Magazine 2017
International Peer-Reviewed Journal  
*Dr Arvind A Dhond  
A firm is required to maintain a balance between liquidity and profitability while conducting its day-to-  
day operations. This paper analyzes the relationship between liquidity and profitability in a group of  
companies comprising the major pharmaceutical companies in India between 2011 and 2015. The aim of  
this work is to verify the relationship between these two indicators over the short term, and also to  
observe their relationship. Using the financial data published by the companies, the relationship was  
studied with the help of statistical procedures. Surprisingly the results indicated a significant positive  
correlation between liquidity and profitability on the short run, contradicting the main literature in financial  
Keywords : Liquidity, Profitability, Funds, Ratio, Dilemma, Short Term. nt.  
Modern days finance manager has to manage financial resources judiciously. The liquidity and profitability  
goals conflict in most decisions which the finance manager makes. Often a challenge usually arises in deciding  
whether to favor liquidity or profitability. It is not possible to favour both in one single decision. The more  
liquidity a firm maintains, the lesser profitability will be achieved. Likewise, the lesser liquidity the firm decide to  
maintain, the more financial resources it is able to channelise towards its fixed capital investments which eventually  
leads to more profitability. Thus a financial manager has to ensure on one hand that the firm has adequate cash  
to pay for its creditors, has sufficient cash to make unexpected large purchases and cash reserve to meet  
emergencies, while on the other hand, he has to ensure that the funds of the firm are used so as to yield the  
highest return. This poses a dilemma of maintaining liquidity or profitability. A proper management of liquidity  
could result in the desired impact on profitability and vice-versa.  
Parameters of the Study  
(a) Liquidity is a precondition to ensure that firms are able to meet its short-term obligations. The ‘liquidity  
position’ in a company is measured based on the ‘current ratio’ and the ‘quick ratio’.  
(b) Profitability is a measure of the amount by which a company’s revenues exceeds its relevant expenses. The  
profitability position’ of a company is measured using the ‘gross profit margin’ and the ‘net profit margin’.  
Review of Literature  
a) Hyun-Han Shin and Luc Soenen (1998) have focused their study on efficiency in working capital management  
and corporate profitability of 58,985 firms covering a period from 1975-1994. The study found that there  
exist a strong and positive relationship between liquidity and profitability.  
(b) Marques and Braga (1995) confirmed the inverse relationship between liquidity and profitability for a  
sample of food companies.  
International Peer-Reviewed Journal  
c) Blatt (2001), found a negative relationship between liquidity and profitability, measured by Dynamic Model  
and profitability.  
d) Eljelly (2004) elucidated that efficient liquidity management involves planning and controlling current assets  
and current liabilities in such a manner that eliminates the risk of inability to meet due short-term obligations  
and avoids excessive investment in current asset.  
Rationale of the Study  
The work is justified because all the researched concepts are widely known and accepted, i.e. there is a wide  
literature inside the financial management area regarding the concepts of liquidity and profitability. There is a  
need felt for the present study to study the relationship between liquidity and profitability because of differences  
in the inferences of results obtained as indicated in the review of literature so as to reconcile their findings with  
logical conclusion, however for a different group of companies from a different business segment and into a  
different period.  
For this purpose the liquidity and profitability ratios of five pharmaceutical companies over a five year period  
were computed and analysed in order to understand the relationship between liquidity and profitability.  
Objectives of the Study  
a) To study the inter-relationship of liquidity and profitability in the pharmaceutical sector.  
b) To compute the profitability, liquidity and solvency ratios of the select sample firms.  
c) To analyse liquidity and profitability ratios of five pharmaceutical companies over a five year period and  
draw inferences therefrom.  
Hypothesis: On the short term the relationship between liquidity and profitability is negative.  
The research paper aims at testing the research question - Is there a negative relationship between liquidity and  
profitability on the short run?  
Research Methodology  
This study is an analytical research. The sample size of the study is five years from 2011 to 2015 wherein five  
companies from the pharmaceutical sector which are listed on BSE are selected based on ‘Top Global Pharma  
Companies’ industry ranking. The secondary data is collected from the records of the select units from the  
published financial statements in the company’s annual reports which included the Balance Sheet and Profit  
and Loss Account of the company. Further analysis of the data is made using certain financial tools and  
techniques as ratio analysis as well as assessment of the statistical significance of such data is undertaken using  
the Pearson’s Correlation coefficient.  
Data Analysis and Findings  
Table-1: Analysis of Financial Data of Select Pharmaceutical Companies  
International Peer-Reviewed Journal  
Source: Data Computed by Researcher)  
The results of correlation between liquidity and profitability testing of the above five pharmaceutical companies  
shows in sixteen out of twenty cases there exists a positive correlation and in only four cases there is a negative  
relationship. Except in four instances, there is a positive correlation between the movement in the profitability  
ratios and the liquidity ratios.  
On testing the hypothesis in order to determine whether the short term relationship between liquidity and  
profitability is negative. This hypothesis was rejected for 80 percent (16 out of 20 instances) of the cases for the  
studied group; as the correlation between the two variables was significantly positive. Hence it can be concluded  
that there exists a strong and positive relationship between liquidity and profitability in the short term.  
The results indicated that for the studied companies, on the short term the higher the liquidity level of the  
company, the higher is its profitability. The correlation between liquidity and profitability ratios indicate that  
liquidity and profitability could goes hand-in-hand. It contradicts the usual findings from the literature, indicating  
that for this sample of pharmaceutical companies the dilemma between liquidity and profitability on the short  
term does not exist.  
The reason for this different result is that the pharmaceutical sector may differ from the segments analyzed in  
other studies. The operation of the pharmaceutical sector demands a high amount of current expenses thus a  
higher level of working capital may be directly related to the capability of reducing the costs, and thus being  
able to obtain higher profits.  
International Peer-Reviewed Journal  
Despite the limited scope of this study, the observations would suggest that a company while planning working  
capital need not maintain a trade-off between the two as is usually felt. In the light of the above, financial  
managers would need to reflect on the implications of each decision that usually involves a trade-off between  
liquidity and profitability. It would also be useful to assess the effect of one decision involving this trade-off vis-  
à-vis another, so that an overall view can be taken.  
a) The study is for a short term period of five accounting years from 2011 to 2015.  
b) The main constraint of this study is considered as the data used is secondary.  
c) The data was collected based on the company annual report. Hence its accuracy depends on honesty in  
reporting of accounting information.  
According to Chandra (2001, p.72), normally a high liquidity is considered to be a sign of financial strength,  
however a high liquidity can be as undesirable as a situation of low liquidity. This would be a consequence of  
the fact that current assets are usually the less profitable than the fixed assets. It means that the money invested  
in current assets generates lesser returns then fixed assets, representing thus an opportunity cost. Besides that,  
the amount employed in current asset generates additional costs for maintenance, thus thereby reducing the  
profitability of the company. It is therefore an important task for the financial manager to achieve the appropriate  
balance between adequate liquidity and a reasonable return for the company. The financial health of the  
company can be improved if stringent control is exercised on raw materials, stores and spares, finished goods,  
collection of receivables and also by reducing the unprofitable investment blocked in current assets as well as  
reducing the unwarranted overdraft and short term bank borrowings. Management of working capital has  
indeed achieved a higher importance in the management of corporate finance due to its impact on profitability.  
Balakrishnan, “A Case Study of Financial Performance of Public Sector Petroleum Industry”, The Management  
Accountant, 2005, pp. 172-174.  
Blatt, A. (2001) Balance Sheet Analysis: Structure and Evaluation of Statements Financial. Sao Paulo :  
Makron Books, (Original Work in Portuguese Language).  
Chandra Prasanna (2001). ‘Financial Management’. Tata McGraw-Hill Publishing Company Limited, New  
Dr. S.N. Maheshwari (2001), ‘Principles of Management Accounting’. Sultan Chand Sons, New Delhi.  
Eljelly. A, “Liquidity - Profitability Tradeoff - An Empirical investigation of Belgian Emerging Market”  
International Journal of Commerce and Management Vol. 14 No.2, 2004, pp 48 - 61.  
Harbans Lal Verma, “Management of Working Capital”, Deep and Deep Publication, New Delhi, 1989.  
Hyun-Han Shin and Luc Soenen, “Working Capital Management in Loss-Making Companies”. The  
Management Accountant April 1998, pp.137-139.  
Marques, J. A. C., & Braga, R. (1995) Dynamic Analysis of Working Capital: Model Fleuriet. RAE - Journal  
of Business Administration. 35 (3) 49-63, (Original Work in Portuguese Language).  
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S.C. Kuchhal (1993). ‘Financial Management - An Analytical and Conceptual Approach’. Chaitanya Publishing  
House, Allahabad.  
Annual reports of select companies.  
Associate Professor In Commerce, St. Xavier College ,CST Mumbai-4000001.