Research Paper Sample On Cash Flow And Liquidity Of Firms

Cash Flow and Liquidity of Firms

Importance of Cash Flow

Cash flow describes the movement of money into and out of the business through its activities that generates income and those that incur expenses. Cash flow occurs in three ways that is; investing activities, operational activities and financing activities. These activities create a movement of cash into and out of the business. Investing activities leads to a cash inflow from sale of assets of an out flow due to capital expenditures. The operational activities results to expenditure or receipts of cash from internal activities of the company (Hall, et al 2008). Financing cash flows arises from activities such as dividend pay outs, issued bonds, purchase of shares and issue of equity among others.

Cash flow is very important to business in the sense that it indicates the level of liquidity of the company based on the cash movement within it. Cash flows help to indicate the stability levels of a company in terms of liquidity and can help avoid insolvency. It also gives the assurance of cash movement which can be used in decision making process. The in and outflows of cash also gives the rate of returns of a company’s investing activities through which can be used to value projects in order to ascertain its returns. Internal rate of return and net present value can be calculated from the cash flow information (Keith 2002).

Cash flows also provide an alternative criterion for analyzing a company’s profits especially if accrual accounting seems to give different results thus serving to improve accurate information extraction of businesses. Furthermore, cash flows describe the value and quality of income by checking where the cash inflows come from. If more income comes from cash elements, income is thus a high quality income. Cash flow also helps in assessing risk of a company and its individual projects thus helps in risk management.

Strategies for Improving Liquidity

Liquidity of a company or any business is very important for growth and profitability both in the short run and long run perspectives. There are several ways a company c an improve liquidity depending on the size and scope of business.

Company can earn extra cash from large sums of money it holds in banks which pays interest incomes on cash balances placed in certain types of accounts. This can be source of extra cash that can be withdrawn after specified period. Another strategy would also be cutting the overhead costs that are normally incurred by the business like marketing expenses, meeting allowances and other non essential expenses (Lance 1999). This will increase cash available for immediate use and can help in capturing opportunities that come abruptly.
Inventory management also help to improve liquidity by ensuring that excess stocks are not kept in the shelves and stock are also whenever they are needed by customers. Having non moving stock can put pressure on cash in warehousing and other maintenance activities. Us of Just in Time strategy can improve cost cutting and increase available cash. Handling of debtors also can help or distort liquidity of a business. Keeping debtors on toes in paying up and reducing sales on credit will increase cash reserves and liquidity.

Constant monitoring of key indicators such as quick ratios, receivable ratios and stock turn over ratios among others can help in maintaining a good level of liquidity that will be good for business. Unnecessary or unused assets can also be a source of finance to purchase other equipments/assets that generate cash easily (Lance 1999). The owners of the business can also be advised not to use money for non-business purposes frequently, thus availing more funds for business use when needed.