Liquidity Vs Profitability

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Liquidity v/s profitability - Striking the right balance A firm is required to maintain a balance between liquidity and profitability while conducting its day to day operations. Investments in current assets are inevitable to ensure delivery of goods or services to the ultimate customers. A proper management of the same could result in the desired impact on either profitability or liquidity. Liquidity is a precondition to ensure that firms are able to meet its short-term obligations.1 The 'liquidity position' in a company is measured based on the 'current ratio' and the 'quick ratio'. The current ratio establishes the relationship between current assets and current liabilities. Normally, a high current ratio is considered to be an indicator of the firm's ability to promptly meet its short term liabilities. The quick ratio establishes a relationship between quick or liquid assets and current liabilities. An asset is liquid if it can be converted into cash immediately or reasonably soon without a loss of value.1 Consequences of low liquidity a) A company that cannot pay its creditors on time and continues not to honor its obligations to the suppliers of credit, services and goods could result in losses on account of non-availability of supplies and lead to possible sickness or insolvency.2 Also, the inability to meet the short term liabilities could affect the company's operations and in many cases it may affect its reputation as well.2 Lack of cash or liquid assets on hand may force a company to miss the incentives given by the suppliers of credit, services, and goods as well. Loss of such incentives may result in higher cost of goods which in turn affects the profitability of the business. b) Every stakeholder has interest in the liquidity position of a company. Suppliers of goods will check the liquidity of the company before selling goods on credit.
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