Question

Discuss the the aspects of the financial manager's role in the firm's cash and liquidity management, and the components of the firm's policies regarding liquidity. Include a discussion regarding the firm's policies when it has excess cash, and the alternatives the firm might consider when it has excess cash.

3 paragraphs

Answer 1

Role of financial manager in cash and liquidity management:
To ensure cash and liquidity in company financial managers might look at reducing cash to cash cycle of the business. Trying to reduce account receivable days ( Sales / average account receivables per 365 days) will inject cash into the company and increasing account payable days by benchmarking with market can improve liquidity too. Focus on increasing inventory turnover, asset turnover, etc. will help in managing liquidity of the firm. Manager focus on short debt financing option can increase liquidity on the condition that it does not increase risk of business.

Components of firm's policy regarding liquidity:
a). Inventory policy: Firms can choose LIFO( Last in First Out) or FIFO( first in first out policy which will affect the cost of goods sold. If higher is the COGS then tax benefits will be higher and the retained earnings or liquidity will increase.
b), Depreciation Policy: The choice of depreciation policy also helps in increasing cash flow in the short term as depreciation is tax deductible. So certain depreciation methods will show higher depreciation at the beginning of the life cycle of machine which will help in attaining higher tax savings initially.
c) Firms might have fixed account payable and account receivable days to ensure liquidity.

Alternatives when firm have excess cash:
Dividend can be paid out to shareholders. They can invest excess cash in growth of business. Cash can be used to retire debt as it reduces the risk in business. It can be used to purchase machines, increase marketing activities, etc.

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