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ABSTRACT
Profitability and liquidity are the most prominent issues in the corporate finance literature. The ultimate goal for any firm is to maximize profitability. However, too much attention on profitability may lead the firm into a pitfall by diluting the liquidity position of the organization. In this way, the present study is initiated to find out the cause and effect relationship between liquidity and profitability. The study covered 31 listed manufacturing firms in Sri Lanka over a period of past 5 years from 2007 to 2011. Correlation analysis and descriptive statistics were used in the analysis and findings suggest that there is no significant relationship between liquidity and profitability among the listed manufacturing firms in Sri Lanka.
Keywords: Liquidity, Profitability, Corporate Finance, Manufacturing Firms.
INTRODUCTION:
Profitability and liquidity are the most prominent issues that management of each organization should take studying and thinking about them into account as their most important duties. Liquidity refers to the ability of a firm to meet its short term obligations. Liquidity plays a crucial role in the successful functioning of a business firm. A study of liquidity is of major importance to both the internal and external analysts because of its close relationship with day to day operations of a business (Bhunia, 2010). A weak liquidity position poses a threat to the solvency as well as profitability of a firm and makes it unsafe and unsound.
Profitability is a measure of the amount by which a firm's revenues exceeds its relevant expenses. Potential investors are interested in dividends and appreciation in market price of stock, so they pay more attention on the profitability ratios. Managers on the other hand are interested in measuring the operating performance in terms of profitability. Hence, a low profit margin would suggest ineffective management and investors would be hesitant to invest in the company.
The liquidity and profitability goals are contradictory to each other in most decisions which the finance manager takes. For example, the firm by following a lenient credit policy may be in a position to increase its sales, but its liquidity may tend to worse. In addition to this, referring to the risk return theory there is a direct relationship between risk and return. Thus, firms with high liquidity...