Determinants of profitability in Chinese companies

Abstract

Purpose This study is conducted to determine the factors that affect profitability in Chinese listed companies (by using financial ratios). Four independent variables liquidity, intangible assets, working capital and company leverage were empirically tested for their relationships with profitability besides two control variables which are firm size and company efficiency.Design/methodology/approach This study used secondary data extracted manually from the annual reports of non-financial Chinese listed companies on the Shanghai stock exchange (http://www.szse.cn/); the data set covers 100 companies during the period of 2017–2019, and a random selection method was used in order to achieve credibility and fairness as much as possible.Findings The findings show firm size, working capital and intangible assets have positive and significant relationships with profitability [return on assets (ROA) and earnings per share (EPS)]. Positive working capital is important to lower the cost of capital and improve companies' profitability. Intangible assets are also an essential source to improve profitability due to their low costs. In addition, the findings display a negative and strong relationship between liquidity and profitability, meaning that companies suffer low profit due to inefficient use of liquid items. Interestingly, leverage, which is measured by debt ratio and leverage ratio, shows mixed results; debt ratio shows a positive and strong association with ROA but not with EPS; while leverage ratio displays a strong but negative association with ROA but not with EPS. These results confirm the inverted U-shape relationship between leverage and profitability, which depends on the balance between benefit and cost of debt.Social implications Profitability is also important for employees and society where business organization provides sustainability and stability for both of them. Employees can then significantly contribute to achieve higher firm's profitability by efficiently using firm's resources.Originality/value This study differs than previous studies in number of aspects: First, this study focuses on financial ratios to explain profitability in Chinese companies. This study provides empirical results about the factors connected to profitability and help stakeholders to make their right decisions. Second, it examines the impact of four independent factors and two control variables that some of them are new in Chinese context such as intangible assets. Third previous studies focus on financial industry such as banks; however, this study focuses on non-financial industry.