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Liquidity and Profitability Amna
Liquidity and Profitability Amna
Evaluation of the Financial performance of a business organization is essential to ensure that the
business is able to grow and expand in the long run. The financial performance would reveal whether
the company is being able to reach their objectives. In the financial performance there is a strong
element of profitability and Liquidity . Liquidity refers to the ability of an organization to meets short
term financial obligations while profitability of a business refers to the amount income it has been able
to make over the financial period. For a successful business both the aspects are important. Absence of
Liquidity would mean that the business would not be able to function as it would not be able to meet
the day to expenses which would be incurring on a daily basis while lack of profitability would mean that
the investment from the shareholders or the owners would be considered as a sunk cost. This report will
assess the importance of Liquidity and profitability for a firm. It would then assess the profitability and
Liquidity of two United Arab Emirates firms. The report would conclude by explaining how to ensure
that those companies can improve their Liquidity and profitability position.
Theoretical Background
LIQUIDITY is the capacity of the organization to change promptly of its advantages into some
other resource and pay their momentary commitment due on schedule. This is among the significant
estimation which include arranging and controlling the current resources and current liabilities. Money
is among the fluid resources contrast with fixed resource which is illiquid.
LIQUIDITY examination of the organization must be done first in breaking down the
organization's money related position. This is because of the major issues that may emerge, for
example, expected bankruptcy and bungle by the administrator. The normally LIQUIDITY proportion
utilized are current proportion and fast proportion for a brisk check of Liquidity , however there are
likewise another segment to have better comprehension of organization's capacity to make installments
to different gatherings, for example, money cycle, working capital, records of sales, inventories, current
liabilities.
Other than the utilization of the LIQUIDITY proportion as determinant of association's capacity
to pay for momentary obligation, it additionally can be utilized to stay away from of exorbitant holding
of stock. The budgetary experts usually utilized the particular LIQUIDITY proportion, for example,
current and brisk proportions, which permit them to make fleeting or cross sectional examination which
As a feature of it, another idea that additionally ordinarily used to recognize the LIQUIDITY of
the organization is WORKING CAPITAL which is determined by deducting the current liabilities of the
firm from the current liabilities. The WORKING CAPITAL is significant estimation in deciding budgetary
security for the organization. It is wellbeing for the organization to have increasingly current resources
The organization needs to weight on the LIQUIDITY the executives in light of the fact that from
the past examination on organization's accounting report piece in Spanish found that 69 percent of the
advantages is current resource and 52 percent of liabilities speak to current liabilities (La Porta et al,
1997). As per Petersen and Rajan (1997), the high level of current liabilities because of the explanation
that the current liabilities become one of their fundamental outside budgetary advances in light of the
fact that the organization neglected to get the drawn out store from the bank and different loan bosses.
This is additionally bolstered by other specialist, for example, Whited (1992), Petersen and Fazzari
(1993) that expressed that current liabilities become one of assets because of their budgetary oblige.
Likewise research done in US by Elliehhausen and Wolken (1993), Petersen and Rajan (1997) found that
the US little and medium firm size rely upon flow liabilities when they have budgetary issues. The
effective LIQUIDITY the executives is especially significant for the large organizations just as little
organizations. It is fairly significant in little organizations as featured by Peel and Wilson (1996).
In the event that an organization's present liabilities surpass the measure of current resources, the
organization will confront the issues to repay the leasers for the time being. On the off chance that this
difficult continues, the organization could wind up into chapter 11. As expressed by Nicholas (1991) that
organizations that didn't worry to improve LIQUIDITY the executives until it was past the point of no
return and arriving at emergency conditions or end up nearly chapter 11. Besides, it is critical to have
investigation. Essentially, these calculations are used to recognize the capacity of the firm to pay its
financial obligation, to assess organization execution just as to get to organization esteem. Concurring
Palepu et al (2003) examination done might be inside organization itself, or for the specific firm yet think
about for quite a long while, look at a similar proportion for the distinctive organization in same
industry.
From past examinations, they found that bookkeeping proportion additionally helpful in giving
data to dynamic procedure (Houghton, and Woodliff, 1987, Thomas and Evanson (1987, Lewellen,
2004). For some moment, LIQUIDITY proportion likewise valuable in anticipating business
disappointments (Beaver, 1966; Altman (1968). The overabundance in WORKING CAPITAL speaks to a
security pad for suppliers of momentary assets of the organization, for example, loan bosses, bank. This
is likewise seen decidedly the accessibility of inordinate degrees of WORKING CAPITAL and money. In
any case, from a working perspective, this over the top of WORKING CAPITAL has been looked as a
restriction on budgetary execution on the grounds that these advantages don't add to return on value
(Sanger, 2001).
A ton of strategies could be applied to improve LIQUIDITY and money positions, simultaneously
it can build the productivity of their administration. Toward the end it would bring about high
PROFITABILITY. These incorporate credit protection (Brealey and Myers, 1996; Unsworth, 2000; and
Raspanti, 2000), considering of receivables (Brealey and Myers, 1996; Summers and Wilson, 2000).
The productivity of LIQUIDITY arranging and control which incorporate LIQUIDITY the board,
WORKING CAPITAL and money the executives have critical impact towards the benefits. In reality, the
most significant is to have effective LIQUIDITY the executives and the following, PROFITABILITY will
follow too.
The significant of organization's LIQUIDITY can be seen from alternate points of view. Essentially
organization's LIQUIDITY laid on the going concern idea which not included any default in not so distant
future. The primary party who intrigued on organization's LIQUIDITY is transient moneylenders. These
moneylenders intrigued on installment made on the obligation and transient commitment since they
can sensibly expected to be paid. For their own security, loan specialists would lean toward the
For the financial specialists and the executives, holding enormous money adjusts isn't the
advantage exercises in the organization. Other than the issue because of the presence of the money,
this money additionally become as additional expense to the organization. The organization really has
renounced the premium salary from momentary venture in the event that they hold a ton of surplus
money.
Then again, it is additionally important for organization to hold money to make quick
installments for the situation to attempt quickly the most alluring tasks, and to bargain without
significant disturbances with unexpected issues. The measure of money rely upon expected
development and faces hazard, the higher the desire, the more the organization must have a pad of
prepared money. The excess money close by permit organization to make the most of new open doors
rapidly. A solid money position helps originating from new items, changing client tastes or changing
economic situations.
Another factor to be considered for keeping close by other fluid resources, for example,
receivables is as a piece of deals procedure of the firm. Organizations generally offer their client to take
30, 60, 90 days or more to pay for their buys. This is to empower prompt acquisition of the client in the
Record payables are a significant component of corporate money. As indicated by Rajan and
Zingales (1995) the total measure of payables in American firms was a huge part (17.8%) of complete
resources for all in the mid-1990s. Other nation, for example, Germany, France and Italy, additionally
indicated the critical measure of payables which speaks to in excess of a fourth of complete corporate
resources, in United Kingdom payable likewise show huge worth which speak to 70% of all out
momentary obligation (credit broadened) while 55% of all out credit got by firms is comprised of record
Truth be told, payables are likewise significant factor in rising economies, similar to China,
because of constrained help from the financial framework. The organizations relying more upon credit
on buys contrasted with different structures, for example, bank advances as featured by Ge and Qiu,
(2007). Like Atanasova and Wilson (2004) locate that littler UK organizations will in general increment
their dependence on between firm credit to keep away from bank credit apportioning.
In any case, creditor liability doesn't require completely consideration for the organization since
it doesn't devours assets however fill in as present moment of wellspring of account. The advantages
Past analysts have seen the relationship exchange off among inventories and payables, for
example, Nadiri (1969), Schwartz (1974), Ferris (1981) and Emery (1987)). Just Emery (1987) considers
unequivocally the exchange off between exchange credits and inventories yet his examination does
exclude the deterministic variable interest system. All the more as of late, the examination from Daripa
and Nilsen (2005) has hypothetically explored how this exchange off could influence the terms of credit
understandings. In their model, providers offer exchange credit as a motivation to purchasers to hold
Typically, administrations worried about LIQUIDITY yet they can't possibly concern LIQUIDITY as
single component since when there are lack or inordinate in receivables or stock it generally will
reflected to creation, deals endeavors, fixed resources or other administration choice boundaries, not
LIQUIDITY alone. As featured previously, receivables and stock reflected to deals and creation systems.
WORKING CAPITAL is likewise significant factor in LIQUIDITY the executives because of its impact
on the PROFITABILITY and danger of the firm. In particular, the interest in WORKING CAPITAL is
profoundly related with tradeoff among PROFITABILITY and hazard which implies that if the organization
chooses to expand the benefit, they need to confront the expansion in chance just as expressed by
Smith (1980).
Another investigation has been done on effect of the various factors of WORKING CAPITAL
administration by Rehman (2006). The examination have perceive that the variable including Average
Collection Period, Inventory Turnover in Days, Average Payment Period and Cash hole on the Net
This research is based on secondary data. The first step has been to get information about profitability
and liquidity using the scholarly articles and then the information from the financial statements from
two companies were compared. The ratios were calculated based on the information collected from
Empirical Analysis
This section will include the calculation of profitability and liquidity ratios of two companies. The
performance would compared and analyzed using the ratios. The names of the companies have been
kept anonymous due to the request from the owners. The following are the details
Income Statement
Details Company-A Company-B
Analysis
There is a stark difference as far as the working capital is concerned. The company A is having a negative
working capital which would mean that the company is in a huge risk. It does not have the liquid funds
to meet its financial obligations in the short run. Company B on the other hand has funds to meet their
The working capital ratio speaks the same store. Company A has only 0.67 AED for every 1 AED of
liability. This would mean that in the event of a breakdown the company would be in a serious issue
when related to paying their dues. Company B on the other hand has managed its liabilities and finances
in a more stringent manner. This is why they have an ideal working capital ratio of 2. This would mean
that they are having enough current assets to meet their liabilities.
The debt to equity ratio would show the fact that how much long term debt which has been taken by a
business. For Company A the debt is close to 40% of the money invested by the shareholders. In other
words the company’s actual investment is only 60%. A higher debt ratio would mean that the interest
expense would be high and the company would find it difficult to deal with the expansion. Company B
on the other hand has only 10% debt which is a positive sign.
Company A has a debt to asset ratio of 18% while company B has the same ratio of only 6%. In this
regard both the companies are doing well and would not need much of a changing as the debt is well in
Company A is making substantially higher profits and have a margin of 80%. This would mean that either
their cost of sales is lower or they are able to sell at higher prices as the company B has a margin of only
25%. Despite the higher profits the company A is being able to make it has some serious difficulties in
There is similar store for operating profit margin, return on assets, and return on equity Company A has
been substantially better when compared to Company B. However, one of the most important aspect
which must be taken into account is the fact that the company A is in huge risk of going out of business.
It would need to make some desperate measures to ensure that the business is able to meet their
expenses on a daily basis. They might even need to sell off their fixed assets to ensure that they can
Recommendations
From the given data it is clear that Company A has been extremely efficient in generating profits for the
shareholders. However, there is a clear note that the company cannot succeed or continue to operate in
the same manner if it is not able to meet their expenses. There is a strong need to ensure that they
improve the liquidity position. On the other hand the profitability condition of Company B is not up to
the mark when the financial statements for both companies are compared. Some of the ways a
company can improve its liquidity and profitability are discussed below:
Selling off surplus fixed assets: this approach would bring some vital cash flow into the business
and the funds can then be used to ensure that the liabilities are cleared. This would also mean
that long term future can be secured. This is particularly applicable for Company A where there
Invest in fixed assets to improve efficiency: the investment in fixed assets or a newer
technology can also mean that the efficiency of the firm would increase and the expenses would
reduce. This would also ensure that the profits of the company can increase.
Bulk Purchases: a company must use its cash resources to purchase goods in bulk quantities.
This would reduce the purchasing costs and would also ensure that the business is able to
increase their profit margin. This would be applicable for company B as they have surplus
current assets which can be used to ensure that trade discounts can be achieved.
Conclusion
Businesses must follow a fine line in ensuring liquidity and profitability. The liquidity of a busines
would ensure that the business is operating while the profitability of the business relates to one
of the ultimate objective of the business. A company which has some resources can survive in
the market if it is not making profits in the short term but liquidity is essential for any business
at all times. Thus, a business should focus equally on both the aspects as both would be needed
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