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JES
45,3
Factors affecting profitability
in Malaysia
442
Tunku Puteri Intan Safinaz School of Accountancy, Universiti Utara Malaysia,
Sintok, Malaysia, and
Ali Saleh Alarussi
Received 16 May 2017
Revised 8 July 2017
27 August 2017
Accepted 20 September 2017
Sami Mohammed Alhaderi
Department of Management, Universiti Utara Malaysia, Sintok, Malaysia
Abstract
Purpose – The purpose of this paper is to examine the factors affecting profitability in Malaysian-listed
companies. It has been argued that profitability is the main pillar for any company to survive in the long run.
Although profitability is the primary goal of all business ventures, scant attention has been paid to the factors
that affect profitability in developing countries. This study investigates the factors affecting profitability in
Malaysian-listed companies.
Design/methodology/approach – This research is based on five independent variables that were
empirically examined for their relationship with profitability. These variables are: firm size (as measured by
total sales), working capital (WC), company efficiency (assets turnover ratio), liquidity (current ratio) and
leverage (debt equity ratio and leverage ratio). Data of 120 companies listed on Bursa Malaysia covering the
period from 2012 to 2014 were extracted from companies’ annual reports. Pooled ordinary least squares
regression and fixed-effects were used to analyze the data.
Findings – The findings show a strong positive relationship between firm size (total sales), WC, company
efficiency (assets turnover ratio) and profitability. The results also show a negative relationship between both
debt equity ratio and leverage ratio and profitability. Liquidity (current ratio) has no significant relationship
with profitability.
Research limitations/implications – Due to the time limitation, the data includes only 120 companies
listed in bursa Malaysia and covers the period from 2012 to 2014.
Practical implications – These results benefit internal users (such as mangers, shareholders and
employees). They can realize the determinants of enhancing the profitability of their company after the
depreciation of the Malaysian currency and therefore concentrate more on the factors that enhance their
companies’ profitability. On the other side, other external users (such as investors, creditors, new established
companies, tax authority) also may get advantages of these results. It is clear that those users concern about
the profitability of companies and the determinants of their profitability after the currency’s depreciation.
Originality/value – This study differs than previous studies in many ways: first, it focuses on non-financial
listed companies in Malaysia. Previous studies have concentrated on companies in the financial sector, such
as banking and financial institutions or on industrial organizations. Second, this study analyzes the data in
companies’ annual reports for a three-year period from 2012 to 2014. During this period, the economy in
Malaysia was fluctuating due to currency depreciation. Third, the study used both return on equity and
earnings per share as indicators of profitability. Fourth, the results of the study provide empirical evidence
that large size firms with efficiently managed assets can improve operating income and ultimately enhance
profitability. Last but not least, this study applies the resource-based theory and the trade-off theory.
Keywords Profitability, Malaysia, Efficiency, Leverage, Liquidity, Working capital
Paper type Research paper
Journal of Economic Studies
Vol. 45 No. 3, 2018
pp. 442-458
© Emerald Publishing Limited
0144-3585
DOI 10.1108/JES-05-2017-0124
1. Introduction
One of the main goals of any company is to be sustainable in any competitive environment.
To do so, it is important for the company to develop, implement and maintain strategies that
can enhance its performance. This can be done by investigating the internal and external
factors that may have an impact on the company’s profitability. The quality and efficiency
of managers depend on their ability to identify those elements that can lead to increased
The authors of this paper has not made the authors research data set openly available. Any enquiries
regarding the data set can be directed to the corresponding author.
profitability. In general, profitability is defined as the earnings of a company that are
generated from revenue after deducting all expenses incurred during a given period. It is one
of the most important factors that signal management’s success, shareholders’ satisfaction,
attraction for investors and the company’s sustainability (Bekmezci, 2015). Undoubtedly,
the ultimate goal of any firm is to maximize the wealth of its shareholders by increasing the
value of its stocks. Previous studies have found a positive relationship between earnings
and stock values (Kalama, 2013). In other words, if earnings announcements come as
expected or are better, stock prices will increase, but if earnings announcements fall short of
expectations, the stock prices will decline.
A majority of companies, if not all, realize the concept and the importance of
profitability but they may not know how to enhance it and what the factors affecting
profitability are. This is more obvious during a time of crisis; some companies attempt to
preserve their financial status by undertaking risky measures, but due to limited
experience and high risks, these kinds of actions more often than not result in worsening
their financial status.
Identifying the factors which determine profitability is still one of the major concerns of
researchers. A number of previous studies have investigated the factors that influence
profitability of firms, including size (Stierwald, 2010a, b; Yazdanfar, 2013; Mohd Zaid et al.,
2014); working capital (WC) management (Goddard et al., 2005; Chowdhury and Amin, 2007;
Alipour, 2011; Charumathi, 2012); age of the firm (Geroski and Jacquemin, 1988; Bhayani,
2010; Agiomirgianakis et al., 2013); and leverage (Burja, 2011; Mistry, 2012; Boadi et al.,
2013). However, previous studies have shown inconsistent findings that make
generalization questionable. Based on this, this study is concerned with profitability in
Malaysia. Malaysia is widely recognized as an emerging market.
The Malaysian economy showed strong signs of recovery in 2010 from the global
economic crisis (Datamonitor, 2010; Watanabe et al., 2011). The profitability persistency of
individual firms exists in seven developing nations, including Malaysia (Glen et al., 2003).
This puts Malaysian companies in competition with others and has increased the challenges
they have to face. The main challenge Malaysian companies are facing is how to achieve
stability and sustainability. In order for a company to achieve this, it is crucial that the
company has a good knowledge of specific internal and external conditions within which
the company operates. The quality and efficiency of managers depend on their ability to
identify those elements that can enhance company performance and profitability (Burja,
2011). This is also applicable for Malaysian companies if they wish to continuously compete
in the emerging market. The Malaysian currency started began depreciating during the
Asian Financial Crisis of 1997–1998 and dropped to almost 50 percent of its value.
Companies have less incentive to reduce costs because they can rely on devaluation to boost
competitiveness. The recession over the long term can lead to lower productivity due to a
decrease in incentives and inflation (Todorović and Veličković, 2010). This creates an
ambiguous picture about companies’ profitability in Malaysia.
Generally, very few studies, such as Ahmad Farid (1980), Mohd Zaid et al. (2014) and the
latest study by Ulfana Nisa (2015), have investigated the factors affecting profitability in
Malaysia. However, this study differs from the previous studies in a number of aspects: first,
it examines different independent variables (IVs), including company efficiency and WC.
Second, the study covers the period during the depreciation of the Malaysian currency
(Ringgit). Third, the study uses two measurements for profitability, i.e. earnings per share
(EPS) and return on equity (ROE), which can produce more realistic results that are
beneficial to stakeholders of these firms, specifically, creditors, investors, management
and shareholders. Therefore, based on previous studies, this study examines the impact of
five factors on companies’ profitability by using six financial indicators, namely, total
sales, WC, assets turnover ratio, current ratio, debt equity ratio and leverage ratio.
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The profitability factor is measured by using ROE and EPS. This study intends to achieve
the following objectives:
(1) to examine the relationship between firm size and profitability;
(2) to examine the relationship between WC and profitability;
444
(3) to examine the relationship between company efficiency and profitability;
(4) to examine the relationship between company liquidity and profitability; and
(5) to examine the relationship between company leverage and profitability.
This study is organized into five sections as follows: Section 2 displays briefly previous
studies. Section 3 explains the source of data, the hypotheses under investigation and the
research model. Results of the tested hypotheses are included in Section 4. Finally, Section 5
concludes the study.
2. Literature review
2.1 Previous empirical studies
It has been proven that a business will not survive if it is not profitable, and a business that is
highly profitable has the ability to reward its owners with high returns on their investment.
Thus, companies that want to achieve stable profitability need to know internal and external
factors that may have a significant effect on profitability. Earlier and recent studies have
attempted to determine the financial indicators for profitability by empirically examining
different factors that have theoretical relationships with profitability, like size (Mehta, 1955;
Comanor and Wilson, 1969); net operating profitability (Ito and Fukao, 2006; Rahman et al.,
2010; Burja, 2011); liquid ratio, receivables turnover ratio and WC to total assets (Singh and
Pandey, 2008); debt ratio (Burja, 2011); return on total assets (Padachi, 2006); return on invested
capital and return on assets (ROA) (Narware, 2010); financial leverage (Burja, 2011); equity
ratio (Burja, 2011); market share (Nagarajan and Barthwal, 1990); current assets ratio (Singh
and Pandey, 2008; Burja, 2011); and R&D (Fenny and Rogers, 1999). Some related studies have
examined these aspects in different countries, like Huang and Song (2006) and Chakraborty
(2010) in China; Akintoye (2008) in Nigeria; Pirtea et al., Burja (2011), Moldovan et al. (2013) and
Vătavu (2014) in Romania; Sivathaasan et al. (2013) in Sri Lanka; Kaen and Baumann (2003),
Hoffmann (2011) and Growe et al. (2014) in the USA; Raza et al. (2012) and Bhutta and Hasan
(2013) in Pakistan; Dencic-Mihajlov (2014) in Serbia; Geroski et al. (1997) in the UK; Fenny and
Rogers (1999) in Australia; Claver et al. (2006) in Spain; Ito and Fukao (2006) in Japan; Chander
and Priyanka (2008) in India; Asimakopoulos et al. (2009) in Greece; and Goddard et al. (2009) in
11 European countries. Some of these studies are descriptive and others are empirical, which
show the relationship between profitability and its determinants.
The findings of previous studies have broadly highlighted a number of variables that have
a significant impact on companies’ profitability. All these variables, namely, company size,
age, risk, liquidity, leverage, industry type, capital intensity, skill, concentration ratio, capacity
utilization, market share, advertising intensity, R&D intensity, retention ratio, growth in
revenue, long-term financing, turnover ratios, ownership characteristics, exports, working
assets, indebtedness level, etc., are equally popular among researchers. However, previous
studies differ from each other because of the period the study was undertaken, ranging from
one year (as seen in Jones et al., 1973; Barthwal, 1984) to 20 years (Kaur, 1997), or because of
focusing on country-specific and firm-specific factors (Kaur, 1997; Glancey, 1998; Ito and
Fukao, 2006); and inter-industry-specific factors (Barthwal, 1984; Nagarajan and Barthwal,
1990; Grinyer and McKiernan, 1991). In addition, the review also shows that most of the
research work relating to inter-industry profitability has been conducted in developed
countries. Vătavu (2014) examined the determinants of financial performance in 126 Romanian
companies listed on the Bucharest Stock Exchange over a period of ten years (2003–2012). The
analysis was based on cross-sectional regressions, performance was measured by ROA, while
the IVs were debt, asset tangibility, size, liquidity, taxation, risk, inflation and crisis. The
outcomes of regression analysis indicate that profitable companies operate with limited
borrowings. Tangibility, business risk and the level of taxation have a negative impact on
ROA. Although earnings are sustained by significant sales turnover, performance is affected
by high levels of liquidity. Periods of unstable economic conditions, reflected by high inflation
rates and the financial crisis, have a strong negative impact on corporate performance.
Several financial indicators, such as current ratio, liquidity ratio, receivables turnover
ratio and WC to total assets, have been examined in other studies (Singh and Pandey, 2008);
while some studies have considered performance assessment expressed by earnings before
interest and taxes and the associated risks resulting from the influence of using a certain
financing structure (Akintoye, 2008), or expressing it through economic value added, ROE,
operating profit margin (OPM) and EPS (Rayan, 2008).
Profitability is the main concern of Malaysian-listed companies as it is the concern of other
related parties. However, the studies done in Malaysia are very few and the focus has been
mostly on two sectors, i.e. the construction and banking sectors. Examples of these studies
include Ramasamy et al. (2005), Narware (2010), San and Heng (2011), Razak et al. (2008) and
Salim Yadav (2012). Nevertheless, all of these studies have highlighted the importance of
profitability at the microeconomic level. Mohd Zaid et al. (2014) examined the determinants of
profitability based on construction companies in Malaysia. The data were collected for the
period of 2000–2012. This study used ROE to measure the profitability of companies; debt
equity ratio to measure capital structure; quick ratio to measure liquidity; sales to measure the
size of companies; and term premium to measure the economic cycle. The result shows that
liquidity and size have significant relationships with profitability. A negative and insignificant
relationship is found between capital structure and profitability. Another study (unpublished)
by Ulfana Nisa (2015) examined factors that affected profitability during the financial crisis of
2008. The ROA was used as a measurement for company profitability, while size, liquidity,
leverage, sales growth and gross domestic product were examined as IVs. The data of
161 listed companies for the period of 2001–2012 were analyzed using ordinary least squares
(OLS) and fixed-effects estimation. The findings show that leverage has a negative and
significant relationship with ROA; and size, liquidity and sales growth have a positive and
significant relationship with ROA. However, gross domestic product does not have a
significant relationship with ROA. In general, in today’s economy, where strong competition
dominates and where all processes are highly dependent on information (Alarussi et al., 2009),
the success of a company requires specific measurements and management systems.
To comply with the principle of rational economics, a company must systematically analyze its
financial result, or in other words, analyze profitability. Parkitna and Sadowska (2011)
affirmed that when determining the profitability index of a business entity, it is important to
use many variants of the numerator and denominator to gain more information about a
company. This paper is concerned with the profitability of companies in Malaysia and chooses
the most common variables in order to check whether the determinants of profitability for
developed countries are applicable in Malaysia’s case as a developing country following the
depreciation of the Malaysian Ringgit. The results of the study will be useful for related
parties, including management, shareholders, financial analysts and investors.
2.2 Selection of variables, hypotheses
Profitability is significantly affected by different factors. Many empirical studies have been
done to explore the association between various factors and profitability in different
countries and they have produced mixed results. For example, Pathak (2011) found a
significantly negative association between level of debt and profitability. This result is not
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446
consistent with studies done on western economies but consistent with some of the studies
done for Asian countries. One important reason for this conflicting result can be the high
cost of borrowing in developing countries, like Malaysia, compared to western countries.
Hadlock and James (2002) suggested corporations with high level of profitability having a
high level of debts. Arbabiyan and Safari (2009) found a positive relationship between
short-term debts and profitability (ROE) but a negative relationship between long-term
debts and ROE, when they studied 100 Iranian-listed firms from 2001 to 2007. In addition,
Wiwattanakantang (1999) reported a negative relationship between leverage and ROA by
using the data of 270 Thai companies. Similar results were found by Huang and Song (2006).
This study attempts to focus on financial indicators, i.e. firm size (total sales), WC,
company efficiency (assets turnover ratio), liquidity (current ratio) and leverage (debt equity
ratio and leverage ratio) as IVs and profitability as the dependent variable (DV ), measured
by ROE and EPS.
2.2.1 Firm size. Size is considered as a proxy for many positive aspects, including
profitability. Ha-Brookshire (2009) found a positive and significant relationship between size
and profitability when he examined US non-manufacturing companies. Similar results
were reported by Stierwald (2010a, b) when he examined large companies in Australia.
The resource-based theory states that the more the access to financial resources, the lesser
the cost of capital. This is applicable for big size firms. As the size of the company increases,
it is easier for it to access more financial resources which lead to the lower cost of capital and
higher profit. Punnose (2008) and Malik (2011) showed a positive relationship between firm
size and profitability. Nguyen (1985) found that large foreign-owned firms generally earn
higher profits than large domestic firms. However, Keith (1998) found that size has a limited
value in explaining profitability when he examined 38 small manufacturing firms in the
Tayside Region of Scotland. Goddard et al. (2005) examined the determinants of profitability
for manufacturing and service firms in Belgium, France, Italy and the UK. The results
provide evidence of a negative relationship between size, gearing ratio and profitability.
This study examines the association between firm size and profitability. Firm size is
measured by total sales, which is the same measurement used by Kajüter (2006). Based on
the above discussion, the first hypothesis is drawn as follows:
H1. There is a positive association between company firm size and profitability.
2.2.2 Working capital. Grinyer and McKiernan (1991) found that WC is amongst the variables
that play a significant role in explaining corporate profitability. This is the result that was
obtained when the data of 45 UK electrical companies was examined. Similar results were
found by Chowdhury and Amin (2007), who investigated the profitability of pharmaceutical
companies listed on the Dhaka Stock Exchange. The results provide evidence of the impact of
WC on profitability as measured by ROA. In addition, Alipour (2011) employed the multiple
regression technique and the Pearson correlation test on 1,063 companies on the Tehran Stock
Exchange. The results show a significant relationship between WC management and
profitability. In developing countries, Malik (2011) tested the profitability of 35 life and non-life
insurance companies in Pakistan. The findings reveal a positive and significant relationship
between WC and profitability. Similar results were found by Burja (2011). However, Dong and
Su (2010) found a negative relationship between WC management and profitability for firms
listed on the Vietnam Stock Market. Since the results are not consistent in developing
countries, this study examines the association between WC and profitability in Malaysianlisted companies, and based on the above discussion, the second hypothesis is as follows:
H2. There is a positive association between WC and profitability.
2.2.3 Company efficiency. There is no doubt that efficiency is the cornerstone to achieve
higher profits. Efficiency can refer to the operations per se or to the whole company. Innocent
et al. (2013) tested the profitability of the pharmaceutical industry in Nigeria covering 11 years
from 2001 to 2011. The results show a negative and insignificant relationship between
profitability and debt turnover ratio, creditor’s velocity and total assets turnover ratio.
Inventory turnover ratio is also found to have a negative but significant relationship with
profitability. Warrad and Al Omari (2015) studied the impact of total assets turnover ratio and
fixed assets turnover ratio on ROA of firms in the Jordanian industrial sector. A simple liner
regression was used to test the impact during the period of 2008–2011. The study shows a
significant impact of total assets turnover ratio on the Jordanian industrial sector’s ROA.
Hence, changes in ROA can be explained by total assets turnover ratio. However, a prior study
conducted by Selling and Stickney (1989), using data from a group of Compustat companies
over a period from 1977 to 1986, examined total assets turnover and OPM ratios as they
related to ROA. Their sample was classified into 22 industries; they found negative
correlations between total assets turnover and OPM ratios in 15 of them. Another study by
Reed and Reed (1989) found the total assets turnover and OPM ratios are negatively
correlated. Fairfield and Yohn (2001) studied the use of OPM and assets turnover ratios to
forecast future profitability. They found that the two variables are negatively correlated, and
that the correlation is statistically significant. Skolnik (2002) used the non-financial firms in
the S&P 500 and a time-frame of 1989 through 1999 to study the relationship among operating
returns, OPM and total assets turnover ratios. He found that the total assets turnover ratio
decreased over the study period while the OPM ratio increased. Consequently, he found a
statistically significant and negative correlation between total assets turnover and OPM
ratios. As the results show contradiction in this relationship, this study examines the assets
turnover ratio as one of profitability measurements. It is expected that there is a positive
relationship between company efficiency (measured by assets turnover ratio) and profitability.
Therefore, based on the above discussion, the third hypothesis is as follows:
H3. There is a positive association between company efficiency and profitability.
2.2.4 Company liquidity. Liquidity is defined as the ability of a firm to convert an asset to
cash quickly. It is also defined as the ability of a firm to pay off its short-term obligations.
Liquidity is measured by a number of ratios, such as current ratio, quick ratio and cash
ratio. Liquidity is very important to run the business properly. Bhayani (2010) examined
factors that influence profitability for cement firms covering the period from 2001 to 2008.
He concluded that liquidity, age of the firm, operating ratio, interest rate and inflation are
important determinants of profitability for the Indian cement industry. Boadi et al. (2013)
found a positive relationship between liquidity and profitability. Elsiefy (2013) tested the
determinants of profitability of commercial banks in Qatar and found evidence of a strong
relationship between liquidity and profitability for Islamic banks. A more recent study by
Al-Jafari and Alchami (2014) investigated the determinants of profitability of Syrian banks
utilizing the generalized method of moments technique. Their results reveal that liquidity
ratio, credit risk, bank size and management efficiency affect significantly the profitability
of Syrian banks. Similarly, Pratheepan (2014) tested the determinants of profitability for 55
Sri Lankan manufacturing companies using static panel models. The results show that size
has a significantly positive relationship with profitability. Likewise, Mohd Zaid et al. (2014)
investigated the factors affecting profitability for construction companies in Malaysia. They
found that liquidity and size have a significant and positive relationship with profitability.
However high liquidity may lead to agency cost and may hinder performance (Ganguli,
2016). Eljelly (2004) did a study on companies listed on the stock market in Saudi Arabia; he
examined the relationship between profitability and liquidity measured by current ratio and
cash gap (cash conversion cycle). He found a negative relationship between profitability and
liquidity indicators. Similar results were found by Raheman and Nasr (2007) when they
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studied 94 Pakistani companies listed on the Karachi Stock Exchange. Based on the above
discussion, the fourth hypothesis is as follows:
H4. There is a positive association between company liquidity and profitability.
448
2.2.5 Company leverage. Leverage is one component of the capital structure of a company.
This is because the choice between debt and equity suggests somehow a trade-off between
business and financial risk. When companies choose more borrowings to finance their
needs, they do not affect corporate ownership (Yazdanfar, 2013). After examining the data of
12,530 non-financial micro-firms operating in four industrial sectors in Sweden to measure
the factors affecting profitability as well as industry affiliation, the researcher concluded
that companies with a large proportion of equity based on shareholders’ investment offer
better credit rating for the companies. Therefore, companies using large borrowings face
higher risks while those using more equity tend to operate more conservatively by relying
on internal funds. According to the trade-off theory of capital structure, the optimal debt
level balances the benefits of debt against the costs of debt. The tax benefits of debt
dominate up to certain debt ratio, resulting in higher ROE, but the benefit would be less than
the cost after a certain level of debt ratio. The more a company uses debt, the less income tax
it pays, but the greater its financial risks (Myers, 1984). Charumathi (2012) examined the
determinants of profitability for the Indian life insurance companies. He found that leverage
has a negative and significant impact on profitability. Eriotis et al. (2011) investigated the
relationship between debt to equity ratio and profitability. They concluded that financing
investments using retained profits are more profitable than using borrowed funds. Another
study conducted by Boadi et al. (2013) examined the factors affecting profitability for the
insurance companies in Ghana and revealed a positive and significant relationship between
leverage, liquidity and profitability. Agiomirgianakis et al. (2013) found a positive and
significant impact between low cost access to bank financing and profitability, when they
investigated factors that influence profitability for the tourism industry in Greece. Burja
(2011) obtained the same results when he examined factors that influence profitability for
the Romanian chemical industry.
Generally, the influence of capital structure on performance is not clearly stated in the
literature. Some studies have argued that companies have higher returns when they
operate with a larger amount of borrowed funds, but there is a negative influence on longterm debt (Abor, 2005). Other studies have not found any relationship between financing
decisions and profitability (Ebaid, 2009). This study uses two ratios to measure this
variable, i.e. debt equity ratio and leverage ratio. They show the extent to which the total
assets of the company are funded by loans. For this reason, it is necessary to rationally
and efficiently use this financing method. Based on the above discussion, the fifth
hypothesis is as follows:
H5. There is a negative association between company leverage and profitability.
3. The data, sample and model specifications
3.1 Data description
This study utilized secondary data collected from annual reports of non-financial companies
listed on Bursa Malaysia (www.bursamalaysia.com). Due to the time limitation, the
data includes only 120 companies and covers the period from 2012 to 2014. The study
employs the most important factors that influence firms’ profitability and commonly
utilized in the previous literature. However, some of variables are new in the Malaysian
context, i.e. WC and company efficiency. The variables and their measurements used in this
study are listed in Table I.
Pooled ordinary least regression was used to analyze the data to find the results. Two
models were estimated in the study and both measured e profitability as follows:
(Model 1):
Profitability in
Malaysia
ROE ¼ aþb1LTS þb2WC þb3CRIOþb4ASTRIO þb5LEVRIO þb6DTERIOþe:
(Model 2):
449
EPS ¼ aþb1LTS þb2WC þb3CRIO þb4ASTRIO þb5LEVRIO þb6DTERIO þe;
Here, α and β1–β6 are coefficients, Log of Total Sales (LTS), WC, Current Ratio, Assets
Turnover Ratio, Leverage Ratio and Debt to Equity Ratio are the explanatory variables, and
ε is the error term.
Table II shows the descriptive statistics for the sample. The mean (median) of
absolute value is ROE 6.7 (6.64) whereas the minimum value is negative, showing loss.
In addition, the mean (median) of EPS is 12.61772 (8.305); however, the minimum
value is negative 75. In terms of WC, the mean (median) is 4.15 (1.01); the mean (median)
company efficiency (assets turnover ratio) is 0.5790497 (0.686061); the mean (median)
of liquidity (current ratio) is 3.03802 (1.858931); and, lastly, the mean (median) of
leverage (debt equity ratio and leverage ratio) is 0.4262042 (0.3894299) and 0.6138858
(0.8631349), respectively.
Table III shows the correlation between the IVs and the DV in this study. Total sales and
WC are positively correlated with EPS. However, leverage is negatively correlated with EPS.
These results are similar to the studies of Malik (2011), Burja (2011), Stierwald (2010a, b),
Warrad and Al Omari (2015) and Al-Jafari and Alchami (2014). Total sales, WC and assets
turnover are positively related with ROE. However, within the IVs, the maximum correlation
No Variable
Measurements
Supported studies
1
Profitability
2
3
Firm size
Working capital
Yasser et al. (2011), Nawafly and Alarussi
(2016)
Kajüter (2006)
Diakomihalis (2012)
4
5
6
Company efficiency
Liquidity
Leverage
(1) Returning on equity
(2) Earnings per share
Total sales
Current asset − current
liabilities
Assets turnover ratio
Current ratio
(1) Debt equity ratio
(2) Leverage ratio
Variable
ROE
EPS
LTS
WC
CRIO
ASTRIO
LEVRIO
DTERIO
Note: n ¼ 360
Lesáková (2007)
Gurbuz et al. (2010)
Alarussi and Shamki (2016)
Table I.
Variables’
measurements
Mean
Median
Minimum
Maximum
SD
6.74725
12.61772
8.443028
1.15
3.03802
0.5790497
0.4262042
0.6138858
6.64
8.305
8.46
1.01
1.858931
0.686061
0.3894299
0.8631349
−35.3
−75.61
5.7
−1.13
−2.204296
0.0078316
0.0054159
−3.91677
66.32
130.3
10.48
1.74
34.15189
3.863519
2.148005
4.413547
12.55171
25.36119
0.7969461
2.15
4.288155
0.5505352
0.2779165
1.003956
Table II.
Descriptive statistics
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is −0.4245, which is between leverage ratio and current ratio. It is very important to treat
any econometric problems relating to serial correlation, multicollinearity and
heteroskedasticity before going further for regression analysis. According to researchers,
empirical analysis done on panel data should be controlled for individual heterogeneity and
multicollinearity (Kyereboah-Coleman, 2007). Myers (1990) indicated that a variance
inflation factor (VIF) value of greater than 10 is a concern. Accordingly, the VIF values are
well below 10, at 1.25. Therefore, multicollinearity is not a problematic issue or concern for
this study. A test for homoscedasticity was also conducted using Breush–Pagan/Cook–
Weiberg test for heteroskedasticity (Table IV shows the results of the test). After the
researcher ensured that data and model are free from heteroskedasticity, pooled OLS
Regression was used to analyze the data. Pooled OLS Regression is widely used and
recommended for panel studies because it derives unbiased and consistent estimates of
parameters even when time-constant attributes are present (Zariyawati et al., 2009; Zhang,
2013). Moreover, pooled OLS regression is favored for data without dummy variables, which
is the case of this study. In order to obtain robust results, a fixed-effects model was run.
Table IV shows the results which are identical to Pooled OLS in terms of significant factors.
The major advantage of using the fixed-effects estimator is that it controls for firm
EPS
Table III.
Correlation between
DV and IVs
INS
EPS
1.0000
ROE
0.6232*
1.0000
INS
0.5765*
0.3584*
1.0000
WC
0.3065*
0.0871*
0.3130*
CRIO
−0.0355
−0.0198
−0.2227*
ASTRIO
0.1406
0.2819*
0.2551*
LEVRIO −0.1792* −0.1339
0.0727
DTERIO −0.0301
−0.1342
0.1776*
Note: *Significant in less than 5 percent
Variable
Table IV.
Regression results of
determinants and
profitability
ROE
Expected sign
LTS
+
WC
+
CRIO
?
ASTORIO
?
LEVRIO
−
DTERIO
−
Cons
F(6,353)
16.52
ProbW F
0.0000
0.2192
R2
2
0.2059
Adj-R
n
360
Main VIF
1.25
Heteroskedasticity test
Breusch–Pagan
Cook–Weisberg
Notes: **,***Significant in
WC
CRIO
ASTRIO
LEVRIO
DTERIO
1.0000
0.0418
−0.0047
−0.0854
−0.1724*
1.0000
−0.1651
−0.4243*
−0.2579*
1.0000
0.0296
0.0085
1.0000
0.3437*
1.0000
MODEL (1) ROE
Fixed-effect
Coefficient t-statistics t-statistics
5.836509
−3.94
0.0169658
4.393316
−4.96923
−2.179542
6.87***
−1.31
0.11
3.91***
−2.04***
−3.32***
6.88***
−1.32
0.11
3.89***
−2.01***
−3.31***
−5.81***
MODEL (2) EPS
Fixed-effect
Coefficient t-statistics t-statistics
17.93849
11.88***
1.24
2.33**
−0.0639419 −0.820
0.0827936
0.04
−18.24041
− 4.20***
−1.169142
−1.00
38.47
0.0000
0.3953
0.3851
360
1.25
χ2 (1) ¼ 0.13
ProbWχ2 ¼ 0.7166
less than 5 and 1 percent, respectively
11.84***
2.32**
−0.821
0.967
−4.19***
−1.00
−10.24***
characteristics which are not observable or measurable, but are likely to be correlated with
the regression, thus allowing a limited form of endogeneity (Lazar, 2016). The results of
analysis are shown in Table IV.
Table IV consists of two models: the first model examines the association between the
five IVs of the study and ROE. In this model, the results show that LTS has a significantly
positive association with ROE (as coefficient is 5.836 and significant at 1 percent).
An almost 5 percent increase in the sales will increase the ROE by 1 percent. This result
shows the importance for Malaysian companies to increase and expand their sales to
different territories and places. In other words, as the total sales measures the company
size, it is clear that firm size is a significant determinant of ROE. The first model also
shows that assets turnover has a positive association with ROE, with coefficient of 4.3933
and significant at 1 percent; a 4.3 percent increase in assets turnover ratio leads to an
increase of 1 percent in ROE. Thus, assets turnover is one of the factors affecting company
profitability in Malaysia. The result motivates companies to increase their efficiency
(as assets turnover ratio measures the efficiency) and properly manage their assets to
increase their sales and therefore profitability. This will generate more investment in these
companies. Another determinant of profitability is leverage. The first model shows a
negative and a significant association between leverage (as measured by debt equity ratio
and leverage ratio) and ROE, with coefficient of −4.96923 and −2.179542, respectively,
and significant at 1 percent. The result reveals that the more the external funds that a
company depends on, the less the ROE it gets. This may mean that the cost of financing
from external sources is quite high and it affects the profitability of the company.
However, other variables, i.e. liquidity (as measured by current ratio) and WC, show a
positive relationship with company profitability (ROE) but not significant. The R2 is
0.2192 and the Adj-R2 is 0.2059. The second model examined the relationship between the
same five IVs and EPS.
In the second model, firm size and WC show significant relationships with profitability
(as measured by EPS), with coefficient of 17.93849 and 1.24 at 1 and 5 percent significance
levels, respectively. This result reveals that WC plays a significant role in increasing
the company’s profitability; actually, the coefficient, which is 17.938, shows how this
determinant is important for profitability. Consistent with the determinants of ROE, the
second model shows a negatively significant relationship between leverage and profitability
(EPS) as coefficient is −18.24041 and significant at 1 percent. The R2 is 0.3953 and the
Adj-R2 is 0.3851.
4. Discussion of results
This study focuses on financial indicators of profitability, i.e. firm size (total sales), WC,
company efficiency (assets turnover ratio), liquidity (current ratio) and leverage (debt equity
ratio and leverage ratio). These are the IVs and profitability is the DV, measured by ROE
and EPS. The results are elaborated on as follows.
4.1 Firm size
It is known that firm size is considered as a proxy for many positive aspects, including
profitability. The result of the current study shows a significantly positive correlation
between LTS (as a measurement for firm size) and ROE. The coefficient t-value ¼ 5.836 and
p o0.001 indicate this positive and significant relationship. This result supports that big
companies have different markets to market their products and this enhances their
performance which leads to high profitability. This supports the resource-based theory – as
the size of the company gets bigger, it is easier for it to access more financial resources
which leads to lower cost of capital and higher profit. Similar results have been found in
previous studies, such as Ha-Brookshire (2009), Stierwald (2010a, b) and Malik (2011).
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452
All these studies have found a positive relationship between firm size and profitability. The
second model also shows a positive and significant relationship between LTS and EPS. The
coefficient t-value ¼ 17.93849 and p o 0.001 indicate this positive and significant
relationship. Hence, the first hypothesis cannot be rejected.
4.2 Working capital
Several studies have linked WC and operational efficiency (e.g. Barine, 2012). The results
of the current study show a positive and significant relationship between WC and EPS as
the coefficient t-value ¼ 1.24 and p o 0.05. This relationship is not applicable to ROE in the
first model. Thus, WC is positively correlated with EPS but not with ROE. Hence, the
second hypothesis cannot be rejected. The logical reason behind this relationship may be
that more WC (whether debt or equity) will lead to more EPS but may not lead to ROE.
Similar results of a significant relationship between WC management and profitability
were found by Grinyer and McKiernan (1991), Chowdhury and Amin (2007), Malik (2011)
and Alipour (2011).
4.3 Company liquidity
The findings of the study show unexpected results in terms of liquidity. It has been
predicted that there is a positive relationship between liquidity and profitability but the
results do not show any significant relationship between current ratio (CRIO) (as a
measurement of company liquidity) and either ROE or EPS. This is because profitability
does not depend on cash base, and liquidity is important in financial institutions, such as
banks, but not in non-financial companies. In banks, the liquidity is for covering the firms’
current obligations (excluding shareholders). Hence, the third hypothesis cannot be
accepted. Similar results were found by Pratheepan (2014), who tested the determinants of
profitability for 55 Sri Lankan manufacturing companies using static panel models, and
found that liquidity has an insignificant impact on profitability.
4.4 Company efficiency
The results of the study show a positive and significant relationship between assets
turnover ratio (ASTORIO) (as a measurement of company efficiency) and ROE in the first
model as the coefficient t-value ¼ 4.3933 and p o0.001. This relationship is not applicable to
EPS in the second model. Thus, ASTORIO is positively correlated with ROE but not with
EPS. Hence, the fourth hypothesis cannot be rejected. The reason behind this results may be
that assets turnover ratio and ROE both measure company efficiency but not EPS.
4.5 Company leverage
Table IV shows a negative and significant relationship between LEVRIO and both RIO and
EPS. In the first model, the coefficient t-value ¼ −4.9692 and p o0.001, and in the second
model, the coefficient t-value ¼ −18.24 and po 0.001. Hence, company leverage has a
negative and significant relationship with profitability. Thus, the fifth hypothesis cannot be
rejected. It is known that financial leverage is one of the capital structure policies in a
company. This is because the choice between debt and equity suggests somehow a trade-off
between business and financial risk. When companies choose more borrowings to finance
their needs, they do not affect corporate ownership (Yazdanfar, 2013). In addition, the results
also show that debt to equity ratio (DTERIO) has a negative and significant relationship
with ROE but not with EPS. The first model shows the coefficient t-value ¼ −2.1795 and
p o0.001. Thus, there is a negative and significant relationship between DTERIO and ROE.
This is a logical conclusion because a company has a choice whether to finance its activities
by equity or debt or both, based on how the company sacrifices on its ROE percentage.
Similar results were found by Charumathi (2012), that leverage has a negative and
significant impact on profitability. Also, Eriotis et al. (2011) found the same results when
they investigated the relationship between debt to equity ratio and profitability.
5. Conclusion, limitations and application
This study aims to determine the factors of profitability in Malaysian-listed companies. Five
IVs, namely, firm size (as measured by total sales), WC, company efficiency (assets turnover
ratio), liquidity (current ratio) and leverage (debt equity ratio and leverage ratio), were
empirically examined for their relationships with profitability. Data of 120 companies listed
on Bursa Malaysia, covering the period from 2012 to 2014, were extracted from companies’
annual reports and pooled OLS regression was used to analyze the data. The results
emphasize strong positive relationships between total sales, WC and assets turnover ratio
and profitability. The results show also negative relationships between debt equity ratio
and leverage ratio and profitability. Liquidity does not show any significant relationship
with profitability. The study concludes that large growing firms with efficiently managed
assets improve operating income and ultimately enhance profitability.
This study, as with any other study, has a limitation. The database is limited to 120
companies and it covers the period from 2012 to 2014, which is considered as a short time
period. However, the findings of this study benefit both internal users (such as mangers,
shareholders and employees) and external (such as investors, creditors, newly established
companies and the tax authority) users. They can be aware of the factors affecting the
profitability of the companies after the depreciation of the Malaysian currency and therefore
concentrate more on the factors that can enhance their company’s profitability. The results
may help the external users to make the right decision. This study provides empirical
evidence that supports the resource-based theory and the trade-off theory. This study also
recommends that future studies include more factors or conduct a comparative study that
includes companies in different countries in order to figure out whether the determinants of
profitability are the same in different business environments in different countries.
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Further reading
Alarussi, A.S. and Alhaderi, S.M. (2018), “Factors affecting profitability in Malaysia”, Journal of
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About the authors
Dr Ali Saleh Alarussi is an Assistant Professor at Xiamen University Malaysia, he has been Visiting
Assistant Professor at University Utara Malaysia since 2013. He has more than nine years of teaching
accounting subjects in different international universities, and his areas of expertise are financial
reporting, financial disclosure, environmental disclosure, online internet reporting and corporate
governance. Dr Ali Saleh Alarussi is the corresponding author and can be contacted at:
[email protected]
Dr Sami Mohammed Alhaderi is Senior Lecturer with School of Business Management, University
Utara Malaysia. He was Manager in Human Resource Training Division in Yemen Public
Telecommunication Corporation for 25 years; his areas of expertise are strategic management,
leadership, organization behavior, human resource, information system, ethics and research methodology.
For instructions on how to order reprints of this article, please visit our website:
www.emeraldgrouppublishing.com/licensing/reprints.htm
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