Introduction

The goal of establishing any company is profit maximization, which is necessary for its long-term growth and development. After the world economic crisis in 2008, financial managers realized that, in addition to profit maximization, it is necessary to seriously consider the issue of liquidity (Bigio, 2015; Lang and Maffet, 2011, Raykov, 2017). Therefore, one of the most important tasks of financial managers is determining the optimal financial structure, which is determined by striving for a higher level of profitability while ensuring the necessary level of liquidity (Figure 1).

Figure 4: Optimal ratio of liquidity and profitability of the company

Source: adapted from Balaban (2022)

There are two different approaches that theoretically explain the relationship between liquidity and profitability. According to the first approach, a higher level of liquidity leads to an increase in costs, i.e. high opportunity costs, which can have a negative impact on profitability. However, this impact is likely to be short- lived. Hirigoyen (1985) found that in the medium to long term there is a possibility of a positive relationship between liquidity and profitability because low liquidity would cause low profitability, since it results in more loan requests and insufficient cash flow. Similarly, Hollmayr and Kühl (2019) believe that active liquidity management has a positive impact on profitability, while Bakić and Petković (2020) claim that both liquidity and profitability are equally important components for the existence of the company and the maximization of the company's value (Knauer, 2013). Namely, a higher level of liquidity is a positive indicator of the company's financial condition, and although in the short term, a higher level of liquidity can have a negative impact on profitability, in the medium and long term it will increase the profitability of the company and minimize the risk of bankruptcy. Gonçalves and authors (2018) consider that finding a balance between profitability and liquidity is one of the main challenges of managing business finances. In this regard, the subject of research in this paper is the analysis of the relationship between liquidity and profitability of companies in the processing sector in the Republic of Serbia, while the goal is to quantitatively determine the impact of liquidity on the profitability of the observed companies. In accordance with the available theoretical and empirical literature, the following hypotheses were set:

H 1: There is a direct relationship between liquidity and profitability

H 2: A higher level of liquidity implies a lower level of profitability

H 3: There is an optimal level of liquid assets for each company.

The majority of available empirical research proved the existence of a relationship between liquidity and profitability (table 1), and the first hypothesis was formed in accordance with this fact. Although the available theoretical literature indicates a long-term positive relationship between liquidity and profitability, our assumption is that a higher level of liquid assets implies a lower rate of profitability. We were led to this assumption, i.e. the definition of the second hypothesis, by studies that analyzed the mentioned relationship on the example of companies in the environment (Raykov, 2017; Vuković and Jakšić, 2019). The results of a study conducted by Korent and Orsag (2018) imply the existence of a relationship between net working capital and return on assets. This indicates the existence of an optimal level of net working capital, that is, in our case, liquid assets that balance costs and benefits and maximize the profitability of the analyzed companies. In accordance with the mentioned results, the third hypothesis was defined. In every company, the level of working capital should be optimized, which entails the need to maintain a balance between two seemingly opposite goals, profitability and liquidity (Van Horne and Wachowicz, 2009; Bieniasz and Gołaś, 2011; Gołaś, 2020).

Literature review

The relationship between liquidity and profitability has attracted the attention of a large number of authors, and the results of a certain number of empirical studies are presented in Table 1.

As can be seen from the table, most authors applied regression and/or cointegration to panel data, i.e. the observed sample of a larger number of companies. What is clear is that there is no consensus regarding the ratio of liquidity and profitability of the company. In this regard, the goal of this paper is to quantitatively determine the impact of liquidity on the profitability of companies in the processing sector in the Republic of Serbia, which also represents the scientific contribution of this paper.

Table 2: Results of previous empirical studies

Source: author's systematization

Table 1- continued: Results of previous empirical studies

Source: author's systematization

Data and methodology

The sample consists of 100 companies in the processing sector with the highest level of business income from the territory of the Republic of Serbia, and the time frame of the research is the period from 2016 to 2020. When considering the impact of liquidity on company profitability, most empirical studies used the regression model (table 1), so the authors opted for the regression model assessment. Following Milošev (2021), Nanda and Panda (2018), Gonçalves and authors (2018) and Knauer and Wöhrman (2013), the ROA indicator was used as a measure of profitability in the paper. As a measure of liquidity, the indicator of accelerated liquidity was used, since only liquid funds can be used in a relatively short period of time to settle the assumed short-term obligations of the company. The same measure of liquidity was used by Milošev (2021), Boțoc and Anton (2017), as well as Raykov (2017). In order to obtain relevant results, control variables were entered into the regression model. In this regard, the following regression model was evaluated:

-  net return on assets, i.e. a measure of the company's profitability,

-  the ratio of debt to capital, i.e. a measure of the company's indebtedness,

-  the duration of the business cycle, i.e. the approximation of the success of working capital management,

-  the capital turnover ratio, i.e. the indicator of the company's activity i

-    the first difference of the natural logarithm of the asset value, i.e. a measure of the size of the company,

- section, varies among individual units of observation, but is constant over time. It consists of a constant part and an error term for individual observation units ,

– model error.

Descriptive statistics of the observed variables of 100 processing companies with the highest level of business income in the Republic of Serbia in the period from 2016 to 2020 are presented in Table 2.

Table 2: Descriptive statistics

Source: author's calculation based on APR data, EViews program

Results of work with discussion

Correlation analysis was conducted in order to detect the possible problem of multicollinearity that can lead to a wrong interpretation of the estimated parameters. Based on Table 3, it can be concluded that there is no correlation between the observed independent variables, which implies the absence of multicollinearity in the estimated regression model.

In order to test the stationarity of the observed variables, unit root tests (Levin, Lin, Chu and IPS test) were conducted. In order to determine whether it is appropriate to apply the unit root test of the first or second generation to the observed variables, an interdependence test (Pesaran CD test) was also conducted, and the results of the obtained tests are shown in table 4.

Table 3: Correlation matrix

Source: author's calculation based on APR data, EViews program

Table 4: Interdependence test and unit root tests

Source: author's calculation based on APR data, EViews program

Note: Pesaran CD test of interdependence – H 0: There is no interdependence; Levin, Lin and Chu unit root test – H 0: There is an individual unit root; IPS unit root test – H 0: There is a common unit root.

Based on the obtained results from Table 4, it can be concluded that there is no interdependence in the individual observed variables, which implies the use of unit root tests of the first generation. The authors opted for the Levin, Lin and Chu test and the IPS test, since the mentioned tests have different null hypotheses and can serve as checks against each other. Based on the conducted unit root tests (table 4), it can be claimed that all the observed variables, except the size of the company, are stationary. The variable expressing the size of the company is stationary in the first differentiator, so it will be included in the model as such.

The Hausman test shows that it is adequate to use a regression model with fixed effects. The results of the performed FE regression are presented in Table 5.

Judging by the obtained results, liquidity has no influence on the profitability of the largest companies in the processing sector in the Republic of Serbia, which implies that there is no direct connection between profitability and liquidity, as well as that there is no optimal amount of cash and cash equivalents that would enable the maximization of the net return on assets.

Table 5: Estimated regression model with fixed effects

Source: author's calculation based on APR data, EViews program

Profitability, expressed by the ROA indicator, is not even related to the length of the business cycle of the observed companies. On the other hand, the higher indebtedness of companies in the processing sector in the Republic of Serbia negatively affects the profitability of the company, while the faster capital turnover and larger company assets have a positive impact on the net return on assets in the observed period.

Conclusion

There is no single opinion on the relationship between the company's liquidity and profitability. According to one approach, the relationship between the two variables is negative, since higher liquidity requires a higher level of opportunity costs and discourages new investment. However, some authors claim that this relationship is present only when two variables are observed in the short term. In the long and medium term, liquidity and profitability move in the same direction. In other words, companies that have liquidity problems in the medium and long term cannot be profitable. In this regard, the goal of this paper is to quantitatively determine the impact of liquidity on the profitability of 100 companies in the processing sector in the Republic of Serbia with the highest level of business income observed in a five-year period.

Initial hypotheses were formed on the basis of available theoretical and empirical literature and tested on panel data with the help of regression with fixed effects. The obtained results indicate that there is no direct connection between indicators of accelerated liquidity and net return on assets when the observed companies are concerned, which implies that it is not possible to determine the optimal amount of cash and cash equivalents that would enable the maximization of net return on assets. There is no direct connection between profitability and the length of the business cycle of the observed companies. It can be argued that a faster turnover of capital results in a higher level of profitability, as well as the growth of the company's assets. On the other hand, higher indebtedness has negative implications for the profitability of companies in the processing sector.