Introduction

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

is inside the organization itself or different organizations in the businesses.

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

over its present liabilities expected to be polished by the organization.

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

LIQUIDITY to ensure that the business can grow.

The importance of Liquidity

LIQUIDITY ratio as a component of bookkeeping tool is significant apparatuses in monetary

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

organization with a high LIQUIDITY as their assurance.

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

enormous sum. (Jędrzejczak-Gas, 2017)

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

payables(Kohler et al., 2000; Guariglia and Mateut, 2006).

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

emerge that it could decrease the money hole.

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

higher inventories(Liew et al., 2020).

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

Operating PROFITABILITY of firms has a solid negative relationship

Research Methodology

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

different financial statements.

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

AED Million AED Million

Sales 500 600
Cost of goods Sold 100 450
Gross Income 400 150
Operating expenses 200 75
Net Income 200 75
Interest Expense 10 5
Balance sheet
Fixed Assets 450 300
Current Assets 100 200
Current Liabilities 150 100
Owners’ Equity 400 400
     
Ordinary Shares 250 300
Retained Earning 50 70
8% Debentures 100 30
  400 400
INVENTORY 30 40
 Calculation of Ratios
Company-A Company-B
WORKING CAPITAL -50 100
WORKING CAPITAL RATIO 0.67 2
QUICK RATIO 0.47 1.60
DEBT TO EQUITY RATIO 40% 10%
DEBT TO ASSET RATIO 18% 6%
PROFITABILITY RATIONS
MARGIN 80% 25%
OPERATING PROFIT MARGIN 40% 13%
RETURN ON ASSETS 36% 14%
RETURN ON EQUITY 80% 25%

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

liabilities which is one of the key aspects of success for a business.

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

control in both the companies. (Tsuruta, 2019)

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

paying their current liabilities.

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

operate(Mun & Jang, 2015).

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

is a clear shortage of liquid assets(Masri & Abdulla, 2018).

 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

for a business to succeed in the long run(Ding et al., 2013).

References

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