Liquidity means that: 1) Firm has adequate cash to pay for the expenses 2) Firm has enough cash to make unexpected large purchases 3) Firm has cash reserve to meet emergencies at all times For this, regular Cash flow is must and it can be done by maintaining ratio between Expenses and Profit. -Determine the source of finance: -> Long term finance in the form of shares is good option, it can be sold and buy back as and when required without much loss. -> Short term finance must be used for emergency and for higher profit expected project -> Plan some of regular profit amount in safe way in the form of deposit, company infrastructure, property which can be a future source of cash Manufacturing Cycle must be faster so that final furnished product can be sold early and get working cash back to reduced debt interest. Estimation of working capital to optimum level as it balances risk and returns. For this Working Capital Policy Index (WCPI) can be calculated by the ratio of Current Assets to Fixed Asset. Higher Ratio indicates conservative policy and low ratio indicate aggressive policy. Conservative policy gives greater liquidity and lower risk and returns and opposite for aggressive policy. Current Ratio should be at least 2:1 CASH MANAGEMENT: -controlling level of cash balance by preparing cash budget monthly basis, finding alternate source of cash, for seen situation like strike, recession, flood while preparing cash budget -controlling the inflow of cash by using techniques which help in speedier collection of cash -controlling outflow of cash by creating centralized system for disbursement, effective payments only on the due dates, float system for cheque payment -optimum investment of surplus cash in short deposits.
The higher short term assets and the less your short Term debt; make your ability better to pay the debt (short Term liquidity ratio / liquidity ratio help you determine this). 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 has sufficient liquidity or the capacity to pay its current obligations due to good liquidity position. The current assets should either be liquid or near liquidity. These should be exchangeable into cash for paying obligations of short-term nature. If current assets can pay off current liabilities, then liquidity position will be satisfactory. The ideal current ratio is 2:1 means if company
’s current assets are reduced to half, then
also the creditor will also able to get their payment in full. 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. The ideal liquidity ratio is 1. This indicate short term solvency of company. Hence, adequate cash planning, cash budgeting, financial fore casting is required to maintain liquidity.
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?
