Impact of Liquidity and Financial Leverage on Firm’s Profitability- An Empirical Analysis of the Textile Industry of Pakistan

Abstract

Purpose-This study empirically investigates the impact of liquidity and financial leverage on the profitability of textile firms listed on the Pakistan Stock Exchange (PSX). Utilizing panel data, liquidity is proxied by the current ratio and quick ratio, while financial leverage is measured through the debt-to-equity ratio. Profitability is represented by return on equity (ROE), with firm size (log of total assets) incorporated as a control variable. Design/methodology/approach– Through quantitative approach, panel regression and descriptive statistics models are used by taking annual data of Pakistan’s textile sectors from 2016 to 2025. Secondary data has been gathered from financial statements of the firms. The analysis employs Ordinary Least Squares (OLS) estimation, complemented by a Random Effects Model selected based on the Hausman specification test. Findings-The empirical results indicate that the current ratio exerts a positive and statistically significant effect on profitability, suggesting that efficient working capital management enhances firm performance. Conversely, the quick ratio is found to be statistically insignificant, implying limited explanatory power in the context of the textile sector. The debt-to-equity ratio exhibits a positive and significant relationship with profitability, supporting the trade-off theory of capital structure, where moderate leverage contributes to improved returns. However, firm size does not demonstrate a significant association with profitability. Practical implications–The findings underscore the critical role of optimal liquidity management and prudent leverage decisions in enhancing firm profitability. This study provides important implications for financial managers, investors, and policymakers in developing effective financial strategies within Pakistan’s textile industry.