Nature of Trade off
If a firm wants to increase its profitability, it must also increase its risk. If it is to decrease must decrease profitability. The trade off these variables is that regardless of how increases its profitability through the manipulation of working capital. the consequent corresponding increase in risk as measured by the level of NWC.
The effects of changing current assets and current liabilities on profitability risk trade discussed first and subsequently they have been integrated into an overall theory of capital management.
In evaluating the profitability risk trade off related to the level of NWC, three basic assumptions, which are generally true, area: (i) that we are dealing with a manufacturing firm; (ii) that current assets are less profitable than fixed assets; and (iii) that short term funds are less expensive than long term funds.