Final answer:
Even profitable firms can go bankrupt if they lack the cash flow needed to meet short-term liabilities. While profits can be reinvested in the business, if funds are not liquid, and debt obligations high, a profitable firm may not survive a cash crunch.
Step-by-step explanation:
A firm can be profitable on paper with a positive net income, yet still face bankruptcy due to a lack of cash flow to meet its short-term obligations. Profits, as indicated on an income statement, do not always equate to the cash available. Many firms earn significant revenues and may have attractive profits, which they can reinvest in equipment, structures, and research and development. However, if these profits are tied up in non-liquid assets or if revenues do not come in fast enough to cover immediate expenses, the firm may find itself in a cash crunch.
Firms often seek financial capital to sustain operations or to fuel expansion. Established companies with a history of revenue can secure capital through borrowing from banks or issuing bonds. New companies, without profits to show, must convince investors of their potential to pay a return on investment. In both cases, the crux of the issue is whether the firm can maintain enough liquid capital to not only cover its costs but also to handle its debt and interest payments. If it cannot, even a profitable firm might go bankrupt, as its liabilities overwhelm its available cash.