University of Arkansas System
Type of paper: Thesis/Dissertation Chapter
Liquid Assets in Firm
What will your outlook towards maintenance of liquid assets to ensure that the firm has adequate cash in hand to meet its obligations at all times? Almost every action of company has financial implications, manager responsible for or with oversight of cash flow get directly involved in many functional areas of the business. Cash flow manager although in large company the financial management function may be broken down into various segments and the cash flow management segment may concern itself primarily with short term management issues, or the daily cash flow management task.Examples of these would be the maintenance of only minimum balance in non-interest bearing bank accounts, the movement of excess cash into short-term investment , and the maintenance of adequate cash balance to cover the normal operating expenses of the company that must be paid from day to day. In any event, those responsible for short term cash flow must consider the long term financial management objective of the company.
Objectives of the Financial Management
1. To ensure that the company always has enough cash to meet its legal obligations and avoid illiquidity – i.e. to maintain adequate short term financial flexibility.
2. To arrange to obtain whatever funds are required from external sources at the right time , in the right form and the best possible terms.
3.To ensure that the companies assets and liabilities ; current and long term, financial and operating are utilized as effectively as possible.
4.To forecast and plan for the financial requirement of future operations.
5.To make all decisions & recommendations on the basis of one primary criterion, maximizing the long term value of the organization . this objective is attained in a publicly owned corporation through maximization of the wealth of the owner [stakeholders] by maximizing stock price. ‘Liquid Asset’
An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally regarded in the same light as cash because their prices are relatively stable when they are sold on the open market. Liquid assets are cash on hand or any tangible or intangible item that can be converted quickly and easily into cash, typically within 20 days, without losing much of their value. These assets are among the most basic types of financial resources used by consumers, businesses, and investors. Cash and checking accounts are the two most obvious forms of liquid assets.
Legal tender for purchases and to settle outstanding debts, currency remains the most common type of liquid asset used consistently by retail consumers. Money that is deposited into a current account is considered to be a liquid asset because it is possible to immediately access the funds in order to settle debts. The debit card offers consumers even greater access to immediate liquid assets.
Some interest-bearing investments can be liquidated quickly, qualifying them as liquid assets. Money market fund shares, bonds, mutual funds, and the cash value of a life insurance policy are examples of investments that can provide quick cash when necessary. Certificates of deposit and stocks might also qualify under this definition. While the actual market liquidity of each asset may vary, the key is that there are always people looking to buy these items, so they can be sold relatively easily. In the case of some jointly owned assets, only a percentage of an asset could be considered liquid.
The final settlement awarded by a court for damages in a lawsuit could also be considered to be a liquid asset, depending on the terms of payment specified by the court. Tax refunds and the balances of trust funds are often included in the working definition of liquid assets.
Less Liquid and Illiquid Assets
Mortgages are sometimes considered a liquid asset, but they are much less liquid than many other types. Real estate is also more likely to sold at less than its value if it must be liquidated quickly; if the market is unstable, it may be difficult to determine the true value of real estate as well. Since a key part of liquidity is that the asset be sold at or very near its actual value, this means that real estate is often considered “illiquid” or not easy to sell. Any item for which there is no established value is not considered to be a liquid asset, even if that item might be sold for a high price. When the market for the item is small or uncertain, a sale could significantly affect its value. Even stock, usually considered a liquid asset, could be illiquid if a large block is put up for sale, which could lower its market value.
For businesses, liquid assets can include cash, marketable securities, and receivables. Cash equivalents, which can be quickly converted to cash as needed, are also considered to be liquid. A business needs to be liquid enough to meet expenses, but not have so much cash on hand that short-term investment opportunities are not pursued. Companies often divide their assets into net liquid, quick, and current assets. Net liquid assets are what would be left if all of the businesses debts were paid off. Quick assets are those that can be converted into cash immediately, while current assets are those that can be converted within a year. For an asset to be liquid it needs an established market with enough participants to absorb the selling without materially impacting the price of the asset. There also needs to be a relative ease in the transfer of ownership and the movement of the asset. Liquid assets include most stocks, money market instruments and government bonds.
The foreign exchange market is deemed to be the most liquid market in the world because trillions of dollars exchange hands each day, making it impossible for any one individual to influence the exchange rate. Liquid assets include items such as accounts receivable, demand and time deposits, gilt edged securities. In some countries, precious metals (usually gold and silver) are also considered liquid assets. Generally speaking, you must limit expenses and ensure that some of your assets are in the form of short term assets. The higher your short term assets and the less your short term debt, the better your ability to pay the debt (short term liquidity ratio / liquidity ratio help you determine this).The ratio analysis will be the guide stick for the liquidity ratio.
Maintenance OF LIQUID ASSETS TO ENSURE ADEQATE CASH IN HAND
A common problem for small business owners is the struggle to maintain adequate cash flow levels. Without cash, a business must eventually close its doors. Understanding and managing the company’s cash flow will help to measure the amount of cash on hand and prepare for cash flow shortfalls in the future. a. Do the Math : Cash flow is the movement of money in and out of a business. Cash inflow is the movement of money into your business, and most likely comes from the sale of goods or services to your customers. Cash outflow is the movement of money out of your business, and is generally the result of paying expenses. By projecting the inflow and outflow of your businesses cash, you can determine the amount of cash that will be available during a designated period of time. b. Prepare Your Profit and Loss Statement Your business plan should contain several financial statements. If you’re a start-up businessman, base your estimates of cash inflow and outflow on the revenues and expenses listed in your profit and loss statements. Complete your profit and loss statement before completing your cash flow statement. Over time, you will be able to base cash inflows and outflows on actual historical data. c. Develop a Cash Flow Statement: A cash flow statement measures cash flow over time.
During your first year in business, you should include a month-by-month cash flow statement in your business plan. If you’re seeking a loan, an important feature of your cash flow statement is that it will show the lender exactly how you’re going to afford loan payments. In order for a business to stay afloat, it must maintain an adequate level of cash. These are some which we can apply to improve the cash flow in our organization. Adequate cash means that you can meet your obligations. It is to remember that cash is king and life blood of the organization. The following points help make it easier to maintain the adequate cash level and an improvement in cash position can be seen sooner rather than later:
1. Check Customers’ Credit Histories: Decide the type of customer to whom you want to extend credit. Do you want to have a particular cut-off credit score? If you extend credit to customers with questionable credit histories or low credit scores, you may experience late payments or no payments, which will slow down your cash flow and increase your collection costs.
2. Keep Track of Your Customers’ Payments: Have up-to-date payment records. Keep accurate payments records by using a specialized accounting software program that will keep track of your invoices and when payments are made. If customers are late with their payments, it could cause a cash flow bottleneck for you. Accurate record keeping will help solve this problem.
3. Set Appropriate Credit Terms and Offer a Cash Discount : Make sure your customers understand how long they have to pay their bill. In order to speed up the cash they pay, you might want to offer a cash discount to any customer that pays in a short period of time, designated by you, or to a customer who pays cash.
4. Extend Your Timetable for Making Cash Payments :: Pay your bills on time and take advantage of any cash discounts your suppliers offer you. However, hold onto your cash as long as possible. Don’t pay bills weeks earlier than they are due. Your company can use that cash balance, rather than letting your supplier use your company’s cash.
5. Cut Back on Spending Wherever Possible : Do you really need to take money out of your business for a Hawaiian vacation right now? Cut back on spending until it is less than your revenue on a month-by-month basis. If an emergency happens, then you will be prepared from a cash standpoint.
6. Increase Your Sales : Make sure you aren’t holding on to obsolete inventory. If you are, mark it down and sell it. Storing it is costing you money and selling it at a lower price is better than not selling it at all. The longer you hold on to obsolete inventory, the less likely it is to sell.
7. Think before investing : The price and value of investments and their income fluctuates: you may get back less than the amount you invested. Remember that how an investment performed in the past is not a guide to how it will perform in the future. We need to project the cash flow statement, and employee the companies fund in short term investment. Along with that we have to check expenses. And maintain the liquid assets. Projected cash flow statement is the guided stick. Our sales, realizations, and fixed and variable expenses need to be kept in mind while judging the balanced need of liquid assets. We may consider the short term investments with reference to interest rate and surplus funds. Generally it is indispensable that we must limit expenses and ensure that some of the assets are in the form of short term assets. The higher short term assets and the less your short Term debt, the better your ability to pay the debt (short Term liquidity ratio / liquidity ratio help you determine this).
The ratio analysis will be the guide stick for the Liquidity ratio. The short term creditors of a company like supplies of good of credit and Commercial banks providing short-term loans, are primarily interested in knowing the companies ability to meet its current or short term obligations of a firm can be met only when there are sufficient liquid assets. Therefore, a firm must ensure that it does not suffer from lack of liquidity or the capacity to pay its current obligations due to lack of good liquidity position, its goodwill in the market is likely to be effected beyond repair. Liquidity refers to the ability of a concern to meet its current obligations as and when there become due. The short-term obligations are met by realizing amounts from current, floating or circulating assets.
The current assets should either be liquid or near liquidity. These should be convertible into cash for paying obligations of short-term nature. The sufficiently or insufficiency of current assets should be assessed by comparing them with short term liabilities. If current assets can pay off current liabilities, then liquidity position will be satisfactory. The standard current ratio is 1: 1.33 means any firm / company is having adequate funds to meet its obligation in time. The firm has to maintain core current assets which is easily realizable at all times. The laid down bench mark ratio to maintain the ratio of core current assets to current liabilities is 1:1