CONCEPT OF LIQUIDITY:
Finance is a like blood in our body so long as blood-circulate, properly in the body; we feel healthy and have the capacity to work. If circulation is not proper, It will put effect, on the functioning of the body, similarly, it will be difficult for the business concern to take financial decision related to the determination of the amount of long-term finance required and the sources from which such finance is to be raised. The optimum capital structure should be determined by keeping in mind the long-term and short-term requirement of finance.
No doubt the investment decision is very much important from the long-term point of view aid in the changing spectrum of business. A business organization has to face quite often the problem of capital investment decision because investment in this project has quite heavy and have to be made immediately, but the returned will be available in the long run. For replacement expansion diversification, research and development investment decision are most crucial and critical, but the availability of short-term fund in most in liquid form is also very important. The small, but very important short-term transactions need availability of sufficient liquid resources. Short-term solvency much depends on upon the availability of liquid resources as per short-term availability as short-term requirements. No businessman can aspire to keep the surplus fund in the business but while developing these surplus funds he has to estimate its short-term requirements. Liquidity effects over short-term capacity to pay day to day say routine transaction.
Thus, we say that businessmen want to hold imbalance a sufficient quantity of liquid assets. So that undue solvency risks are not imposed on it. This is a logical approach indicating the quantitative amount of liquid resources. Thus, the modern business atmosphere financial experts have to consider a minimum amount of liquid capacity in the business apprises management in estimating property that prospects need. Insufficient liquid resources may cost, a black shadow on the goodwill of the concern because the ability to pay short-term liability may be doubted by the external parties. Thus the concept of liquidity comes in the light of proper financial functioning to the business.
CONCEPT OF LIQUIDITY MANAGEMENT :
"In the management of liquidity two characteristics of current assets must be boom in mind: -
1. Short life span and,
2. Swift transformation into other assets forms. "1
1. Short life Span
Current assets have a short life span, cash balance may be held idle for a week or account receivable may have a life span of 30 to 60 days and inventories may be held for 30 days to 100 days. The short life span of current assets depends on upon the requirement of the firm, in the activities of procurement production sales collection and the degree of synchronization among them.
2. Swift transformation into Other Assets Forms
Each current asset (C.A) had swiftly transformed into other assets forms. Cash is used for acquiring raw materials. Raw materials (R.M) are transformed into finished goods (this transformation may involve several stages of work in progress) Finished goods generally sold on credit are converted into account receivable (book debts); and finally, Account receivable on realization generated cash.
The short life span of working capital components and their swift transformation form one into another as certain implementations: -
(1) Decisions relating to working capital management are repetitive and frequent.
(2) The difference between profit and the present value is in significant.
(3) The close interaction among working capital components implies that efficient management of one component cannot be under taking without simultaneous consideration of other components that is if the firm has a large accumulation of finished goods inventory. It may have to provide more liberal credit terms or show laxity in credit collection. Another example if they have a cash crunch it may have to offer generous discounts.
The investment of net current assets could not reveal the capacity to pay very short-term obligation. Investment in these assets may seem to be sufficient but the composition of a current asset may say a different story. Suppose a business concern has working assets of Rs. 5 laces and its current liabilities are Rs. 1 Lacs. Then the concern may be said solvent keeping in view the investment in short-term assets. But if the value of stock in these assets is Rs. 450 thousand then the situation here reverses the concept of liquidity developed. It is correct that stock may be converted into cash (the most liquid form of the asset). But how much time it will take, we cannot say that in this case payment of short-term obligation may be difficult. Hence, the idea developed that sufficient of cash and bank balance plus other liquid assets should be kept as a minimum. So that businessman discharges its short-term commitment due to this reason the concept of liquidity developed. It indicates what portion of current assets in the form of liquid assets.
MEANING OF LIQUIDITY MANAGEMENT:
The term 'Liquidity' means the ability of an organization to realize the value in money the post liquid among all assets. It implies conversion of assets into cash during the normal course of business and to have a regular uninterrupted flow of cash to need outside current liabilities as and when due and payable and also ensure availability of money for day-to-day business operations. The concept of liquidity in case of companies has to dimensions viz; the quantitative and qualitative. The quantitative aspect includes the quantum, structure and utilization of liquid assets. The qualitative aspect emphasizes upon the ability of a firm to need all present and potential demand for cash in a manner that minimizes cost and maximizes the value of the business.
The liquidity is a vital factor in business operations. For the very survival of business, the firm should have the requisite degree of liquidity. It should be neither excessive nor inadequate. Excessive liquidity means an accumulation of ideal funds. Which may lead to lower profitability, increase speculation, and unjustified extension, an extension of liberal credit terms, liberal dividend policy etc; whereas inadequate liquidity result in interruptions of business operations. A proper balance between these two extreme situations, therefore, should be maintained for efficient operation of the business through skill full liquidity management. The need of efficient liquidity management corporate sector has become greater in recent years.
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