Distinguish between the following: Liquidity and profitability

Difference between Liquidity and Profitability Liquidity is defined as ability of the business to meet short-term obligations whereas profitability as a decision criterion is another important tool for taking decisions on different dimensions of the business processes/activities after evaluating the performance of the company in different spheres. Liquidity is used for managing liquid resources or current assets or near cash assets so as to enhance the effectiveness with which they are utilized with a view to minimize costs where as profitability is used as a measure of comparison and standard of performance. Lack of liquidity in extreme situations can lead to firm's insolvency. If the firm does not invest sufficient funds in current assets, it may become illiquid and therefore risky. But if current assets lie idle then it may impact the profitability negatively. Liquidity shows the quickness with which a business/company can convert its assets into cash to pay it dues in the near future where as profitability is the measure to evaluate the performance of the company and related to sales or total capital employed or to net worth of the company. There is an inverse relationship between liquidity and profitability. Thus, a proper trade-off between profitability and liquidity is required.