Theoretical Basis for the Impact of Liquidity

CONCLUSION OF CHAPTER 1

In the overview, the author has reviewed previous studies worldwide and in Vietnam on the impact of TTK on the financial performance of enterprises. To provide the most comprehensive and general picture, the author has reviewed from two perspectives, including studies focusing on measuring TTK according to traditional ratios, including the indicators CR, QR, CAR, CCC and including studies measuring TTK according to cash flow ratios including CFR, CIC and CNCC.

Most previous studies focused on studying the impact of TTK on HQTC when measuring TTK by traditional ratios. Recently, a few studies have emphasized and affirmed the need to measure TTK by cash flow ratios. Therefore, a few studies have examined the impact of TTK on HQTC from the perspective of cash flow ratios.

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Research results show that TTK has a multi-dimensional impact on the financial performance of enterprises, depending on each economy, each country, each time and each type of measurement. It can be a positive impact, a negative impact, a mixed impact and even some studies find no impact of TTK on the financial performance of enterprises.

Through an overview of previous studies, pointing out issues that have been mentioned in previous studies, the author has found gaps in issues that have not been researched in Vietnam, from which the author has formed the next research directions to be carried out in the author's thesis.

CHAPTER 2. THEORETICAL BASIS OF THE IMPACT OF LIQUIDITY

TO FINANCIAL PERFORMANCE IN ENTERPRISES

2.1. Theory on business liquidity

2.1.1. The nature of liquidity

All relevant partners are interested in the financial situation of a business. For banks, the financial situation of a business affects the ability to access loan sources. When considering and evaluating loan applications, banks always focus on indicators reflecting the financial situation of the business. Businesses will have difficulty accessing preferential loans, or even be unable to borrow capital, if the figures on the financial statements show poor financial situation. For suppliers, the decision on which credit policy to apply when selling on credit to businesses is shown through the financial situation of previous shipments and the financial situation of future shipments. When a business falls into a state of poor financial situation and does not have money to pay its debts to suppliers, it will go bankrupt. The distance between insolvency and bankruptcy is only a matter of time. Because suppliers can file a petition to the court to declare bankruptcy to liquidate assets to pay debts. Employees are interested in the company's payroll when they want to know whether the company can meet its obligations: salary, allowances, bonuses, etc. as agreed in the labor contract or not?

The role of the CFO is even more important for shareholders, or owners. The lack of CFO often predicts low financial performance of the enterprise and many risks, few opportunities. It not only affects investment profits but can also cause owners to lose control of the enterprise or lose investment capital. If the type of enterprise is a private enterprise or the owner is a general partner of a general partnership, the owners are unlimitedly responsible for the debts of the enterprise, then the lack of CFO also seriously threatens the personal assets of the owners themselves. In the stock market, a company with poor CFO is also shown by the difficulty in selling shares, meaning it is difficult to raise capital from the external financial market.

Therefore, a firm must pay attention and maintain the TTK at an optimal level (Owalabi et al., 2011). An inability of a firm to meet its NNH obligations can affect its operations and in many cases it can affect the reputation of those firms. Insufficient cash or current assets can cause a firm to miss out on incentives offered by good suppliers of credit, services and goods. Loss of such incentives can lead to higher costs of goods which will affect the firm’s profitability. In a sense, when a firm lacks TTK, it means that the firm cannot take advantage of incentives or seize business opportunities when they suddenly appear (Wang, 2002). TTK is a prerequisite to ensure that a firm

Payment of NNH dues and its continuous flow will ensure a profitable business (Bibi and Amjaad, 2017).

Therefore, Shim and Siegel (2000) define the liquidity of a firm as the ability to pay off its current liabilities. The liquidity is determined by the ease, cost and speed with which assets can be converted into cash. Cash is the most liquid of all assets of a firm. The management of liquidity is that the firm must maintain sufficient cash and high current assets, and must be able to promptly mobilize capital from other sources to promptly pay and fulfill financial obligations. An optimal liquidity level is the level at which the firm ensures that it can pay off its current liabilities without reducing its profits (cited in Ismail, 2016).

Eljelly (2004) explained that effective management of current assets involves planning and controlling current assets (CAs), NNH in a manner that helps firms eliminate the risk of not being able to meet current obligations as well as avoid over-investment in these assets. Stickney (1996) defined: “Cash is the ability of a firm to pay its current liabilities using the cash generated from its operations”.

“ According to the author, the liquidity of an enterprise is the ability to pay debts due in full and on time, reflected in the value of liquid assets that the enterprise holds and the ability to convert these assets into cash. The higher the value of liquid assets held by the enterprise and the easier and more convenient it is to convert them into cash, the higher the liquidity of the enterprise and vice versa. Liquid assets are assets with high liquidity, including: cash and cash equivalents, short-term financial investments, short-term receivables, short-term advances and inventory .

2.1.2. Measuring liquidity

The financial situation of an enterprise is measured through indicators on the enterprise's financial statements, including the balance sheet, the income statement and the cash flow statement. In which, the indicators on the balance sheet and the income statement are accounting data indicators, showing the situation of assets, capital sources and operating results of the enterprise in the past period. The indicators on the cash flow statement reflect the movement of money, information on the enterprise's cash flow, including cash inflow, cash outflow and net cash flow at the end of the period. In other words, the calculation of financial situation is based on the data on the balance sheet and the income statement, which are recorded according to traditional ratios, while the data on the cash flow statement is recorded according to cash flow ratios.

Atieh (2014) conducted a study to compare the assessment of liquidity status by traditional ratios and cash flow ratios of 07 large pharmaceutical industry enterprises in Jordan over a period of six years (2007 - 2012). The study

This study found that there is a difference in the liquidity of pharmaceutical companies measured by traditional ratios and measured by cash flow ratios. At the same time, a conclusion about the liquidity of a company based only on traditional ratios can lead to incorrect decisions and managers should analyze it using cash flow ratios before drawing conclusions about the liquidity of the company. This research result is consistent with the research result of Kirkham (2012).

In Vietnam, Pham Quang Tin and colleagues (2017) also compared the measurement of TTK by traditional ratios and ratios based on cash flow of SMEs on the Vietnam stock market. The results showed that there were significant differences in the liquidity status of enterprises according to different measurement methods.

Therefore, in this study, the author will measure the TTK of enterprises from both perspectives.

is based on traditional ratio and based on cash flow ratio.

2.1.2.1. Measuring corporate liquidity using traditional ratios

Measuring a company's liquidity using traditional ratios is the calculation of liquidity ratios based on data provided from the Balance Sheet and Income Statement.

Authors Nguyen Dinh Kiem and Bach Duc Hien (2010) proposed 4 indicators to measure the business's liquidity (also known as the group of liquidity ratios) including: (1) Current liquidity ratio (CR),

(2) Quick Ratio (QR), (3) Cargo Ratio (CAR), (4) Interest Ratio.

Author Van Thi Thai Thu and colleagues (2015) also pointed out 4 indicators used to measure the TTK of enterprises, in which 3 indicators (1), (2), (3) are similar to those of authors Nguyen Dinh Kiem and Bach Duc Hien (2010), the fourth indicator is replaced by CCC.

According to Demirgünes (2016), Mun and Jang (2015): CR is the most optimal measure of TTK, but Eljelly (2004) showed that CCC is more important than CR when measuring TTK. Podilchuk (2013) used all three indicators: CR, QR and CCC to examine the impact of TTK on the profits of enterprises in Ukraine, while Thuraisingam (2015) used only CR, QR to measure TTK when examining the impact of TTK on the profits of enterprises in Sri Lanka.

Inheriting the research of Van Thi Thai Thu et al. (2015), Eljelly (2004), Podilchuk (2013), the author will use 4 indicators: (1) CR, (2) QR, (3) CAR, (4) CCC to measure TTK according to the traditional ratio of enterprises.

According to studies by Nguyen Dinh Kiem and Bach Duc Hien (2010), Van Thi Thai Thu and colleagues (2015), Podilchuk (2013), the indicators are determined as follows:

- Current Ratio ( CR)

The current KNTT coefficient of an enterprise is defined as the relationship between all current assets and NNH of the enterprise, calculated as follows:

Current KNTT Coefficient (CR)

Total TSNH

NNH

CR shows the ability of the enterprise to convert current assets into cash to pay due debts. Therefore, the enterprise must mobilize the current assets it has and convert these current assets into cash to pay debts.

To evaluate the current payment capacity of a business, it is necessary to rely on the average CR of businesses in the same industry. Because there will be different CRs among different business groups. At the same time, it is also necessary to compare with the CR in previous periods of the business.

If CR > 1: The company's current assets are sufficient to pay NNH. The higher the CR, the greater the company's ability to pay debts, the lower the risk of bankruptcy, and the better the financial situation. However, if CR is too high, it shows that the company has abundant financial resources but reflects low capital efficiency because the company has invested too much in current assets, leading to poor financial situation.

If CR < 1: The company's ability to meet its current liabilities is not good due to lack of resources to ensure current liabilities from its current assets. However, CR < 1 is not necessarily a serious problem, because if a company has good long-term prospects, it can borrow from potential customers to meet current obligations.

If CR approaches 0, the enterprise will lose its ability to pay its debts and is at risk of bankruptcy.

The disadvantage of this coefficient is that the numerator (TSNH) includes many asset items, including asset items that are difficult to convert into cash such as bad debts, doubtful receivables, unsold inventory, unprocessed losses, etc.

- Quick Ratio ( QR)

To raise capital to pay off due debts, businesses must first convert current assets such as inventories into cash, but there are specialized types of inventories used for regular reserves for business operations that take a very long time to convert into cash.

For example, raw materials, materials, tools, equipment, finished products, goods, etc. Therefore, in addition to using CR, the enterprise's TTK is also measured by QR. This indicator will more closely evaluate the enterprise's KNTT.

Quick KNTT Coefficient ( QR)

Cash and cash equivalents + Financial investments

= short-term capital + short-term receivables

NNH

or Quick KNTT Coefficient ( QR)

TSNH – HTK

NNH

If the QR has a value between (0.5 - 1), it means that the enterprise has an optimistic KNTT. However, to determine whether the QR of an enterprise is good or not, it is necessary to consider the current state of the enterprise's operations. If QR < 0.5, the enterprise may be having difficulty in mobilizing capital to pay off debt, leading to the enterprise having to quickly sell assets to pay off debt. However, if QR is too high, it means that the enterprise has a large amount of surplus cash or a lot of outstanding receivables, which means that the efficiency of capital use is not good.

- Instantaneous KNTT coefficient (Cash Ratio – CAR)

CAR indicates whether the enterprise can ensure timely payment of debts with the current cash and cash equivalents.

Instantaneous Rate of Return (CAR)

Cash and cash equivalents

NNH

This ratio is also in the range of 0.5 to 1. However, to determine whether this ratio is good or bad in a business, it is necessary to consider the actual operating status of the business. But if this ratio is too small, it is certain that the business is currently facing difficulties in paying its debts.

Compared to CR and QR, CAR requires more stringent calculations. Short-term receivables and inventories are not included in the numerator because the ability to quickly convert into cash to meet the due debts of these two items is relatively difficult and uncertain. This ratio is especially useful to evaluate the financial situation of some enterprises during the period of economic crisis when inventories cannot be consumed and many receivables are difficult to collect.

- Cash Conversion Cycle (CCC)

CCC is an indicator reflecting the time it takes for a business to consume inventory, collect receivables and pay its payables.

If CCC is smaller, the stagnant working capital will be significantly reduced, reducing the demand for working capital, improving operational efficiency, and increasing the business's profitability. The specific formula for calculating CCC is based on the research of Richards and Laughlin (1980) and Afeef (2011):

CCC = ICP + RCP – PDP

In there:

+ ICP (Inventory Conversion Period) - inventory conversion period: reflects the number of days of an inventory conversion cycle.

ICP = Average inventory value / Average daily cost of goods sold

+ RCP (Receivable Conversion Period) - average collection period: reflects the average number of days of a debt cycle, from sale to collection.

RCP = Average Accounts Receivable/Average Daily Sales

+ PDP (Payable Deferral Period) - average payment period: reflects the number of days a business needs to pay its payables.

PDP = Average Accounts Payable / Average Daily Cost of Goods Sold

2.1.2.2. Measuring the liquidity of a business by cash flow ratio

In the current difficult economy due to the impact of the pandemic, money plays a very important role in the operation of enterprises, it is considered the center, the goal of the production and business process. An enterprise with a large cash flow reserve and the ability to generate large amounts of money reflects the financial capacity of that enterprise, ensuring that it can overcome the crisis, creating peace of mind for investors and related parties. Therefore, measuring the TTK of an enterprise based on the cash flow ratio, that is, using data on the cash flow statement, will help administrators and investors more accurately assess the liquidity status of the enterprise.

According to Vo Van Nhi et al. (2001), Bui Van Van and Vu Van Ninh (2013), Kirkham (2012), Eyisi and Okpe (2014), Barua and Saha (2015), Pham Quang Tin et al. (2017), the indicators measuring TTK based on cash flow ratio include:

- Cash flow ratio (CFR)

This indicator is used to examine the ability of a business to pay NNH debts through net cash flow from operating activities. Through that, it assesses whether the ability to generate cash from operating activities of the business is enough to pay debts or not. The higher this ratio, the greater the ability to pay debts.

CFR =

Average NNH net cash flow from operating activities

Among firms with equal average NNH, investors will be more likely to invest.

invest in firms with higher cash flow ratios. This ratio should be at least 0.4, as suggested by Ryu and Jang (2004). If the cash flow ratio is less than 1, the amount of money the firm has generated is less than the amount of debt it needs to pay. This may signal a need for additional capital. Therefore, investors and analysts often prefer a higher CFR (Sanghani, 2014).

- Cash interest coverage ratio (CIC)

This indicator is used to assess whether the ability to generate cash from operating activities of a business meets the requirements for interest payments or not. This ratio shows more realistically whether the business is able to pay interest or not. If the business has a lot of borrowed capital, this ratio will be calculated to have a low value, otherwise the ratio will have a high value.

CIC =

Net cash flow from operating activities + Interest paid Interest paid

The interest coverage ratio from net cash flow from operating activities is not only different

between industries but also between companies within the same industry. This is one of the useful indicators to assess the liquidity status of a company. Because a company cannot develop - and cannot even survive - unless it can pay interest to its creditors. This ratio of 2 (two) is considered the minimum acceptable figure for a company with stable and solid revenue. Anything below one (1) indicates that a company cannot meet its current interest payment obligations and is therefore not in good financial condition.

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