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Hi,
I’m currently revising for my upcoming exam and came across a MCQ, which I don’t quite understand.
The correct answer to the question is that when trying to decide on a optimal level of current assets, management would face a “trade-off between profitability and risk”. Other options were:
– trade off between equity and debt
– trade off between short term and long term borrowing
or – trade off between liquidity and risk.
I would have thought management would face the latter, rather than profitability and risk.
Would you be able to explain this?Thanks a million!
PS THank you so much for providing all your study material! It’s been so helpful!!
To reduce risk they would have higher current assets.
However, higher current assets will reduce profitability (e.g. more inventory means more costs of holding inventory).
So there is a trade off – less risk is ‘good’ but less profitability is ‘bad’.As regards liquidity, more current assets means less risk and it also means more liquidity which are both ‘good’ so there is not a trade-off one against the other.
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