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The tradeoff between liquidity and profitability: evidence from Indian manufacturing firms

The main aim of this research paper is to examine the trade-off between liquidity and profitability of Indian firms. The target population of the study is manufacturing firms. The study used convenience sampling for collecting the data. The study is based on secondary data for the period from 2008 to 2017 and 20 Indian manufacturing firms are selected for this purpose. Analysis of the data has been undertaken using SPSS software. Findings revealed that current liabilities ratio have a positive and significant impact on earnings per share and profit after tax. On the contrary, the current ratio and quick ratio have an insignificant impact on earnings per share, return on capital employed, return on assets and profit after tax. This study suggests that managers should incorporate liquidity into their evaluation decisions in order to boost the financial return of their businesses. The current study offers valuable insights into the success of Indian listed companies for administrators, analysts, regulators, investors, and other interested parties. There is insufficient research that has been conducted to examine the trade-off between liquidity and profitability. Furthermore, findings from this literature cannot be relied upon as they are outdated. Therefore, this study is going to provide updated evidence on the trade-off between liquidity and profitability of Indian manufacturing firms, an area that has largely remained unexplored.


Introduction
Liquidity refers to the availability of funds to meet working capital requirements and how quickly current assets can be converted into cash. It has a vital impact on the overall smooth functioning of a company. Understanding the concept of liquidity is crucial to both external and internal analysts is demonstrating a firm's potential to conduct its day-to-day operations (Al-homaidi et al., 2020; Elangkumaran and Karthika, 2013). The concept of liquidity is important for a business as it signify its capacity to fulfil its short-term financial obligations. The common indicators of liquidity are the ones that are used by companies that have the existing amounts of cash and marketable securities, which are those that exceed their long-term liabilities. The current ratio establishes the relationship between short-term assets and liabilities. In general, a high current ratio indicates that the firm's potential to fulfil short-term financial obligations is strong, while a low fast ratio indicates a low connection between a firm's current liabilities and its corresponding current assets. Liquid assets refer to those assets that can be converted into cash easily without incurring losses against their current market value. A low current ratio signify that a business is unable to meet its short-term financial commitments to creditors, service providers, and suppliers of products and services on time. (Owolabi et al., 2011, Alahdal et al., 2016. Wang (2002) discovered that proactive liquidity management improves a firm's financial efficiency and typically results in a firm's increased market value. Effective liquidity management downgrades and removes the risk of being unable to fulfil short-term financial obligations as they mature, while also preventing undue investment in these properties (Priya and Nimalathasan, 2013). Profitability information is important in operational and financial decision-making since it is useful for financial managers, shareholders, and investment analysts as a yardstick for dividend payments, a measure for assessing management efficiency, and a tool for evaluating decision making (Nassirzadeh and Rostami, 2010). Profitability and its corresponding concept of liquidity constitute critical issues that all commercial entities should continue to research and consider as one of their primary responsibilities. Nassirzadeh and Rostami (2010) consider liquidity to be very important, since low-and-zero-profits companies can serve the economy while companies without liquidity cannot serve the economy. Liquidity management and operational profitability are substantial areas for the growth and long-term survival of a company that require management to strike-a-balance between them (Priya and Nimalathasan, 2013). This paper aims to provide a review of literature on the relationship between liquidity and profitability of a firm using archival literature to explore the gap for future directions.
For any company, cash provides a protective shield and bulwark in its business operations. Thus, it serves as a backbone of working capital requirements and continuous business operations and its ultimate survival. (Boisjoly and Izzo, 2009;Gitman, 2009) noted that all companies must have an ample amount of funds that matches operational expenditure as dictated by the nature of the business operations to ensure continuous functioning (Boisjoly and Izzo, 2009;Gitman, 2009). The integrative model of managing cash largely rely on business operation cycle. Any deviations from this management stimulates a positive/negative impact on the effectiveness of working capital (Boisjoly and Izzo, 2009).
Ordinarily, firms hold cash to be in a position to pay for business operation expenditures such as compensations, taxation, dividends and essential operational needs. When a firm is able to synchronize its receipts and payments in its operations, it does not need to increase the current funds it holds as there is sufficient cash for its short-term needs. However, in practice, this is not always the case, as this synchronization is constantly violated. As a result, the firm resorts to raising the cash it holds as payments overtake receipts. One of the ways through which a firm or company can raise cash quickly is through investments in marketable securities, particularly those whose maturity matches with the terms of anticipated payments. This way is generally resorted to when the company has payments that are not perfectly matching with receipts. The motive of holding cash for this purpose is called the transaction motive.
The quick ratio and the current ratio are the most frequently used techniques or strategies for calculating liquidity and working capital requirements. The quick ratio is denoted by the difference between current assets and current liabilities, while the current ratio is equal to the difference between current assets and current liabilities. Additionally, these two ratios are used to assess corporate liquidity. Essentially, they determine if the business is able to meet its financial obligations through the sale of liquid assets (Farris et al., 2002). Nevertheless, several researchers including Emery (1984) and Kamath (1989) criticized these measures as they considered them to be static in nature. However, their opinions were largely ignored as several authors utilized them to evaluate corporate liquidity ("Bhunia et al. ). Therefore, this study seeks to evaluate the trade-off between liquidity and profitability of Indian manufacturing firms. The rest of the paper is structured as follow: section 2 presents a review of prior studies, section 3 demonstrates the research design, section 4 interprets and discusses the results and finally, section 5 gives a brief conclusion of the paper.

Literature review
Numerous scholars have examined how liquidity affect profitability using conventional methods for determining liquidity of a firm, namely the liquidity ratio. Further, several researches indicate that there is a dearth of studies that address the issue of financial performance in India (e.g., Hashed Saleem and Rehman (2011), whereas on the other hand, the investigators applied three separate measures: "return on equity, return on assets, and return on investments"; in Mushtaq et al. (2015), meanwhile, the authors use return on assets. This investigation has shown to be quite beneficial in establishing a link between "liquidity and profitability". However, while Panigrahi (2013) and Krishnakumar (2010) researched India's software, cement, and steel industries using both "traditional liquidity indices and alternative profitability metrics such as return on investment, gross profit margin, return on assets, and earnings per share", Bhunia et al. (2011) and Panigrahi (2013) instead performed their research in these industries using both "the liquidity ratios metrics and alternative profitability metrics such as return on investment, gross profit margin, return on assets, and earnings per share". Findings were consistent with the notion that lower liquidity was correlated with lower profitability. While researching the data from Morgheim (2015) , the previously cited researchers discovered that there is a negative relation between liquidity and profitability, as measured by traditional indices, according to three additional research projects done in the United States, Nigeria, and Saudi Arabia Niresh (2012) sought to unravel the profitability-liquidity link. The research indicated a "mixed association between the independent and dependent variables" (positive and negative). The author observed a negative link between the current ratio and net profit and return on capital employed, but a positive association between the current ratio and return on equity. Additionally, the quick ratio correlates positively with net profit and return on capital employed, but negatively with return on equity. Hemalatha and Under (2005) sought to ascertain the liquidity and profitability of the chosen societies. Their study incorporated trend analysis, ratio analysis, variance analysis, and average and correlation coefficient calculations. The study concluded that "SWCSs failed to maintain an appropriate current and liquid ratios, owing to the fact that none of the SWCSs examined provided enough protection to creditors". Using current liquidity indicators such as the detailed liquidity index, cash conversion period index, and net liquid balance index, researchers in "Kenya, Sweden, Nigeria, Turkey, Greece, Japan, Taiwan, and China" sought to establish the influence of liquidity on firm profitability. They arrived at diametrically opposed conclusions. Unlike previous researchers who relied on conventional indices to assess liquidity and its influence on profitability, "Nobanee et al.  Ware (2015), and Yazdanfar and hman (2014)" chose to measure liquidity using a modern index, namely the cash conversion period. All of this research used "descriptive statistics, correlation analysis, and regression models" to evaluate the connection between variables. Liquidity, they found, had an adverse influence on profitability as defined by "return on assets, return on equity, and return on investment". In the Greek food business, Lyroudi & Lazaridis (2000) examined the link between liquidity as assessed by the cash conversion period and profitability as evaluated by "return on investment, return on equity, and net profit margin". They established a positive association between the cash conversion period and return on assets, return on equity, and net profit margin using regression and correlation analysis, as well as t-tests on two distinct samples. Duncan et al. (2015) objectively investigated and quantified the influence of cash management on deposit-taking institutions' financial performances. They developed a "self-administered standardised questionnaire for 92 respondents and gathered secondary data from the audited financial statements of the SACCOs and the regulator (SASRA)". The review of this study shows a strong positive relationship between cash management and financial performance. They recommended that SACCOs to accept deposits must have an appropriate cash management strategy in place to ensure optimum financial efficiency. By liquidity management (measured by the "cash flow management, credit policies, and cash conversion period of a firm"), Uyar (2009) argues that liquidity management has a significant impact on a firm's overall profitability. Jihadi et al., (2021) tested the link between firm value and liquidity, operation, leverage, and profitability. The sampling methodology used was a random sample of 22 index companies that were publicly traded on the Indonesian Stock Exchange between 2014 and 2019. The study indicated that the liquidity, operation, leverage, and profitability ratios all contribute significantly to firm value. Priya and Nimalathasan (2013) and Zygmunt (2013) conducted studies in Poland and Sri Lanka, respectively, with a sample size of ten firms. They used correlation and regression analysis. Their research established a high association between business profitability and liquidity, as evaluated by contemporary and historical indexes. Nassirzadeh and Rostami (2010) and Sandhar and Janglani (2014), on the other hand, performed research in Saudi Arabia, Iran, and India, respectively. They used correlation and regression analysis to ascertain the trade-off between liquidity and profitability. Their study revealed that profitability and liquidity, as measured by both standard indexes, are adversely associated. There are only slight discrepancies in the research findings based on current liquidity indexes. According to Nassirzadeh and Rostami (2010) and Sandhar and Janglani (2014), although conventional liquidity indicators have a significant influence on profitability, current liquidity indices have a minor influence. Surprisingly, Bibi and Amjad (2017) examined the link between firm liquidity and profitability by examining the influence of all liquidity components on profitability on the Karachi Stock Exchange. They calculated liquidity using the cash difference in days and the current ratio. They established a substantial positive link between conventional profitability indicators and contemporary liquidity indices, but contemporary liquidity indices had a strong negative association with profitability. Al-homaidi et al. (2019) studied the financial and operational liquidity factors that were important for all banks in India from 2008 to 2017. The findings indicate that "bank size, capital adequacy ratio, deposits ratio, operating efficiency ratio, and return on assets ratio all have a significant positive impact on liquidity, while assets quality ratio, asset management ratio, return on equity ratio, and net interest margin ratio all have a significant negative effect on liquidity". The study indicated that "debt, return on assets, and firm age" are the primary internal determinants of liquidity in India. Additionally, the findings indicate that among the internal determinants, "firm size, leverage ratio, return on assets ratio, and firm age" all have a substantial positive association with firms' liquidity, except for leverage ratio and firm age which have a negative relationship with firms' liquidity. Sari and Sedana (2020) results revealed that net income statement data and financial soundness have a "positive and significant" impact on the capital structure. As for financial soundness, net income has a significant effect whilst it also serves to exacerbate capital structure, and deflate capital value. Dadepo and Afolabi (2020) examined the effect of liquidity management on the output of ten manufacturing firms from 2012 to 2016. The study discovered that the current ratio has a substantial negative effect on the profitability of the selected companies, while fast and cash ratios have a favourable but negligible effect on ROA. Putri and Wiksuana (2021) studied the effect of liquidity and profitability on firm value through the lens of dividend policy. The findings of this study indicate that liquidity has a significant negative impact on firm value, while profitability has a significant positive impact on firm value, and that the dividend policy is incapable of implying the effect of liquidity and profitability on firm value. It is clear from the above discussion that there are a few studies that have analyzed the "trade-off between liquidity and profitability". Furthermore, these studies are not recent, a situation that renders their outcome outdated. Therefore, this study seeks to provide updated evidence on the trade-off between liquidity and profitability of Indian manufacturing firms, which is an area that has not been widely focused on by researchers.

Research methodology
The target population of the study is manufacturing firms. The study used convenience sampling for collecting the data. The reesrach is based on secondary data for the period from 2008 to 2017. 20 Indian manufacturing firms are selected for this purpose due to availability of data. The dependent variables are earnings per shares, return on assets, return on capital employed and profit after tax. The independent variables are cash to current liabilities, current ratio and quick ratio. In order to achieve the study objectives, descriptive statistics, correlation matrix and regression analysis are used and their results are interpreted further below. The following are the regression models which have been used in the analysis.

Correlation matric
Correlation matrix is an econometric tool that examines the trend of relationship between the variables. It indicates the strength of the correlation between the study's factors. It also provides an indicator of multicollinearity absence and presence. Another critical aspect of the correlation matrix is revealing whether the multicollinearity issue exists among the variables, or not. Field (2009) suggested that "if any variable in the correlation matrix has a coefficient higher than 0.87 or 0.97", it reveals the presence of multicollinearity. The results in Table (3) reveal that there is no coefficient value greater or equal to 0.87 which confirm the absence of multicollinearity in the models. Pearson correlation is used to determine the trade-off between liquidity and profitability. The results in Table (3) indicate that the cash to current liabilities ratio, current ratio, and quick ratio all have a positive and statistically significant relationship with all profitability measures, including earnings per share, return on capital employed, return on assets, and profit after tax, for the entire sample period from 2008 to 2017.

Regression analysis
The linear regression model is used to examine the impact of liquidity of the profitability of Indian manufacturing firms. The results in Table 4 shows the fitness of earnings per share model which is used for finding out the impact of liquidity on the earnings per share of Indian manufacturing firms. The table reveals that R square is 0.278 and the adjusted R square is 0.255, which means that cash to current liabilities, current ratio and quick ratio explain 0.255 of the changes in earnings per share of Indian manufacturing firms and the remaining is explained by other variables which are not included in this study. These results mean that the regression model is a perfect fit at predicting the outcomes.
The results in table 4 shows that the cash to current liabilities ratio has a positive and significant impact on earnings per share of Indian manufacturing firms. On the contrary, current ratio and quick ratio have an insignificant impact on the profitability of Indian manufacturing firms. Regarding the impact of liquidity measures on return on capital employed of Indian financial firms, table 4 reveals that the return on capital employed model is a perfect fit. R square is 0.111 and the adjusted R square is 0.084, which implies that the cash to current liabilities, current ratio and quick ratio explain 0.084 of changes in the return on capital employed of Indian manufacturing firms and the remaining is explained by other variables which are not included in this study. Further, the results in model 4 shows that the cash to current liabilities, current ratio and quick ratio have insignificant impact on return on capital employed of Indian manufacturing firms. In case of the return on assets model, the results in Table 4 demonstrates the fitness of return on assets model which is used for finding out the impact of liquidity on the return on assets of Indian manufacturing firms. The table reveals that R square is 0.165 and the adjusted R square is 0.139, which means that the cash to current liabilities, current ratio and quick ratio explain 0 0.139 of the changes in return on assets of Indian manufacturing firms and the remaining is explained by other variables which are not included in this study. Moreover, the results showed that the cash to current liabilities, current ratio positively and insignificantly impact return on assets of Indian manufacturing firms. In the same vein, the quick ratio negatively and insignificantly impact return on assets of Indian manufacturing firms. Regarding the impact of liquidity measures on profit after tax of Indian financial firms, table 4 reveals that profit after tax model is a perfect fit. R square is 0.231 and the adjusted R square is 0.207, which imply that the cash to current liabilities, current ratio and quick ratio explain 0.207 of changes in profit after tax of Indian manufacturing firms and the remaining is explained by other variables which are not included in this study. Furthermore, the results in model 4 shows that cash to current liabilities have a positive and significant impact on profit after tax of Indian manufacturing firms. On the other hand, current ratio and quick ratio have insignificant impact on profit after tax of Indian manufacturing firms. The findings of this study contradict those of Al-homaidi et al.

Conclusion
The main aim of this research paper was to examine the trade of between liquidity and profitability of Indian manufacturing firms. The target population of the study is manufacturing firms. The study used convenience sampling for collecting the data. The study is based on secondary data for the period from 2008 to 2017. 20 Indian manufacturing firms are selected which their data are available for the full study period. SPSS software is used for analyzing the data. Cash to current liabilities ratio has a positive and significant impact on earnings per share and profit after tax and insignificant impact on return on capital employed and return on assets. Current ratio and quick ratio have insignificant impact on earnings per share, return on capital employed, return on assets and profit after tax. Researchers believe that there are only few studies that are conducted to examine the trade of between liquidity and profitability. Further, these studies were conducted long back. Therefore, this study is going to provide updated evidence on the trade of between liquidity and profitability of Indian manufacturing firms which has been neglected by researchers. Thus, the current study provides an intriguing glimpse into the factors influencing listed firms' profitability in India. In India, only a few empirical studies have been conducted on this topic. Hence, this study attempts to fill a void in the body of literature on the profitability of firms in India.