Evaluation Of Cash And Credit Management Policies As An Instrument For Avoiding Liquidity And Liquidations


Concepts of liquidity and its effect on business operations

If a person with a passable level of proficiency in accounting or finance is asked what the term liquidity is, one or more of the following varied responses will be obtained:

The number of times current assets cover current liabilities, the ability of the business to meet its short term liabilities by liquidating short term assets the excess of current assets over current liabilities.  All the aforementioned responses are reflective of liquidity but like the fable of the elephant and the blind examiners, they amount to partial glimpses of the complete structure.  A down to earth working definition of liquidity is “the ability of an organization to access funds when most needed”  Tiko (1997) Paraphrased, this translates to the capacity of an industrial/commercial organizations to ensure that its commitments are readily met at all times by reasonably priced funds.  The advantage of this definition is that it brings the role of the treasury department – (Financial manager/controller officer) into proper focus-that funds are always available to the organization at a price that will enable it earn an adequate spread on its transaction.

In the banking industry, the concept of liquidity has become an indispensable feature in accessing the existence and survival of banks in the current wave of distress in the financial sector to their inability to meet depositors claims arising from liquidity problems.  The same applies to many manufacturing companies, which requires being liquid always so as to remain in business and take profitable investment opportunities.  The questions most people often as is why liquidity is so crucial to efficient financial management of organization? First, it prevents the organization from resorting to a five sale of assets.  When companies encounter periods of financial distress, the first thing they do is to unload their portfolios of short term funds.  In the case of banks, they will unload their portfolios of treasury bills.  Although loses have been  suffered in the past by the bank that rediscounted their bills prior to maturity, this would be noting compared to loses  that are likely to be realized in these days of open market operations. This is because its yields on treasury bills would now generally be moved in with the direction and magnitude of market shift in interest rates.  Since banks generally find them in financing distress at times of high interest rates, bill discounting would even seriously erode the capital cushion in some instances.

Banks must realize that investing in treasury bills to provide liquidity is a myth and an activity they cannot hope to profit from due to the negative carry (unless they are small commercial banks who wish to keep the bills in portfolio to maturity with an operation of falling interest rates)..

Secondly, the concept of liquidity enables the company to continue to do business while others are closing shop.  This is because  proactive firm would have taken cognizance of likely future outflows in determining an adequate level of liquidity within a given period.  Moreover, the perception of regulars, creditors, analysts and the general investing public of such a company is very positive and conducive for increased businesses.

Thirdly, it prevents the company from going to the money market (market where short term funds are borrowed when it really doe not have to or when conditions are not conducive such as a season of rising interest rates or when every other bank is scratching for funds in the market place) fourthly, in the case of bank, it protects it from going to the central bank of Nigeria.  (C.BN’s) discount window to borrow.  Although the CBN is the lender of “last resort” of banks, the latter hardly utilize the facility because of the stigma such borrowing confers on the affected bank (proof of liquidity.

Furthermore, since he that plays the piper dictates the tune, it is inconceivable that the CBN would simply dole out the money and not take more than a passing interest in the bank’s activities – a situation any bank would want to avoid  at all cost since the mouse is hardly expected to welcome the cat into its sanctum with open arms.

One of the long term objectives of a company must be to make money for its owners and its future is guaranteed or jeopardized according to the satisfaction, or lack of it, that the shareholders exhibit regarding its performance on their behalf.  There are of course other long-term objectives of a company, in particular those involving employee and customer satisfaction, but it is not possible to compromise not the financial objective.  According to Hayek (1960) “the only specific purpose which corporations ought to serve is to secure the highest long term returns on their capital, Friedman states.

There is one and only one social responsibility of business-

To sue its resources on to engage in activities designed

To increase its profited as long as it stays within the rules of the game”

During particular period of time, it may seem rather optimistic to think in terms of making profit (profit maximization consideration) for the owners and in the short-term all efforts may have to be devoted to keeping the company liquid and to maintaining the value of the owner’s investment.  The million-Naira questions is “what constitute an adequate level of liquidity?  The starting point in determining the optimum level of liquidity will be to consider the current position as well as to consider series of dates into the future .e.g. weekly, monthly, quarterly etc.  this entails calculating the bank’s basic surplus.  The basic surplus is a key short-term indicator of liquidity and asset and its day-by-day operating expenses and liabilities.  In this case, liquid assets may include but are not necessarily limited to current assets. They include any other assets that can be very quickly disposed off without impairing client relationships or generating high levels of capital losses.  By  this definition, even short-term loans may be excluded if calling them would seriously jeopardize the relationship.  Similarity, some investment though of a short – term nature, may be excluded if selling of a short – term nature, may be excluded, if selling them would result in very large losses. There are also some facilities that are nominally short-term but keep being rolled over like ever green loans could possibly be excluded.  He length of operating cycle and the rate of flow of costs determine the company’s liquidity levels within the operation cycle.  The rate of flow of the costs in firm depends on the volume of production and sales, and the cost associated with the production and sales activities.  Each of these is also influenced by several other factors including:

  1. Nature of industry and length of the period of operating cycle. Generally, the cycle is factor in consumer industries than in durable goods industries
  2. The seasonal nature of an industry for example fruit and canning industries require maximum amount of liquidity well before the busy season commences and least amount during the season.
  3. Credit policy: the longer the duration of credit to a customer, the greater will be the amount of receivables and hence the need for more liquid funds.
  4. The terms and conditions of purchases of goods and cost of services also influence the company liquidity level.
  5. Government policies regarding taxation, environmental protection, depletion, patent amortization, and so forth may also affect the size of liquidity requirements.
  6. In the case of Anambra motor company ltd where scarce or imported materials for spare parts are concerned, a higher volume of liquid funds is required as such materials have to be stocked over a long period of time.
  7. Finally, the company policies such as those affecting depreciation, dividend payment and expansion plans equally influenced the level of liquidity.

Many businesses have excess liquidity while others have weak or negative liquidity which poses a threat to the solvency of he company and makes it unsafe and unsound.  The causes and repercussions of negative and excess liquidity can be outlined as follows:



  1. Payment of unearned dividends
  2. Operating losses
  • Loss due to unforeseen circumstances
  1. Diversion of current assets for the financing of fixed assets
  2. Reduction in the value of inventories due to inflation depreciation etc
  3. Excess bad debts and doubtful account receivable increase in the volume of business and the consequent need for additional current assets especially inventories without adequate resources to fund the increase.

More  importantly, weak/negative liquidity results in faulty working capital management policies.  The consequence of weak liquidity according to Osisioma (1996) includes:


  1. It can lead to business failure \
  2. It can frustrate the noble objectives of the company
  • It could lead to drastic reduction the rate of return on total investment
  1. It could erode the capital base of the company and thereby adversely affect the company credit worthiness

The effect of excess liquidity includes:

  1. Management may become more complement, less aggressive and less dynamic for the maximization of profit and shareholders wealth
  2. It could lead to wasteful expansion program]
  3. Management may adopt a liberal dividend policy
  4. It can lead to very risky specialization in the securities market


  • Issues in cash management

Cash according to march 91978) consists of money or any negotiable money order or cheque including the collected balance on deposit with bank that is assumed to be available for use by the enterprise.  This definition explains that cash does not only include money but also includes cheque or bank deposit, which is available for use.  To Hough (1999) cash include all cash held for what ever purposes, including bank balances and short term market securities.

Cash is represented by those monetary as well as non-monetary items immediately available to management for business purposes.  Includes commercial and savings deposits in banks and elsewhere, available upon demand and money items on hand that are acceptable for deposit at face value by a bank.  Cash is involved in most business transactions due to the nature of business transactions, which include a price and conditions calling for settlement in terms of a  medium of exchange.  At any point in time, non- availability of cash or availability in the distant future of any of he components of cash means that there is lack of cash of there is cash when any of the  components is available for use.

Businesses and individuals have three principles or primary motives for holding cash and these are:

  1. The transaction motive
  2. The precautionary motive
  3. The speculative motive

The transaction motives: it involves holdings cash for he day-to-day business requirement both for operational and capital purposes.   The precautionary motive; it relates to the  need to have cash available for unforeseen circumstances.

  1. It enables a firm to provide enough fund as a protection against unaccepted demands
  2. This motive depends on the predictability of cash flow and the ability of the company to borrow on short motive.

If cash flow is relatively stable, than the amount needed to be held for precautionary purpose will be small but it is susceptible to large fluctuation then the amount of precautionary cash needed will be much more significant.  Precautionary cash in the context could be a standing credit line which can be drawn upon at very short notices. The speculative motive enables the opportunities as may arise.  Specification in this context means being able to take up unexpected profitable business opportunities, which might arise from time to time.  The management of cash, irrespective of the purpose for which it is held, in just as important as the management of any other assets. Fund tied up in actual cash do not generate any income for the business and therefore must be kept to a minimum.  Other form of cash must be made to give the best possible return consistent with the degree of liquidity required in the cash balance.

There are two aspects to the issue of management of cash:

  1. To minimize the actual amount of cash held in the business and to maximize the benefits of any cash held and
  2. To ensure that cash flows into and out of the business are judiciously an expeditiously managed.

Cash management requires proper synchronization of cash inflows and outflows and involved proper planning and control of cash resources in order to avoid illiquidity problem such as stoppage of production/other business activities, labour strikes, sub-optional performance, bankruptcy or liquidation proceedings.


  • Cash planning and control
  1. Techniques of cash planning:

Mcfarland (1979) defined planning as a process of using related facts and assumptions about the future to arrive at courses of action to be followed in seeking specific goods.  The warth and Newport (1976) sees planning as  a process by which manager visualize and determine future actions that will lead to the realization of desire objectives.  Planning involves selecting enterprise objectives as well as goals of departments and the programmes and the determination of reaching them.  Cash planning entails forecasting the flow of cash into and out of the company’s bank account.  An essential financial forecast for any business concern is the forecast of cash. Profits are of questionable value if tied up in inventories or slow receivable.  A business with a suitable amount of cash can replace worm out or depreciated asset as required.  Cash is also necessary to expand output even without the necessity for new machinery or other capital equipment.  Expanded operations almost invariably require heavier working capital through the need of carrying large inventories and more accounts receivable.  There are some business organizations particularly the small one that has been liquidated in the face of opportunities for profitable business expansion.  This, however, accounts for the importance of cash flow forecast or plan the survival of every business concern, large or small



The forecast of cash is made up of cash sources and cash sources and cash requirements.  The sources include, in addition to revenues generated from operations, cash received from investments, borrowings, liquidation of assets and others. Cash requirements arise not only from cash operating expenses but also from expenditure of capital equipment, investments in new buildings, working capital requirements and from interest, tax and divided disbursements.  Since the availability of cash is so strategic for successful business operations and since the flow of cash through a business is subject to many variations, cash forecasting is a matter of time as well as amount.

The modern trend towards estimating the cash sources and cash requirements is the preparation of a cash flow statement (cash budget).  The statement if properly / adequately prepared should assist the financial manager or director in his financing and investment decisions since the budget will indicate the period in which cash resources are inadequate or a period of excess liquidity of cash.  If the budget indicates cash shortages, the financial manager must arrange additional finance for such periods such as obtaining short term loans or overdrafts.

On the other hand, if the cash budget indicates a surplus cash balance (excess liquidity), the financial manager would be required to invest such idle funds, in appropriate securities.

Excess Liquidity and investment options the term “excess liquidity” according to merit and sakes (1993) is that portion of the funds available to a decision making economic unit, which that unit does not have, immediate need for.  It follows logically from this operational definition that excess liquidity creates both the opportunity and the need for investment as idle funds or excess liquidity have no earning power and can therefore not increase future consumption. It can, on the contrary reduce future consumption due to the efforts of inflation. Ordinarily, investment implies the act of postponing current consumption for the sake of future consumption. Emekwue (1996) sees investment as the decision to put current finds most efficiently in projects in anticipation of an expected flow of future benefits over series of years. Nweze (1994) defined investment in the following way:

“The acquisition of a claim over the assets of another economic unit the user unit” in whatever manner an investment may be defined, it involves a sacrifice of present consumption in exchange of future benefits; hence it is subject to elements of risk that future outcomes Mary not be realized.  Thus investment decision is an ambit rage over time that involves degree of risk.  The problem commonly faced by the financial managers of acquisition organizations relates to how to invest idle funds under their control in the short or long run with multifarious investment options (choice among alternatives). The first step to the researcher’s mind in dealing with this problem is the establishment of the object.  However there are various objectives of an investment decision. Some complimentary and some conflicting as the following list which is not exhaustive reveals:

  • Income maximization
  • Risk aversion or minimization
  • Liquidity preference
  • Non – rational criteria



          Income is the assertion to wealth whose consumption was postponed to the future.  If a company invest N2 million today and collect N2.8 million after one year, the assertion of N8 million is the company’s income.  It is however in the nature of investment that as income earning opportunity increase, the risk of loss of the capital itself also increases. Since most investors are risk averse, the objective of income maximization is in conflict with the objective of risk minimization.


A condition of risk would arise when the investor has a multi-valued expectation at the time that the decision is being made. This implies that there is knowledge of the range of possibilities and also knowledge on the part of the investor of the Likelihood of accurance of each of the possibilities.  In investment risk denotes exposure to loss arising from variations between the expected outcomes and that, which is actually realized.

Nweze (1994) opined: “Nobody wants to loss anything possessing utilities including life which is enjoyed for its own sake, expect of course the dare-devils who play Russian Roulette; Everyone desires a safe haven for their funds” The problem however is that he safest investment outlets are those offering the least return or income and vice versa for the riskier outlets.  The objective of risk minimization is therefore in  direct conflict with or to sue the language of finance is in invest relationship with the income maximization objective.


Liquidity in relation to investment is the ease with which an investment can be reconverted to cash or liquid funds.  Liquidity preference appears to be a universal idiosyncrasy of most investor and for good reasons too as liquid the situation changes.

However, the more liquid an investment is, the less the income it can attract until we reach a state of total liquidity along the scale which is idle cash that does not constitute an investment and does not earn any income.  The shrewd investor therefore has to balance his craving for income against his liquidity preference.


          Investment theory being a part and parcel of the science of economics is concerned with rationality.  In practice, decision makers are sometimes swayed by non-rational and sentimental criteria like prestige, tribalism, nepotism, social acclaim and ever corruption.

Having discussed the various investment objective, it must be emphasized that those investment objectives which are desirable cannot be maximized without negative fall-outs.  For example, a higher return can only be achieved by accepting a higher level of exposure to risk, which in itself in achieved by getting a mix of the stated objectives, in such a  proportion, that no further improvement in wealth can be achieved by varying the mix.  Hence, the most viable objective of an investment decision is the achievement of maximum return or income at a minimum level or risk of illiquidity which will eventually head to losses as illiquid assets are not maneuverable.

Having stated the objective, this research will now comfier the different investment outlets into which excess liquidity as disclosed in the cash flow projections (cash budget) may be deployed.  There are three major decisions viz:

  • Short term investments
  • Medium term investment
  • Long term investments

This research study is mainly concerned with the short-term investments, which the company can undertake the following purposes aimed at boasting the company’s liquidity.

–        To maximize the return   or earned interest on the investment

–        To arrange for the maturities and cash requirements to coincide.

–        To maintain an easily accessible bank deposit balance or overdraft facility as a hedge against the uncertainty of cash flows.

The short-term investments are generally speaking regarded as investments with maturities of not more than one year.  The following investment fall into this category:

  • Savings account deposit
  • Bankers acceptance
  • Commercial papers (Cps)
  • Treasury bills
  • Tax reserve certificates

Savings deposit, are so to say, at the bottom of he investment ladder in terms of returns being expected.  Aversely,  they are the lowest paying investments in our system today and probably the most clumsy – requiring the physical presence of their owners armed with passbooks before withdrawal or transfer.  Even the notice of withdrawal, which is a  feature of illiquidity in the other types of short-term investments, is applicable to savings deposits for large amounts. However, it is instructor to note that restrictions as to the maximum amount on which interest in payable on savings deposits has since been removed by the monetary authority.  Although interest accrues on the full amount in a savings deposit no mater how large the researcher is of he opinion that this form f investment is not suitable for big.  Organizations like Anambra manufacturing motor company ltd as the operation of a savings account for a large amount is unwieldy and clumsy and low yielding fixed term deposits are fund investment of a fixed amount carrying fixed tenure and more often than not a fixed rate of interest.  The deposit could be 30 days, 60 days, 90 days or 360 days tenures, depending on the liquidity preference of the decision-making unit and the longer the tenure, the higher the applicable rate of interest and vice versa.

Term deposits of more than one-year tenure are more in the realm of medium term investment.  The deposit is a ideal outlet for complains treasury fund ass they are flexible and the treasurer can tailor the tenure to suit the funding needs of his company.  The interest rate is deposits.  Investment in bankers acceptances (BAS) and commercial papers (CPS) are becoming more popular in the Nigeria financial system.  A few years ago they were quite alien to our system, being common in USA.  A banker acceptance is a debt instrument, which is guaranteed by a bank for value not received by the bank hence a BA is called on accommodation bill.

Upon acceptance, the bank holds itself liable to pay on maturity, making the bill a valuable instrument that could be discounted with another bank or investing unit to place the issuer of the BA in funds immediately.

The issuer of the banker’s acceptance is of course expected to be disciplined by the tenure of the BA, which is commonly 90 days, and fund his account in the bank towards the maturity date to enable the bank pay the holder induce course at maturity.  The term holder in due course has been used because the initial purchases of the bill at a discount could discount it again with another party before maturity, the new partly now be coming the holder in due course.  BA’s being bank guaranteed instruments are fairly safe and high yielding and there recommended short-term investments for corporate organizations.  Commercial papers are I.O.Us or promissory notes of large firms and they are not quite as safe being as their name implies, instruments evidencing the existence of a short-term claim between two economic units.  Customarily, these papers are neither guaranteed nor otherwise secured.  Although they are generally higher yielding than banker acceptance, they are not recommend as short term investments for corporate funds unless they are guaranteed by a bank as is sometimes the case.  Treasury bills are obligations of the central bank of Nigeria (CBN) which are normally of three months tenure.  They are promissory notes undertaken to pay specific sums to the original purchasers of the notes or the holders in due course. The interest being required is normally earned up front i.e the principal sum minus interest calculated at the applicable rate.  Hence the bills are said to be issued at a discount, the discount rate being the interest.  Because they are obligations of the central bank of Nigeria, they are virtually risk-free although the applicable interest or discount rate is relatively low.  However, they possess the special feature of being rediscountable, a facility that enables the holder to return the bills before maturity and put himself in funds.  Another short term investments into which excess liquidity could be put to is tax reserve  certificates.  A company with high reserve may deposit with tax authorities tax for say five year.  The authority will then deduce annually the tax for each year.  This deposit is expected to earn interest, which will aid the principal amount in paying future tax.

  • Determination of excess liquidity/weak liquidity through cash budgeting

The financial manager of manufacturing organization needs to maintain liquidity at all times but not        excess liquidity.  Some cash or near cash has to be available, but where liquid assets are substantial, a portfolio should be constructed with securities of varying maturities ranging form overnight be constructed using the cash budget as a guide to future cash requirements and taking into consideration market conditions

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