Relationship between liquidity and profitability: Evidence from small and medium (SMEs) in China

Abstract

The aim of this study is to investigate whether a firm’s liquidity has an impact on a firm’s profitability in Chinese SMEs. I employ multiple proxies to measure SMEs performance: (1) Return on Asset, (2) Return on Equity, and (3) Net Profit Ratio. Using a large sample of Chinese SMEs form 2009 to 2018, this paper finds that Cash Conversion Cycle has significant negative relationship with SMEs performance. In the robustness test, I use pair-wise Granger Casualty Test and also find that firm’s liquidity has an impact on a firm’s profitability in Chinese SMEs, especially between Return on Asset and Cash Ratio and between Net Profit Ratio and Cash Conversion Cycle. These results allow managers of Chinese SMEs to have clear ideas in managing working capital to generate more profits based on their relationship.