Question

In the management of cash and marketable securities for a firm, why should the primary concern be for the safety and liquidity rather than maximization of profit? What about the management of other areas of the business? Discuss the balance between safety/liquidity and maximization of profit. Provide external resources to either support your thoughts above or to provide additional insight by bringing in an example from the corporate world.

Answer 1

Cash and marketable securities are generally used to meet the transaction needs of the firm and for contingency purposes. Because the funds must be available when needed, the primary concern should be with safety and liquidity rather than the maximum profits.

Cash is life blood of business. So it becomes very important to ensure liquidity that is to have cash at firm's disposal so that as and when cash is required in business activities it is readily available. This also gives a feeling of safety. When cash is readily available a firm can make each and every decision regarding manufacturing, processes, payments etc. easily without a feeling of cash crunch. These all things together takes a firm to the path of profit since ultimate aim of everything is to make profit.

There is 3 reasons for the firm to get more safety and liquidity cash :

• Transaction balances : the transaction motive involves the use of cash to pay for planned corporate expenses such as supplies, payrolls, and taxes.
• Compensating balances for banks : for services provided rather than paying directly for those services.
• Precautionary needs: assume management wants cash for emergency purposes when cash inflows are less than projected.