Liquidity and profitability are closely related because one increases, and the other decreases. This study aims to reveal the relationship between liquidity and firm's profitability by using the data of the cement industry listed on the Dhaka Stock Exchange Ltd in Bangladesh.
Liquid assets are less profitable as compared to long term assets. The dilemma to a finance manager is whether to invest in more profitable long term assets and risk low liquidity or invest in short term assets which are less profitable and therefore reduce return on investment made.
The trade-off between maximum profitability and liquidity is the result of value maximization and bankruptcy prevention strategies and this approach is expected to be similar in all listed companies due to investors' expectation.
A company may maintain high liquidity ratios by holding excess cash or highly liquid assets, which could be more effectively deployed elsewhere to generate returns for shareholders. In addition, a company could have a great liquidity ratio but be unprofitable and lose money each year.
While profitability shows that a company can make money from its operations, liquidity ensures it can pay bills and access enough cash when needed. Strong liquidity and profitability together contribute to long-term viability. Companies need profits to sustain operations and grow.
Yes, even a profitable business can have cash flow problems. If your sales are strong, but you're not being paid, or you're spending too much, you might not have the cash flow to keep operating efficiently.
To increase profit, a firm need to forgo liquidity which might damage the firm's goodwill, deteriorate firm's credit standings and that might lead to forced liquidation of firm's assets and excessive liquidity on the other hand indicates the accumulation of idle funds that don't fetch any profits for the firm.
According to the Trade-Off Theory, the most profitable firms have capacity for a higher level of debt, taking advantage of debt tax shields (Mackie-Mason 1990; Fama, French 2002).
Liquidity Preference Theory and Investing
Holding highly liquid assets provides protection and the flexibility to shift into other investments when the market changes. You might take on more risk and illiquidity through investments like stocks, real estate, or high-yield bonds when that occurs.
As institutions quickly try to sell assets or secure additional financing, liquidity becomes scarce, driving up interest rates and spreading financial instability. This event can spread through the economy, affecting businesses, employees, and overall financial stability.
In summary, it is absolutely possible for a company can be profitable but not liquid. This situation can arise due to several factors, such as significant investments in long-term assets, high levels of short-term debt, or a high level of inventory that cannot be sold quickly.
For maintaining higher liquidity, banks will have to minimize the loans and purchase of securities which will sacrifice their profit. Therefore, liquidity and profit are two contradictory goals for commercial banks.
Profitability is a measure of financial performance. Liquidity is a measure of a cash position in the company and how liquid the company is to meet its short-term obligations. Profitability is also a degree of how well the company is generating margins from its business.
Working capital affects both the liquidity as well as the profitability of a business. As the amount of working capital increases the liquidity of the business increases. However, since current assets offer low returns with the increase in working capital the profitability of the business falls.
Profitability is a measure of how efficiently a business converts its expenses into profits for its owners.
Profitability and liquidity directly influence the value of company, whose maximization is a trade-off between maximum earnings and minimum cost of capital related to risk. The trade-off between profitability and liquidity maximization determines the decisions in a company and is the result of their relationship.
The weighted average cost of capital (WACC) is the average rate that a business pays to finance its assets.
The pecking order theory states that managers display the following preference of sources to fund investment opportunities: first, through the company's retained earnings, followed by debt, and choosing equity financing as a last resort.
The effect of liquidity on the profitability is to explain the investments or assets of the bank such a means that the bank perhaps capable of paying the rapid liability due upon it without substantial damage. The pre-arrangement of assets will lead toward gain profit.
Also, according to the economic theory, risk and profitability are positively related (the more risky the investment, the higher the profits it should offer), thus since higher liquidity means less risk, it would also mean lower profits.
Liquidity refers to the extent to which a company can convert its assets into cash quickly and without significant loss of value while profitability refers to the extent to which a company generates profits and returns investments for its owners.
Accounting items like depreciation, capitalized costs, or one-time charges can result in a negative net income even if cash flows were net positive for that period.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization and is a metric used to evaluate a company's operating performance. It can be seen as a loose proxy for cash flow from the entire company's operations.
Cash flow is the lifeblood of any business. Many small businesses falter because they lack enough cash to handle day-to-day operations or unexpected expenses. Effective financial management involves careful monitoring of cash flow, prioritizing that the business can cover its bills and invest in growth opportunities.