In liquidity management, creditworthiness is a vital function that not only determines the overall health of the finances but on that may be enhanced to the benefit of the company. Current, the concept is receiving a lot of attention in light of the prevailing financial situation as well as the state of the world economy. Some corporate goals that are often tied to this are the need for profit maximization, the need to maintain a high level of liquidity for safety, the need for a high level of the owners net worth and the attainment of corporate goals. Liquidity management has a big significance in terms of its effect on corporate profitability. The most important part in the management of capital is that its liquidity is maintained on a day to day basis in order to ensure that its meets the set goals (Eljelly, 2004). Liquidity has a role to play in the success of a business firm.
Every firm is tasked with ensuring that it does not suffer excessive amounts of liquidity. Additionally, it should not suffer from lack of enough liquidity. Any of these scenarios can lead to problems meeting the short term obligations. Both internal and external financial analysts posit that liquidity is one of the most important subjects that they focus on. They agree that liquidity analysis is a day to day activity that requires one to be extremely careful in order to guard (Bhunia, 2012). In the management of liquidity, the dilemma is to reach a desired level of profitability and liquidity (Nahum et al.2007). One the goals of this study are to determine the problems arising from poor liquidity management as an effort to determine their role in influencing bank profitability.
The problem is evident when it comes to granting credit cards. It arises when there is a situation of overinvestment in the receivables. This is more common where the debtors are characterized as high risk. Whenever a company is suffering from problems of liquidity, the implication is that it has to incur high costs every time it seeks to acquire funds from external sources. These sources are typically those ones with a high credit sale that is beyond the optimum level implying a dangerous financial risk. On the flip side, a tight credit policy leads to the reduction of profitability due to low sales. The growth of a business and its ability to handle the tradeoff involved in financing reflect the importance of profitability and management. As such, the development of business, it survival, performance and overall growth are important reasons for maintaining an efficient liquidity and profit management policy. It should be noted that it is inaccurate to assume that a company has high liquidity due to its high level of profitability. It is possible for a company to be profitable and lack a corresponding level of liquidity.
For a business to assume an optimum level of liquidity, it is important that liquidity is managed effectively. This avoids a situation where poverty of ideas by the management is possible. The level of liquidity ought not to fall below a certain level since it can cause the inability to meet short term goals in the business. Liquidity and profitability are some of the key ingredients that one uses in order to measure the going concern in an establishment. This is why many companies around the world have been coming up with ways of creating strategies which ensure that they improve their own liquidity position. The function of managing the working capital covers the tactics that treasurers may use in order to improve the nature of cash flows and liquidity (Ashbaugh-Skaife & LaFond 2011). Ironically, these are the areas that most businesses neglect in times of good business statuses.
The concept of liquidity management has been receiving considerable attention over the last years across the world. This is especially due to the prevailing financial uncertainties of the world economies. Managers and business owners in the whole world have a concern in coming up with strategies that are adequate for the management of the daily operations in an effort to attain their obligations as they develop everyday while increasing the wealth of the shareholders and the periodic profitability.
In corporate profitability, liquidity management is one of the most important financial functions. It plays a vital part in ensuring that a business firm operates with efficiency. The greatest pit falls for any firm is operating with excesses or surpluses when it comes to liquidity. This is vital is the company hopes to handle it short term financial compulsions, long term profitability and wealth maximization goals. According to Raheman and Nasr (2007), the necessary tradeoff between profitability and liquidity is an important deliverable of the liquidity management function. The optimum level of the liquidity aspect of each firm is dependent on the nature of the firm in question. As such, there is no rule book regarding the optimum level that every company ought to assume in order to guarantee profitabilityafter all profitability is not a universal concern in regards to its level or amount.
The credit policy in a company points toward the actions that the company in question takes in order to grant, monitor, or collect the cash. (Maysami, 2010). Additionally, a typical company has a predictable nature of a credit policy: cash discount, collection policy, credit standard and credit period. According to (Joseph 2013), credit policy contains the following: credit limits, deposits, customer information, credit term, and documentation. Each of these components is a potential tool for the purpose of monitoring the companys accounts receivables. The policy covers those customers with whom credit has to be extended to the date on which the collections are made.
The credit policy is arguably the most important tool for regulating and managing accounts receivables. In order to ensure that there is a balanced investment in receivables, the business ought to adopt the right kind of credit policy. In 2005, a study determined that the role of the credit policy is the minimization of costs via credit while ensuring that the maximum benefit is realized from the same (Saunders & Allen 2010). It stands for the guidelines that determine which customers have been sold via an open account, the precise terms of payment, the limits that exist in reference to the remaining balances and the manner in which the company can deal with delinquent account.
As an illustration, a lenient policy allows customers to use credit on highly liberal terms in such a way that the credit is given for long periods to customers that have unclear credit worthiness. On the other hand, a stringent policy is more restrictive and only allows customers who have a good record to receive credit. The customers who can receive credit under such terms are only those that have proven that they are financially strong. It is imperative to note that two businesses may not have the same nature of credit policy. Regardless of whichever policy a company prefers, it is important to ensure that it is attractive to good customers. It should also have capacity to reduce bad ones and retain the good ones without negatively impacting the cash flow (Owolabi & Obida 2012).
In some scenarios, cash management is defined as a series of techniques that impact the liquidity of a company in the short term while affecting the processes and factors that are directly convertible to cash inflow. The ultimate goal is the improvement of the profitability and liquidity of the company. As such, cash management is the foundation of liquidity and profitability management. The challenge faced by most companies is their ability to make determination of minimum cash levels required by a business. Minimum cash levels assist the management to have enough money to meet daily expenses. Administrators need to calculate the amount money needed to the level of activities, planning relevant payments and collections. Liquidity can also be converted to money at low transactional costs so as to serve the support for the treasury (Kalunda & Kabiru, 2012). It is important to establish the levels of disposable assets and short-term investments in companies. Holding wrong amounts of cash can interrupt the flow of business.
Wrong safety margins can lead to financial difficulties. Firms are not able to meet the needs which can arise at a given time. They can also be unable to maximize the use of investment opportunities. Maintaining cash surplus has several advantages. It also allows firms to conduct normal transactions which arise when activities increase. It is also important in covering unexpected needs for money. Being too conservative also has a disadvantage. It can also be shown in opportunity costs by different assets with no or little profitability.