Question

RESPOND ($ $ $ Throughout this discussion, we will discuss the balance between safety/liquidity and the maximization of profit. You may draw from personal experiences, your own research, or $ what you have learned from the readings. • In the management of cash and marketable securities for a firm, why should the primary concern be for the safety and liquidity rather than maximization of profit? What about the management of other areas of the business? • Discuss the balance between safety/liquidity and maximization of profit. • Provide external resources to either support your thoughts above or to provide additional insight by bringing in an example from the corporate world.

Answer 1

The liquidity is the ability of a firm to pay its short term obligation for the continuous operation. A firm is considered normally financially solid and low risky which has huge cash in its balance sheet. The liquidity is not only measured by the cash balance but also by all kind of assets which can be converted to cash within one year without losing their value. It has primary importance for the survival of a firm both in short term and long term whereas the profitability has secondary important. The profitability measures the economic success of the firm irrespective to cash flow in the firm. It is often observed that a firm is very profitable in its books but it does not have sufficient cash and cash equivalent to pay its daily bills and due obligations. That is an illustration of classical poor liquidity management. The empirical studies have proved it that a large number of the firms are bankrupt not because they are not profitable but they do not have sufficient liquidity.

The liquidity of a firm is measured primarily by current ratio and net working capital whereas the profitability is measured by return on assets and return on equity. The liquidity focuses on short term assets which generate low profit and contain low risk. The current ratio is considered acceptable if current assets to current liabilities are equal to 1. In this case the net working capital is zero which is current assets minus current liability. The acceptable rule of thumb of current ratio equal to 1 is dangerous to some extent. The current assets of a firm should be at least at the level which covers the current liability with some extra margin of safety of current assets. The negative working capital generally is a sign of short term financing requirement which is normally expensive and considered an extra burden to reduce the profit. It is an important determinant for corporate loan business to evaluate the working capital, current assets and current liability of borrower firm before providing any credit facility. The liquidity measures also include the quality of current assets. The assets which can be converted in cash within a year without losing their value are considered qualitative current assets.

The profitability of a firm is measured by the ROE (return on equity) and ROA (return on assets). The profitability and the survival of a firm is positively correlated but not perfectly correlated. It illustrates that the firm can survive without profit for some years but the long term survival is not possible without profit. The return on equity is estimated on accrual basis of accounting irrespective to the actual cash flow. The profit and loss figures do not represent the paying capacity of the firm. Additionally, the figures are book value based which are normally not adjusted to current inflation index and other market determinants. ROA (return on assets) is estimated by the considering the return before fixed financing costs to total capital invested (debt plus equity). In this estimation the value of assets is also book based figure. I admit that there are many assets valuation techniques out there. However, these all techniques are suffered by subjectivity of users. It gives us a view that the profitability is not very solid determinant to decide the survival of the firm. There are many other factors to be considered before answering the question of corporate survival.

I conclude the article with a general perception that liquidity is required for the short term survival of the firm and profitability stand for long term survival. I agree with the general statement to some extent. However; the profitability does not sure the liquidity in short term but without the profitability long term liquidity cannot be sustained. On the other side of the coin; Long term profitability cannot be achieved without short as well as long term liquidity. It proves that both are important for the survival of a firm in long and in short run. Despite of the fact that both are important, the cash is still king which can generate the profit and keep the firm floats if two three bad years hit.

Management of cash & Market Securities

1. Cash And Marketable Securities Management
2. Introduction Cash management is one of the key areas of working capital management. Apart from the fact that it is the most liquid asset, cash is the common denominator to which all currents assets can be reduced because the other major liquid assets, that is, receivables and inventory get eventually converted into cash.
3. Motives For Holding Cash • Transaction Motive An important reason for maintaining cash balances is the transaction motive. This refers to the holding of cash to meet routine cash requirements to finance the transactions which a firm carries on in the ordinary course of business. A firm enters into a variety of transactions to accomplish its objectives which have to be paid for in the form of cash. For example, cash payments have to be made for purchases, wages, operating expenses, financial charges like interest, taxes, dividends, and so on.
4. Precautionary Motive In addition to the non-synchronisation of anticipated cash inflows and outflows in the ordinary course of business, a firm may have to pay cash for purposes which cannot be predicted or anticipated The unexpected cash needs at short notice may be the result of: • Floods, strikes and failure of important customers; • Bills may be presented for settlement earlier than expected; • Unexpected slow down in collection of accounts receivable; • Cancellation of some order for goods as the customer is not satisfied; and • Sharp increase in cost of raw materials. The cash balances held in for such random and unforeseen fluctuations in cash flows are called as precautionary balances.
5. Speculative Motive It refers to the desire of a firm to take advantage of opportunities which present themselves at unexpected moments and which are typically outside the normal course of business. The speculative motive helps to take advantage of: • An opportunity to purchase raw materials at a reduced price on payment of • immediate cash; • A chance to speculate on interest rate movements by buying securities when interest rates are expected to decline; • Delay purchases of raw materials on the anticipation of decline in prices; • Make purchase at favourable prices.

Managaement of Other Assets

Asset management is the process of developing, operating, maintaining, and selling assets in a cost-effective manner. Most commonly used in finance, the term is used in reference to individuals or firms that manage assets on behalf of individuals or other entities.

Every company needs to keep track of its assets. That way, the relevant stakeholders will know just what assets are available and what can be used to provide optimal returns. The assets owned by any business fall into two main categories: fixed and current assets. Fixed or non-current assets refer to assets acquired for long-term use, while current assets are those that can be converted into cash within a short amount of time.

1. Enables a firm to keep tabs on all of its assets

The process makes it easy for organizations to keep track of their assets, whether liquid or fixed. Firm owners will know where the assets are located, how they are being put to use, and whether there are changes made to them. Consequently, the recovery of assets can be done more efficiently, hence, leading to higher returns.

2. Helps guarantee the accuracy of amortization rates

Since assets are checked on a regular basis, the process of asset management ensures that the financial statements associated with them are kept updated.

3. Helps identify and manage risks

Asset management encompasses the identification and management of risks that arise from the utilization and ownership of certain assets. This means that a firm will always be prepared to counter any risk that comes its way.

4. Removes ghost assets in the company’s inventory

Instances exist where lost, damaged, or stolen assets are still recorded on the books. With a strategic asset management plan, the firm’s owners will be aware of the assets that have been lost and, thus, not keep recording them in the books.