Profits, Liquid Assets and Investments

Profits, Liquid Assets and Investments
Profits

Studies have indicated that a positive relationship exists
between net investment and a firm’s profit or cash flow.
Cash flows tend to have a bigger effect on the investment of
firms which are more likely to face financial constraints. As
early as 1957, it was found that firm’s seeming preference
for internal funds. Cash flow can affect investment as
capital markets are imperfect and internal finance is
cheaper than external finance. Therefore one would
expect cash flow to play a stronger role on investment of
firms likely to face financial constraints.

Liquid Assets
Some studies also suggest that net investment is
positively related to a firm’s liquid assets. The causality
is however unclear as to whether it is liquid assets that
affect investment or whether expected future investment
could cause liquid assets to be accumulated (i.e. causality
from investment to liquid assets rather than the other way
round).