Profitability & Liquidity

Exam code: 7115

Written by: Ashika|Reviewed by: Caroline Carroll|Updated 2 July 2026

Profit is what a firm earns once the total costs have been deducted from the total sales revenue
Profitability is a measure of how successful a business is
Profitability can be defined in two ways
- A measure of how effectively a business converts sales revenue into profit - effectively, what percentage of sales revenue is profit
- A measure of how well capital resources invested in the business generates profit

Profitability is expressed in percentage form, which allows comparison of business performance over time and also comparisons with other businesses
Several stakeholders are interested in profitability
- Investors look carefully at profitability when deciding which business to invest in
  - The higher the level of profitability, the higher their rewards are likely to be
- Directors and managers consider profitability when assessing business success and determining future objectives and strategy
- Employees may consider profitability as justification for requesting higher wages or better working conditions

Liquidity is defined as the ability of a business to pay back its short-term debts, e.g. its suppliers
A businesses that cannot pay its debts is considered illiquid
- If a business cannot pay its suppliers, raw materials or components may not be delivered and production will be delayed
- If it cannot repay an overdraft, banking facilities may be withdrawn, and its credit rating will suffer
- Creditors may force it to stop trading and sell its assets so that the debts owed to them are repaid
Stakeholders interested in liquidity include
- Suppliers want to be reassured that a business is likely to be able to pay for them
- Financial providers such as banks want evidence that a business is likely to be able to repay loans or overdrafts
- Customers want to be sure that a supplier will be able to produce and deliver goods it orders

The importance of profitability