Question

How does the liquidity objective conflict with the profitability objective? Are the two really in conflict?

Answer 1

Liquidity of a company indicate its readiness to pay short-term obligations. A company with higher liquidity ratios is considered more liquid in comparison to one with lower liquidity ratios. A company with higher liquidity has more cash or cash equivalent assets to meet its short term obligations.

While a company with higher profitability indicates the higher operational efficiency of the company. Profitability indicates the profits made by a company which is the difference between revenues and expenses of a company.

The conflict:

A company with higher profitability won't necessarily have good liquidity. A company which is efficient in its operations might not have sufficient cash or cash equivalents to meet unexpected expenses. So, even if a company is earning good profits, it might go bankrupt if it lacks liquid assets to meet unexpected expenses. However, a company which has good liquidity has enough liquid assets to meet such expenses. Hence, even if it is not making good profits it is more likely to prevent bankruptcy. A company that concentrates more on liquidity might keep aside enough cash or liquid assets that are not utilized for operational purposes, resulting into making less profit. While a company that focuses on profitability is more likely to put in all the available resources into operation. Which is likely to increase the operational efficiency and hence the profits. Such a company will lack funds to meet its short term obligations and hence would be less liquid. So, yes, liquidity and profitability objectives are in conflict.