Liquidity and Profitability Trade-Off: A Study of Indian Pharmaceutical Companies

Abstract

Liquidity plays a vital role in the successful functioning of every business. The important part in managing working capital is maintaining liquidity on a day-to-day basis to ensure the smooth running of the organisation and to meet its obligations. Hence, it is very important to keep a close eye on the liquidity position of the company as without it, the company cannot survive. But efforts to increase the profitability would tend to reduce firms' liquidity and too much attention on liquidity would tend to affect profitability. No doubt, every firm tries to maximise profitability by maintaining liquidity. However, increasing profits at the cost of liquidity might cause serious problems for the firm including financial insolvency. Thus, an effective WCM would be needed to strike a balance between the two core objectives of the firm. It is essential that the firm's liquidity should be properly balanced because excessive liquidity on one hand, indicates the accumulation of idle funds that don't fetch any profits for the firm and on the other hand, insufficient liquidity might damage the firm's goodwill, deteriorate the firm's credit standing, which may lead to forced liquidation of the firm's assets. Hence, a trade-off needs to be maintained between liquidity and profitability. This paper attempts to study the association between liquidity and profitability for a period of five years from 2011-12 to 2015-16 for five selected pharmaceutical companies. The objective of the study was mainly to know whether companies earn profit while maintaining the necessary liquidity or are they ready to sacrifice liquidity for the sake of earning higher profit. The results indicate that among the five selected pharmaceutical companies, i.e. Ajanta Pharma, Biocon Ltd, Torrent Pharma, Ipca Labs and Lyka Labs., the liquidity position of Biocon is best when it comes to liquidity analysis as per Motaal's test of liquidity. The techniques of Motaal's ultimate rank test have been applied to analyse the data. The researchers have used purely secondary data for the purposes of this study. In this paper, an attempt has also been made to study the association between liquidity and profitability of the sample companies by using Spearman's Rank Coefficient of Correlation. The results found were the same with the theoretical views i.e. both are negatively correlated. But there are instances like Wal-Mart, which is able to generate profit and maximise shareholders' wealth with negative working capital, i.e. an example of foregoing liquidity for the sake of maximising profits. In such a case, can we say that the company is on the verge of bankruptcy or is it a sign of managerial efficiency?

Keywords: Pharmaceutical Companies, Working Capital, Motaal's Ultimate Rank, Liquidity, Profitability, Spearman's Rank Correlation