Relationship between liquidity and profitability: An analysis of Indian cement companies

Abstract

The ultimate aim of working capital management is to enable a firm to maximize profits from its operations and to maintain enough liquidity at the same time. As liquidity and profitability are inversely related to each other, hence increasing profitability would tend to reduce firms’ liquidity and too much attention on liquidity would tend to affect the profitability. Though every firm tries to maximize the profitability by preserving the liquidity but, increasing profits at the cost of liquidity might cause serious trouble to the firm and this problem might lead to financial insolvency as well. Thus an effective balance between liquidity and profitability is very much required to achieve both of the objectives of every firm, i.e. liquidity and profitability. 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. Hence a study is very much required to understand how firms earn profit without compromising the liquidity. This study is an attempt to establish the relationship between the liquidity and profitability of top ten Indian cement companies. The data has been analyzed using Spearman's Rank Coefficient of Correlation and it is found that both liquidity and profitability is negatively correlated which confirms the theoretical viewpoint.