What is cash and liquid asset management?

Cash management is the process of controlling cash inflow & cash outflow, managing the cashflows inside the business, and utilizing the cash for business operation at any point in time. A business has to maintain a certain level of cash to meet various financial obligations. Cash management is essential because businesses must utilize the cash to generate maximum profit. Cash management also ensures to maintain maximum liquidity in the business.

Liquid asset management deals with the right quantity of an asset that is being maintained to support business operations and effectively utilize the invested asset to cover the current liabilities. Liquid assets also act as a shield that protects from uncertainties like recession and a decline in demand for the firm's products. A liquid asset is considered as a cash or cash equivalent asset that is easily converted into money in a short period of time with/without losing its value. A business that has more liquid assets can easily pay off debts by selling liquid assets in the market at the time of emergency. The asset that falls under the liquidity category is cash in hand/bank, marketable securities, inventories, bonds, stocks, mutual funds, treasury bills, etc.

Strategies of cash and liquid management

Cash planning

Planning helps to control the use of cash and liquid assets in the firm. A cash flow statement displays all the business' operating, investing, and financing activities. A cash inflow from various activities gives an idea of how cash was generated. A cash outflow from various activities shows how the cash was utilized for business. From this statement, businesses can learn about cash flow and come up with a better plan for the upcoming year.

Cash forecasting

Forecasting the cash receipts and cash payments helps in cash management. Comparing the forecast and actual movement of cash helps to identify the differences between them. These variances could be analyzed to improve cash control in the future period. For example, debts can be collected by creating and maintaining the debtor's list. Such lists must be reviewed frequently by credit control in the company. Such a process establishes a systematic approach towards estimating and considering forecasted expected cash flows.

Cash budget

A cash budget is used to manage, control, and estimate cash receipts and payments. It highlights the point in time when the expected cash flow is excessive or in shortage of cash. It also helps to plan the use of the excess amount or to arrange future cash needs. Estimated recovery of cash from sales, debtors, accounts receivable, dividends, and some other investment is accounted in the cash budget. The dollar spent on the purchase of materials, credit payments, and expenses is also considered in the cash budget.

Cash flow management

Usually, in business cash collection could be performed within a short period however cash payments could be delayed. Every business likes to receive cash at the earliest and wants to dispense cash payments as delayed as possible. However, that is not the case every time since every business wants to do the same thing. So, the time gap between payments and receipts is an important factor that must be considered in order for efficient cash management.

Optimal cash balance

A business must always maintain a certain minimum amount of cash balance to meet day-to-day expenses. Cash has more liquidity features than other liquid assets. Even if the organization has invested cash in liquid assets, it is still eminent to have sufficient cash to run the business smoothly. However, maintaining a high cash balance will keep the amount idle without producing any income whereas maintaining a low cash balance will risk the business operations. Therefore, a business must maintain a balance between cash and liquid assets.

Investing idle cash

If the business generates excess cash than the estimated cash, it should not be retained, instead, it must be used to generate additional income. Generally, excess cash will be invested in a liquid asset like marketable securities, treasury bills, and bonds which will bear interest and can also be easily converted into cash at will. Liquid assets are a better alternative investment choice for using idle cash for investment.

Investing in liquid stocks

If there is an emergency to pay off a debt, the available cash will be used to pay. If the cash is not sufficient to pay, the next option is to sell the liquid asset. Excess cash is generally invested in liquid assets to generate additional income from them. To meet financial emergencies, stocks can be sold as there is a lot of demand persisting in the market due to its liquidity. There is also the possibility of losing some amount on such stocks, so an enterprise could decide how many dollars it could spend on a liquid stock without affecting its business operation.

Investing in marketable securities

Marketable securities are liquid assets that can easily be exchanged for cash. Marketable securities have usually a maturity period of one year. They can either be in the form of equity or debt securities. Investment in marketable securities would generate interest as an additional income for the business. Instead of keeping cash idle in a reserve fund, utilizing cash to fund an investment is the best option for the business. Treasury bills and treasury bonds can be sold instantly for cash without much consequence in the secondary market. Investors who have a high interest in liquid assets invest in such securities by purchasing in the secondary market.  Certificate of the deposit comes under liquid assets where it acts as a savings account and bears interest with a fixed maturity date.  

Need for cash and liquid asset management

An organization should have balanced liquidity to meet the organization’s requirements. Financial health depends on the management of cash and liquid asset. It is important to maintain cash and liquid assets to ensure that cash is available in the right place and at the right time. Liquid asset management is necessary for a business to ensure cash availability at the time of hardship. The organization must ensure that sufficient cash is available to fulfill financial obligations. It is essential for the organization to know the lines of credit for short-term loans along with the balances and limits, in case the organization would not recognize how much credit can be drawn from a specific credit line. The cash and liquid asset management manages the risk of the company and ensures that future obligations are met on time. Even a profit-making organization can go bankrupt if it does not have the necessary cash and liquid asset to fulfill its commitments.

Context and Applications

This segment can be used for preparing exams for undergraduate and postgraduate courses like,

• Bachelors of Business Administration in Finance
• Masters of Business Administration in Finance
• Bachelors in Finance
• Masters in Finance
• Bachelors of Science in Finance and Business Analytics
• Masters of Science in Finance and Business Analytics

Practice Problems

Question 1: Cash management deals with ____________ in the business operations.

A) Managing cash inflows and outflows & utilizing excess cash

B) Utilizing the fixed asset

C) Controlling long-term fund

Answer: Option A is correct.

Explanation: Cash management deals with managing cash inflow and outflow within the business & also utilizes the cash for the business. For a firm, it is the obligation to pay for expenses, maintain the required amount of cash for running the business, and plan for future payment.

Question 2: ________ is considered as liquid asset.

A) Land

B) Certificates of deposits

C) Preference share

Answer: Option B is correct.

Explanation: A certificate of deposit is considered a liquid asset as it can easily be converted into cash within 12 months. It acts as a saving account that bears interest and also has a liquidity feature.

Question 3: A business has to maintain an/a _________to meet its day-to-day expense.

A) Optimal cash balance

B) Fixed asset

C) Long-term liability

Answer: Option A is correct.

Explanation: A business needs to maintain an optimal cash balance to cover daily business expenses. For the smooth running of the business, a minimum cash balance has to be maintained for business operation.

Question 4: A cash budget helps to __________ cash receipts and cash payments.

A) Maintain, control, and estimate

B) Increase, decrease

C) Appreciate and depreciate

Answer: Option A is correct.

Explanation: A cash budget helps in maintaining, controlling, and estimating the cash receipts and cash payments. Here the total cash receipts and total cash payments are recorded for every month, to keep track of the payments and receipts and forecast future payments and receipts.

Question 5: Marketable securities are ___________.

A) Non-current asset

B) Fixed asset

C) Liquid assets

Answer: Option C is correct.

Explanation: Marketable securities are considered liquid assets because they can be converted into cash on the market within a year. This type of security is in great demand and is easy to sell in the secondary market.