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