Risk of technical insolvency the probability that a

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Unformatted text preview: irm’s assets—both current and fixed—in productive activities. risk (of technical insolvency) The probability that a firm will be unable to pay its bills as they come due. technically insolvent Describes a firm that is unable to pay its bills as they come due. A tradeoff exists between a firm’s profitability and its risk. Profitability, in this context, is the relationship between revenues and costs generated by using the firm’s assets—both current and fixed—in productive activities. A firm’s profits can be increased by (1) increasing revenues or (2) decreasing costs. Risk, in the context of short-term financial management, is the probability that a firm will be unable to pay its bills as they come due. A firm that cannot pay its bills as they come due is said to be technically insolvent. It is generally assumed that the greater the firm’s net working capital, the lower its risk. In other words, the more net working capital, the more liquid the firm and therefore the lower its risk of becoming technically insolvent. Using these definitions of profitability and risk, we can demonstrate the tradeoff betwe...
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This document was uploaded on 01/19/2014.

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