Why could ABC face liquidity issues even if profitable?

• A. It may invest heavily in machinery and expansion, creating short-term cash shortages.
• B. Profits create unlimited cash.
• C. It has no fixed costs.
• D. It can always borrow at no cost.

Answer: (A)

Profitability shows earnings on paper, but liquidity hinges on actual cash in the bank at a given time. If ABC spends heavily on machinery and expansion, a lot of cash can go out in the short term for capital expenditure, even while the business is still making profits. Cash from sales may take time to arrive (customers paying on credit), so receipts lag behind the big cash outflows. Profits include non-cash items like depreciation, which don’t put real cash into the business. So, the company can be profitable yet run short of cash unless operating cash flow covers these outlays or financing steps in. In contrast, the other ideas assume cash is freely available or ignore timing, which doesn’t explain why liquidity can tighten despite profits.