Liquidity-Profitability Trade-Off – A Game of Survival and Growth

Author

Ashok Panigrahi

One of the fundamental truths of survival for a firm is that it should be liquid enough while simultaneously being consistently profitable to grow and create wealth. While survival is essential for growth, growth is, in turn, essential for survival. In other words, to maintain liquidity, the firm needs to keep sufficient resources idle, while to earn profit, it needs to invest the idle resources. Hence, the question then arises
whether it is possible to remain liquid and avoid the chances of bankruptcy while simultaneously earning super-normal profits. Although the theory of finance states that both are negatively correlated and can’t be increased simultaneously, a few organisations have proved this wrong with superior profits along with high liquidity. This makes the validity and applicability of the theory of liquidity and profitability a matter of
debate. Some managers opine that proper negotiations with lenders and creditors to safeguard the organisation from bankruptcy will negate the need to block a huge amount of idle resources simply to maintain the required liquidity ratios. But again, the moot question is whether this implies that the right approach to earning more profits is by fully utilising resources, which is practically followed by many reputed organisations like Walmart, Dell, as well as many Indian companies. These companies operate for years with negative working capital while earning superior profits consistently. This is possible only with skilful management of receivables, payables and inventories. Finance experts argue that this situation is possible in FMCG companies, but not in manufacturing companies. However, analysis by the author indicates that many manufacturing companies, including ACC Ltd., have been profitable while operating with negative working capital consistently for a decade. Being able to enhance profitability while avoiding bankruptcy implies managerial efficiency.

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