Relationship between Liquidity and Profitability: An Exploratory Study of SMEs in India

Abstract

In today’s dynamic business environment, survival of the organization is more uncertain even though the companies are earning profit, unless they have a robust financial management system. Among these liquidity management is basically considered as life line for any economic unit and its management is considered as the most important functions of corporate management. The trade-off between the company’s liquidity and the profitability has been an interesting debate in financial management. Theoretically, the liquidity management decisions of any company affect profitability. Bearing in mind this notion, this article makes a modest attempt to investigate the relationship between liquidity and profitability in 28 Bombay Stock Exchange listed and traded small and medium enterprises (SMEs) between 2011 and 2016. The correlation analysis showed that the relationships between liquidity ratios and performance of SMEs are negative but not significant. The results from the pooled regression analysis showed that there is a significant effect of liquidity management on profitability of selected SMEs. Further, the result also showed negative association between profitability measures (net profit margin, return on assets, and return on capital employed) and the explanatory variables (current ratio, quick ratio, and cash ratio) in selected SMEs. Market capitalization, sales growth rate, and financial debt ratio were used as control variables in this study.