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Why do profitable business companies sometimes struggle with liquidity?
Asked on Oct 25, 2025
Answer
Profitable companies can struggle with liquidity due to a mismatch between the timing of cash inflows and outflows, which affects their ability to meet short-term obligations. This can occur even if a business is profitable on paper, as profits do not always equate to immediate cash availability.
Example Concept: Liquidity issues arise when a company has insufficient cash or liquid assets to cover its short-term liabilities, despite being profitable. This can happen if revenue is tied up in accounts receivable or inventory, or if the company has high capital expenditures. Effective cash flow management, such as optimizing accounts receivable and payable cycles, is crucial to ensure liquidity and operational stability.
Additional Comment:
- Liquidity is about having enough cash to meet immediate needs, not just profitability.
- Accounts receivable delays can lead to cash shortages even if sales are strong.
- High inventory levels can tie up cash, impacting liquidity.
- Capital-intensive businesses may have significant cash outflows, affecting liquidity.
- Regular cash flow analysis helps identify potential liquidity issues early.
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