Which scenario best describes a profitable but illiquid firm?

Which scenario best describes a profitable but illiquid firm?

• A. The firm reports profits but has large capital expenditures that tie up cash.
• B. The firm has abundant cash from profits.
• C. The firm has no debt and no investments.
• D. The firm has no profits but ample cash.

Answer: (A)

Profitability can exist alongside illiquidity when cash is tied up in non-cash assets or long-term investments. If a firm reports profits but is making large capital expenditures, it uses cash to acquire assets even though earnings are positive. That means the company’s operations are generating income, but the cash available to meet short-term obligations is limited, creating liquidity problems. The other scenarios either show sufficient cash flow or lack profitability, so they don’t describe being profitable yet illiquid.

Profitability can exist alongside illiquidity when cash is tied up in non-cash assets or long-term investments. If a firm reports profits but is making large capital expenditures, it uses cash to acquire assets even though earnings are positive. That means the company’s operations are generating income, but the cash available to meet short-term obligations is limited, creating liquidity problems. The other scenarios either show sufficient cash flow or lack profitability, so they don’t describe being profitable yet illiquid.