Liquidity and Cash

Management

Introduction
Cash does not enter into P &L. Hence, cash is neither
profit nor loss.
Profit is a liability and nominal in nature.
A company can not manage a suppliers bill or salaries
by simply making profit; it needs cash to do it.
A company can not pay dividend to the shareholders
except through cash.

Cash vs. Profit

Distinction is difficult to understand
Accountants use income statement to calculate cash
flow
Income statement does not contain WC items like
receivables and inventories which captures a sizeable
part of revenue, giving lesser cash to the system.
Problem is more acute for growing companies.
Rising profits induces managers to press growth button
faster.
Continuous erosion of liquidity makes a high growth
company sick.

Cash vs. Profit

Sustained growth of a company depends on cashability of the
profit, not profit per se.
Cash flow concept is more useful in short run.
In the long run, all assets are cashable; perhaps thats why in
long term projects, all profit flows are termed as cash flows.
In the long run, it is the cash flow and fund flow analysis that
gives the total view.

Cash Management
Cash and cash flow are different.
Cash is an asset; it earns only when it is in use- similar to a
machine kept idle.
When cash is in the flow, it is earning for the enterprise.
Cash management not given due importance in Indian
companies because of the easy availability of WC finance from
banks.
3 main activities contributing to cash:
Operating activities arising out of operations
Investing activities arising out of investments
Financing activities arising out of all capital and debt issues

Cash Management
The goal must be
Priority outflows be met fully out of operating cash flows
Discretionary outflows be met with the balance in conjunction with the
financial flows.

Priority outflows: - tax payments, repayments; legal complications

Priority obligation ratio= (Net Operating Cash Inflow / Priority Outflows)
Discretionary outflows:- dividend payments, capital expenditure, portfolio
investments in subsidiaries etc.
When this rule is violated, there is danger of the firm getting into debt
trap.

Cash flow and Fund flow

In the long run, it is the cash flow and fund flow analysis
that gives the total view.
The fundamental difference between funds and cash is
that funds liability and cash asset.
Fund inflow definitely increases the total assets of a firm
but may not necessarily increase its cash level.
Funds precedes assets
Major problem in a firm is the mismatch between current
payments and current receipts happens due to
lengthening of the pipeline of cash.

Liquidity
Net WC provides an important cushion against the mismatch.
This serves as an index for impending liquidity crisis.
Ultimate result of illiquidity is bankruptcy.
Steps taken to prevent this:

Utilize unavailed credit limits

Sell marketable securities
Negotiate spacing of repayment schedules
Negotiate enhancement of facilities with the bank
Defer suppliers bills
Advance buyers payment

Liquidity
Outside creditors current ratio is a good measure
But high current ratio blocks costly long-term fund
Acid test or quick ratio can also be used as a measure
Both these ratios can be manipulated by offsetting part of
cash and CL.
Net WC turnover is a superior measure for liquidity.
Net liquidity ratio is a finer ratio taking into account the
unavailed credit limits.
Sales CCC shorter the cycle better the liquidity lesser the
financing required.