Friday, January 04, 2013

Trade-off of the day: Liquidity vs Growth

In "Corporate Finance" textbook I found this fundamental financial trade-off,
The more liquid a firm’s assets, the less likely the firm is to experience problems meeting short-term obligations. Thus, the probability that a firm will avoid financial distress can be linked to the firm’s liquidity. Unfortunately, liquid assets frequently have lower rates of return than fixed assets; for example, cash generates no investment income. To the extent a firm invests in liquid assets, it sacrifices an opportunity to invest in more profitable investment vehicles (p. 32. McGraw Hill, 2002).

The textbook treats the trade-off as a given, but from business practice we know that successful investors, such as Warren Buffet, break the trade-off by using insurance "float" and/or borrowing against fixed assets. Access to low- or negative cost credit seems to be the most creative way to deal with the problem.

tags: trade-off, constraint, finance, business, problem, solution

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