this paper.

Objectives and aims of the paper: To assess the degree of profitability of Australian banks by understanding the relevant ratios, To explore how liquidity affects profitability, To investigate the relationship between different financial ratios

The data analysis and findings section of the research paper tries to assess the data that has been collected by undertaking descriptive statistical method and the correlation analysis in order to make a comparison of two years and thereby understand the impact of liquidity on the profitability of the Australian banks. The banks that have been selected are National Australia Bank Ltd, Commonwealth Bank of Australia and Bank of Queensland Ltd. The return on asset (ROA) and the net profit margin of the three companies for the year 2014-15 and 2015-16 have been taken into consideration in order to have an understanding of the result of the topic.

Descriptive Statistics for the year 2014-15

Return on Asset		Net Profit Margin
Mean	0.81	Mean	28.48
Standard Error	0.14	Standard Error	3.17169
Median	0.67	Median	29.23
Standard Deviation	0.242487113	Standard Deviation	5.49353
Sample Variance	0.0588	Sample Variance	30.1789
Skewness	1.732050808	Skewness	-0.6029
Range	0.42	Range	10.91
Minimum	0.67	Minimum	22.65
Maximum	1.09	Maximum	33.56
Sum	2.43	Sum	85.44
Count	3	Count	3
Confidence Level(95.0%)	0.602371382	Confidence Level(95.0%)	13.6467

The values that have been attained for return on asset for the three banks explains that the mean comes to 0.81 and the standard error comes to 0.14. The median and the standard deviation comes to 0.67 and 0.242. On the other hand, the value of net profit margin is seen to be 28.48 for mean and the standard error coming to 3.17. The median for net profit margin is 29.23 and the standard deviation is 5.49. The values indicate that the companies have effective level of return on assets and net profit margin.      

Descriptive Statistics for the year 2015-16

Return on Asset		Net Profit Margin
Mean	0.576666667	Mean	21.6933
Standard Error	0.29042115	Standard Error	10.261
Median	0.68	Median	30.26
Standard Deviation	0.503024188	Standard Deviation	17.7725
Sample Variance	0.253033333	Sample Variance	315.863
Skewness	-0.885399612	Skewness	-1.6651
Range	0.99	Range	32.3
Minimum	0.03	Minimum	1.26
Maximum	1.02	Maximum	33.56
Sum	1.73	Sum	65.08
Count	3	Count	3
Confidence Level(95.0%)	1.249581354	Confidence Level(95.0%)	44.1494

The descriptive statistics for the return on asset for the year 2015-16 has a mean of 0.576 and the standard error of the same is 0.29. The median value is 0.68 and standard deviation is 0.503. The value for net profit margin in accordance to the mean is 21.69. The standard error is 10.261 while the median is 30.26. The standard deviation is 17.77 and the figures expresses that no variable changes have been seen for the banks in the next year in accordance to the previous year.   

Correlation for the year 2014-15

Correlation	0.800834254
MSE	6.348014782

The correlation for the three banks in accordance to return on asset and net profit margin indicates that there exists a positive relationship among the same as the value comes to 0.800 as the value is close to 1. The figure explains that return on asset and net profit margin are interrelated to each other and therefore have direct impact on each other. The mean squared deviation for the same comes to 6.34 and this value shows that return on asset and net profit margin are effective.

Correlation for the year 2015-16

Correlation	0.968472885
MSE	6.585598302

The correlation for return on asset and net profit margin for the year 2015-16 for the three selected banks indicate that the value comes to 0.9684 and this figure explains that this figure is very close to 1 and thereby explaining that the two values are mutually related to each other and the value is positively correlated. The mean squared deviation comes to 6.585 for the two variables and these values indicate that liquidity has significant level of impact on the profitability of the three Australian banks that have been taken into consideration. 

The discussion that is undertaken looks to explain the results that have been attained in the previous section. The discussion of the same are as follows:

The results that have been obtained for the three banks for the year 2014-15 and 2015-16 indicates that the mean, median and standard error has been good and effective and have been able to explain that the banks have been performing efficiently and have been able to generate profit according to their goals and objectives (Sufian, & Kamarudin 2015). There has been a rise in the standard error in the year 2015-16 in accordance to the previous year it indicates that the banks have been maintaining their operational level as there has not been a significant change in their return on asset and net profit margin.

The assessment of the correlation among the return on asset and net profit margin for the year 2014-15 explains that there has been key level of relationship and the two variables are positively related and are directly associated to each other. In the similar manner, correlation for the year 2015-16 is even higher than the previous year and the figure is much closer to 1 which indicates that the two variables are related directly to each other. The results therefore explains that liquidity has significant level of impact on the profitability of the Australian banks and therefore changes in the liquidity would directly have an impact on the profitability either negatively or positively (Claessens, & Horen 2014). 

Conclusion, Limitation and Recommendation 

Conclusion (Addressing the aims and questions) 

The assessment of the results that have been attained explains that the research has been able to answer the research aims and questions and thereby have been able to conclude the research results. The explanation of the research questions have been given as follows:

Research Question 1

The results that have been gathered explains that the three banks have effective level of profit during the two years and thereby have been able to pay for all their expenses and have been able to operate in the economy in an effective manner.

Research Question 2

The liquidity scenario of the banks that have been chosen addresses that the banks have significant level of liquidity that is essential for them to operate in the economy in an effective manner. The liquidity position of the company has been in accordance to the aims and goals of the banks.

Research Question 3

The results that have been obtained reveals that liquidity have significant amount of impact on the profitability of the banks as it is seen that two variables namely return on asset and net profit margin are correlated in a positive manner which explains that changes in liquidity would have an effect on profit for the banks.

The limitation that has been attained after the completion of the research paper explains that the data that has been collected from secondary sources may not be authentic as the banks may disclose manipulated data to the users in order to highlight their profit level and brand image of the banks. This can have an impact on the results that have been obtained in this paper. The other limitation has been the limitation of time as the researcher did not have adequate time to collect more data that would have been effective in gaining a better research paper.

The research paper indicates that the banks should make changes in their policies and should monitor their liquidity and profit on a frequent basis in order to mitigate the issues that are existent in their financial reports. The management should even look to make a comparison with their rival banks and construct a benchmark with the help of which their activities can be understood. The market evaluation can even be a process with the help of which profit level can be maintained. 

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