Growth, risk and current assets

Have you ever noticed that some investment managers are reluctant to invest in companies with excessive growth? For example a company with a growth on revenue of 50% . In this article I would like to explain one of the possible reasons which is the trade off between liquidity and profitability. Working capital management is very important when it comes to minimising the risk of insolvency while maximising the return on asset. Just for your better understanding I will explain with an example of overtrading. A company is in an overtrading situation when it strongly increases its revenue but without sufficient capital to fund it. Usually an overtraded company increases the level of sales, increases the level of current assets (inventory and receivables), most of the mentioned assets are financed by credit and the liquidity ratios fall dramatically. The company is in a sweet moment in terms of sales but at the same time is struggling to finance the growth. Remember that profitability is an important measure but it is an accounting measure. The most important factor in a business is the cash flow . Cash pay salaries, pay dividends and pay the suppliers. If you are interested in this topic I highly recommend you read about the operative cycle and liquidity ratios (quick ratio and acid test).With this article I just want with to explain that companies should balance the profitability vs the liquidity and why the investment manager should take it into consideration. The paradox is that a profitable company can fall in an insolvency situation if it can not pay its creditors due to lack of cash budgeting and forecasting. Individuals have to face this problem very often when they buy cars, houses....Decisions in the number of year is a balance between cash and profitability (understood as paying less interest). Finally, we have to remember that the main objective of companies is to maximize the wealth of their share holder, however, some directors acts on his own selfish interest (looking for short term objectives that have impact in their salaries) rather than pursuing the main objectives (agency problem). Having said this if you find a company with very strong growth, just ask yourself a simple question, how is it going to be financed?? maybe it has a sufficient funds and is an excellent opportunity .

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