The Importance of Managing Liquidity for a Company Liquidity is a measure of a firm’s ability to meet immediate and short-term obligations, or assets that can be quickly converted to do it. There are two ratios to measure liquidity. Current ratio is calculated by dividing current assets by current liabilities. Since sometimes inventories are the least liquid of current assets, firms also calculate quick ratio. Managing liquidity is important in terms of operating activities. Firms which usually purchase in credit should have big current assets so the suppliers do not need to worry when allowing the credit transaction.
Besides that, creditors usually give loans to firms which also have the ability to pay their liabilities. If a firm’s current liabilities rise faster than its current assets, the firm may face difficulties in getting a loan. Actually, having a big amount of current assets is not always better although it means the firm always has the ability to pay its current liabilities. It depends on the proportion of the current assets. A high amount of inventory compared to the estimated future sales level means the inventory turnover rate is low and indicates over-investment in inventory.
A high amount of cash also means that firm has a lot of unproductive money. There will be a question of why the firm does not convert it to be an investment. Besides that, a high amount of receivables may means that the firm is having difficulty in collecting their receivables. These cases show that a high current assets is not always good for a firm. Some studies say that having current ratio by two is enough. This statement is actually based on the principle of “safety”. Actually, it is free for a firm to manage its assets.
A low ratio will mean good if the firm spends effectively on the assets that would possibly bring a good future for the firm. Due to the importance of managing liquidity, what firms must do are providing the minimum balance required to meet the short-term liabilities and maximizing the level of inventories turnover. Graduate School of Business UKM – GSB
Bhunia, A. ; Khan, I. ; and Mukhuti, S. (2011), “A Study of Managing Liquidity,” Journal of Management Research, Vol. 3. No 2: E8. Brigham, E. F. and Ehrhardt, M. C. (2005), Financial Management, 11th ed. Singapore, Singapore: South Western.