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How SME's striving Liquidity issuebased on below article? Management of liquidity and liquid assets in small and medium-sized enterprises 1. Introduction Liquidity is an important
- How SME's striving Liquidity issuebased on below article?
Management of liquidity and liquid assets in small
and medium-sized enterprises
1. Introduction
Liquidity is an important factor in determining short-term financial management policies
and it is more of a tactical concept related to the small and medium-sized enterprises
(S.M.E.)'s ability to pay for its current obligations when they fall due at
minimal cost. Literature has demonstrated that there exists a trade-off between liquidity
and profitability which discourages enterprises from having excessive liquidity.
Our studies have analysed the dependence between liquidity level measured by
cash to current liabilities ratio and profitability of surveyed enterprises. We hypothesise
that there may be a negative correlation among them coupled with the fact that a
decrease in liquid assets triggers an increase of profitability expressed in terms of
return on assets. We expect that our findings support the notion that a trade-off
exists between the liquidity position and profitability.
Research has been carried out which studied and improved some aspects of management
of liquidity. However, the financial ramifications from a revision of liquidity
policy, which have important implications for efficient management of cash and
liquidity, have not been explored entirely in previous studies. With the aim of completing
the gaps relating to the financial impact from changing the liquidity policy of
S.M.E.s, the study will explore the ensuing benefits from changing the liquidity policy
as well as net profitability through decreasing the amount of liquid assets and investing
surplus cash or reducing their sources of financing.
The aim of this paper is to contribute to the debate by empirically investigating
the S.M.E.s' level of liquidity as well as the relationship between level of liquidity and
profitability, and by modelling in order to develop a new mathematical model for
estimating the financial effects of changing the liquidity policy of S.M.E.s. This paper
addresses how an S.M.E.'s liquidity position affects profitability.
The purpose of this study is to describe and explore re-evaluation of the liquidity
policy of S.M.E.s in order to decrease liquid assets and invest surplus cash, or to
reduce costs of financing as well as to improve profitability at an acceptable level of
liquidity risk. The outcome represents new models for calculating net savings through
decreasing the amount of liquid assets and investing surplus or through reducing
their sources of financing, and with these models an S.M.E. can consider net profitability
from carrying out these activities.
The remainder of the paper is organised as follows. Section 2 addresses the theoretical
grounds of the research. Section 3 explains the methodology, presents a descriptive
analysis of the data as well as results, and provides a discussion. Section 4
addresses theoretical grounds for modelling and develops corresponding models.
Finally, Section 5 is the conclusion.
2. Literature review
Liquidity is a function of current assets and current liabilities and their composition.
A company's level of liquidity depends upon the amount of the company's cash, the
amount of other assets that can be quickly converted to cash, whether the company
is making or losing money, the amount of obligations that will require repayment in
the near future and the ability of the company to raise more cash by issuing securities
or borrowing money (Chambers & Lacey, 2011, p. 489).
The first essential ingredient of liquidity is the time it takes to convert an asset into
cash or to pay a current liability and the quicker that an asset can be converted into cash,
the more liquid it is. A second ingredient of liquidity is amount and an enterprise must
have enough liquid resources to cover its financial liabilities coming due. Cost is the third
ingredient and an asset is liquid if it can be quickly converted into cash with little cost.
An enterprise is considered to be liquid if it has enough financial resources to cover its
financial liabilities in a timely manner with minimal cost (Maness & Zietlow, 2005, p. 31).
Liquidity refers to an enterprise's ability to meet its current liabilities and is closely
related to the size and composition of the enterprise's working capital position. Other
things being equal, a higher working capital position implies a more liquid position.
This is because the firm's current assets are the easiest to convert into cash, making
them the main source of cash to meet maturing liabilities (Shapiro, 1990, p. 734).
According to Helfert (1997), a liquid asset is an asset that can be rapidly converted
into cash without suffering a significant reduction in value. A perfectly liquid asset is
one that would entail no illiquidity discount (Bodie & Kane, 2009, p. 305). The liquid
current assets are cash, marketable securities, accounts receivable and inventory.
3248 E. KONTU_S AND D. MIHANOVI_C
Some marketable securities mature very soon, and can be converted quickly into cash
at prices close to their book values. These securities are called cash equivalents and
are included with cash. Other types of marketable securities have a longer time, until
maturity, and their market values are less predictable. These securities are classified
as short-term investments (Brigham & Ehrhardt, 2008, p. 86).
Accounts receivable, which arise from the sale of the enterprise's goods or services,
are less liquid than marketable securities while inventory is often less liquid than
accounts receivable. A liquid asset can be converted to cash quickly without having
to reduce the asset's price very much (Brighman & Houston, 2004, p. 77). Campbell,
Johnson and Savoie found that the traditional monitoring of accounts receivable and
inventory, as well as short-term cash flow projections and good bank relationships,
are viewed as extremely valuable tools in the management and planning of enterprise's
liquidity (Maness & Zietlow, 2005, p. 32).
The goal of cash and liquidity management is to plan an enterprise's cash position
so that cash is available when it is needed and all available idle cash is invested to
provide maximum income. To ensure that all available funds are optimally invested,
some enterprises maintain a zero balance in their bank accounts and fully invest all
cash in government securities or money market funds (Engler, 1993, p. 409).
Two major aspects of liquidity are ongoing and protective liquidity. Ongoing
liquidity refers to the inflows and outflows of cash through the enterprise as the
product acquisition, production, sales, payment and collection process takes place
over time. Protective liquidity refers to the ability to adjust rapidly to unforeseen cash
demands and to have backup means available to raise cash (Pinches, 1994, p. 638).
The ongoing liquidity is influenced by all aspects of the cash cycle, because
increases in purchases, inventory or receivables will decrease liquidity. As the cash
conversion cycle lengthens, the enterprise's ongoing liquidity worsens, as the cycle is
shortened, the enterprise's ongoing liquidity improves (Pinches, 1994, p. 639).
Ebben and Johnson (2011) investigated the relationship between cash conversion
cycle and levels of liquidity, invested capital and performance in small firms over
time. In a sample of 879 small manufacturing firms and 833 small retail firms, cash
conversion cycle was found to be significantly related to all three of these aspects.
Firms with more efficient cash conversion cycles were more liquid, required less debt
and equity financing and had higher returns.
Protective liquidity is the ability to have liquid resources to meet unexpected cash
demands. According to Pinches (1994), planning the enterprise's short-term financial
management policies and liquidity needs involves uncertainty and effective managers
always maintain some protective liquidity. Effective short-term financial management
involves a continual trade-off between risk and return. To deal with the risk of running
short on cash at a crucial point in time, enterprises establish various means of
ensuring protective liquidity. This may be in the form of lines of credit which are
short-term borrowing agreements the enterprise has negotiated with a bank.
Campello, Giambona, Graham, and Harvey (2012) explored how enterprises in
Europe used credit lines during the financial crisis. They found that firms with
restricted access to credit draw more funds from their credit lines during the crisis
than their large and profitable counterparts. Their findings suggest that credit lines
ECONOMIC RESEARCH-EKONOMSKA ISTRA_ZIVANJA 3249
did not dry up during the crisis and provided the liquidity that firms used to cope with
the exceptional contraction. Campello, Giambona, Graham, and Harvey (2011) also
studied how enterprises managed liquidity during the 2008-2009 financial crisis. Their
analysis provides new insights on interactions between internal liquidity, external funds
and real corporate decisions such as investment and employment. They show how companies
substitute between credit lines and internal liquidity (cash and profits) when facing
a severe credit shortage. They find that credit lines are associated with greater
spending when companies are not cash-strapped. Firms with limited access to credit
lines appear to choose between saving and investing during the crisis. Their evidence
indicates that credit lines eased the impact of the financial crisis on corporate spending.
Almeida, Campello, and Hackbarth (2011) studied the interplay between corporate
liquidity and asset reallocation. Their findings show that financially distressed firms
are acquired by liquid firms in their industries even in the absence of operational
synergies. These acquisitions of distressed firms by liquid industry firms are denoted
liquidity mergers. Almeida et al. (2011) analyse firms' liquidity policies as a function
of real asset reallocation, examining the trade-offs between cash and credit lines.
Their findings show that firms are more likely to use credit lines in industries with
more liquidity mergers.
Liquidity can be measured by using different ratios but overall liquidity ratios generally
do not give an adequate picture of an enterprise's real liquidity, due to differences
in the kinds of current assets and liabilities the enterprise holds and it is
necessary to evaluate the activity or liquidity of specific current accounts. Various
ratios exist to measure the activity or liquidity of receivables and inventory. The
accounts receivable turnover ratio gives the number of times accounts receivable is
collected during the year and the days sales outstanding determines the average number
of days it takes to collect credit sales. The higher the accounts receivable turnover,
the better since the enterprise is collecting quickly from customers and these funds
can be invested. Inventory turnover can be found by dividing annual cost of goods
sold by the average inventory while the days inventory determines the average number
of days it takes to produce and sell the product (Pinches, 1994, p. 639).
According to Shapiro and Balbier (2000), an evaluation of the quality of an enterprise's
receivable and inventory accounts is critical to any assessment of liquidity. If
accounts receivable and inventory turn over quickly, the cash flow received can be
invested for a return, thus increasing net income.
Costs and benefits for holding liquid assets have to be carefully weighed against
the opportunity costs for holding more productive but less liquid assets. Optimal
amount of liquidity is determined by a trade-offs between the low return earned on
liquid assets and the benefit of minimising the need for external finance (Kim,
Mauer, & Sherman, 1998, p. 335).
If a firm has a temporary cash surplus, it can invest it in short-term marketable
securities (Ross & Westerfield, 2005, p. 769). Short-term investments are usually
undertaken when the firm has an excess of cash and can invest it in order to receive
a higher return since having idle cash is considered inefficient.
Literature reports demonstrated that there is a trade-off between liquidity and
profitability. Garcia-Teruel and Martinez-Solano (2007) examined the impact of
3250 E. KONTU_S AND D. MIHANOVI_C
working capital management on the profitability of a sample of small and mediumsized
Spanish enterprises. They have found a significant negative relation between an
S.M.E.'s profitability and the number of days accounts receivable and days of inventory.
The results also indicate that managers can create value by reducing their cash
conversion cycle to a minimum. Equally, shortening the cash conversion cycle also
improves the firm's profitability.
Czarnitzki and Hottenrott (2011) examined the relation between working capital
level and profitability of S.M.E.s in Germany. They have shown that there is a nonmonotonic
(concave) relationship between working capital level and profitability of
S.M.E.s, which implies that S.M.E.s have an optimal level of working capital that
maximises their profitability.
Nunes, Viveiros, and Serrasqueiro (2011) examined the determinants of young
Portuguese S.M.E. profitability: their findings suggest that age, size, liquidity and
long-term debt are of greater relative importance for the increased profitability, while
risk is of greater relative importance for the diminished profitability of young
S.M.E.s, compared to the case of old S.M.E.s.
In contrast to previous findings, Banos-Caballero, Garcia-Teruel, and Martinez-
Solano (2011) have found that there is an inverted U-shaped relationship between
working capital level and profitability, which in turn indicates that both high and low
working capital levels are associated with a lower profitability. Their results indicate
that enterprises have an optimal level of working capital that balances costs and benefits
and maximises their profitability; enterprises' profitability thus decreases as they
move away from this optimal level.
Banos-Caballero, Garcia-Teruel, and Martinez-Solano (2014) examined the linkage
between working capital management and corporate performance for a sample of
non-financial British companies. The findings provide strong support for an inverted
U-shaped relation between investment in working capital and firm performance,
which implies the existence of an optimal level of investment in working capital that
balances costs and benefits and maximises a firm's value.
Pais and Gama (2015) investigated the impact of working capital management on
the profitability of small and medium-sized Portuguese firms. The empirical results
indicate that a reduction in the inventories held and in the number of days that firms
take to settle their commercial liabilities as well as to collect payments from their customers
are associated to higher profitability. The relevance of quadratic dependences
of the profitability on some variables was also identified and suggests a decreasing
trend of return on assets with increasing values of the working capital management
characteristic variables.
Lima, Martins, and Brandao (2015) investigated the impact of working capital
management on profitability of S.M.E.s in European countries. The findings suggest
that working capital management unequivocally affects profitability in European
countries. The results also indicate that there is a positive relationship between liquidity
and profitability. The positive relationship between liquidity and profitability can
be explained by the fact that enterprises use first of all the amount of internally generated
resources before seeking external resources, especially in the case of S.M.E.s,
which have difficulties in obtaining external financing.
ECONOMIC RESEARCH-EKONOMSKA ISTRA_ZIVANJA 3251
Lyngstadas and Berg (2016) examined the effect of working capital management
on the profitability of small and medium-sized Norwegian firms. The empirical
results indicate that reducing cash conversion cycle will increase profitability. The
relevance of quadratic dependencies of the profitability on independent variables was
also identified and suggests a decreasing trend of return on assets with increasing values
of the working capital management characteristic variables. This study confirms
that working capital management is relevant for firms' profitability.
Banos-Caballero, Garcia-Teruel, and Martinez-Solano (2016) investigated the relation
between the financing strategies of working capital requirement and firm performance.
Using the two-step generalised method of moments estimator, they find
that a suitable financing strategy can help firms improve their performance. The findings
are of interest for managers and researchers and show that managers should not
only be concerned about investing in working capital requirement but also consider
how this investment is to be financed.
Afrifa and Tingbani (2018) examined the relationship between working capital
management and S.M.E.s' performance by taking into consideration the effect of cash
flow. They applied panel data regression analysis on a sample of 802 British S.M.E.s
for the period from 2004 to 2013. The results of the study demonstrate the importance
of cash flow on S.M.E.s' working capital management and performance.
According to their findings, working capital management has a significantly negative
impact on S.M.E.s' performance. Their findings suggest that in an event of cash flow
unavailability (availability) managers should strive to decrease (increase) the investment
in working capital in order to improve performance.
Valaskova, Kliestik, and Kovacova (2018) investigated financial risks of Slovak
companies. They focused on the revelation of significant economic risk factors using
multiple regression. The empirical results suggest that the most significant predictors
are net return on capital, cash ratio, quick ratio, current ratio, net working capital,
RE/TA ratio, current debt ratio, financial debt ratio and current assets turnover based
on which the decision about the future company default can be made. These factors
are significant enough to manage financial risks and to affect the profitability as well
as prosperity of the company.
Zimon (2018) examined the impact of purchasing groups on the financial situation
of enterprises. Empirical research was based on a sample of 60 Polish S.M.E.s covering
the years 2013-2015. The analysis showed that the choice of an appropriate group
purchasing organisation had a large impact on financial situation of companies. The
empirical results suggest that functioning within purchasing groups allows maintenance
of safe financial liquidity, apart from obtaining a low price of purchased goods
and materials, and has a positive impact on the effectiveness of managing receivables
and short-term liabilities. The action within the branch or multi-branch purchasing
groups has a positive effect on liquidity, profitability and management efficiency.
Kontu_s (2018) investigated whether there was a relation between liquidity level,
expressed in terms of net working capital as well as the cash-to-current-liabilities
ratio and profitability of S.M.E.s and large companies in the Republic of Croatia in
2014. The study has not in any case provided empirical evidence that liquidity is
negatively related to profitability.
3252 E. KONTU_S AND D. MIHANOVI_C
Maintaining a proper balance between liquidity and profitability is important to the
overall financial health of a business and in this study we examine the impact of liquidity
on profitability. We also show how through decreasing the amount of liquid assets an
S.M.E. can improve profitability.
3. Research
3.1. Methodology
This paper presents results from an empirical research undertaken on a representative
sample of Croatian S.M.E.s with the aim of exploring their liquidity along with the
dependence between the S.M.E.s' level of liquidity and profitability. The dataset was
provided by the Financial Agency (F.I.N.A.) for Croatian enterprises on a yearly basis.
Our initial sample comprises 150 enterprises included in the F.I.N.A. database. The
enterprises in the sample meet the European Commission's definition of S.M.E.s.
Although the precise definition of an S.M.E. has varied greatly in prior studies, there is an
increasing tendency to rely on the European Commission's one. In line with this definition,
we selected enterprises that met the following criteria: (1) fewer than 250 employees;
(2) sales below 50,000,000 EUR; and/or (3) annual total assets below 43,000,000 EUR.
From the basic set of S.M.E.s, which comprises more than 106,000 enterprises in
Croatia, an initial sample of 150 major enterprises is selected according to the asset
value criterion. The sample is reasonably representative of Croatian enterprises, as
they cover all sectors, other than finance and insurance, due to their distinct financial
behaviour and specificity. We also excluded enterprises that belong to the governmental
sector because of additional requirements that apply to this sector. Enterprises
showing extreme or inconsistent figures in any of the variables were excluded from
the sample. In addition, we discarded observations with missing values. In so doing,
we ended with a final sample of 93 S.M.E.s from Croatia over the period 2010-2014.
The following methods were used for research data analysis: descriptive statistics, correlation
analysis and panel data regression.
A fixed-effects model, random-effects model and pooled regression model were
used in panel data analysis. The Hausman test was performed to decide between a
random effects regression and a fixed-effects regression. The Breusch-Pagan Lagrange
multiplier was used to decide between a random effects regression and a simple
ordinary least squares (O.L.S.) regression. The statistical data analysis was carried out
using Stata software version 15.0.
In this section, we provide an overview of the variables that were used in our
empirical analysis:
1. Cash level is measured as the ratio of cash to current assets.
Cash to current assets ratio cash=current assets
2. Liquidity is measured as
_ Cash ratio: the ratio of cash to current liabilities
_ Quick ratio: the ratio of cash and accounts receivable to current liabilities
_ Current ratio: the ratio of current assets to current liabilities.
3. Leverage is measured as the ratio of total debt to total assets.
4. Profitability is defined as return on total assets.
Return on assets is the relationship of annual after-tax earnings to total assets,
used as a measure of the productivity of a company's assets (Helfert, 1997, p. 359).
Using methods from statistics, we examined the trade-off between liquidity and profitability.
We used financial ratios in order to improve the quality of analysis and
descriptive statistics analysis.
In this study, we also analysed liquidity and liquid assets, as well as their determinants.
The independent variables that determine net earnings through decreasing the
amount of liquid assets and investing surplus cash or through reducing their sources
of financing have been selected and the relations between them have been defined.
For a precise formulation of the relationship between a set of independent variables,
mathematical methods have been adapted to yield net earnings as a dependent variable.
On the basis of our research results, we have introduced new models for calculating
the net savings through decreasing the amount of liquid assets.
3.2. Results of empirical analysis and discussion
We separately analysed the dependence between cash level and liquidity, and the
dependence between the liquidity and profitability of the examined enterprises.
3.2.1. Relation between cash level and liquidity of surveyed enterprises
As cash presents a certain standard of liquidity, we analysed the liquidity position of
the examined enterprises along with the dependence between cash level and liquidity,
as measured by different liquidity ratios. The level of cash expressed in terms of the
ratio of cash to current assets and liquidity in surveyed S.M.E.s in the Republic of
Croatia in 2014 is shown in Table 1.
The results of liquidity analysis, measured by liquidity ratios, indicate that the
liquidity position of surveyed S.M.E.s is appropriate. As it is generally accepted that
the quick ratio should be 1 or higher and an enterprise should have a current ratio
greater than 2 in order to pay off current liabilities in time, it can be concluded that
surveyed S.M.E.s can avoid financial difficulties regarding not-payment of due current
liabilities.
The average value of cash to current assets ratio for surveyed S.M.E.s during the
observed period is 0.11 with a standard deviation of 0.17 while the average value of
cash to current liabilities ratio is 0.59 with a standard deviation of 0.32. For S.M.E.s,
the correlation coefficient between the cash to current assets ratio and the liquidity
expressed in terms of cash liquidity ratio is 0.41, which confirms that the correlation
between them is positive and weak. In addition, our results indicate that the average value
of quick ratio is 1.47 with a standard deviation of 2.75. Cash level is positively related to
liquidity expressed in terms of quick ratio for S.M.E.s under review and the correlation
between them is positive and weak. Repeating our analysis of liquidity expressed in terms
of current ratio, we have found similar relation between cash level and liquidity.
We have found a weak positive dependence between cash level and liquidity
expressed in terms of current ratio. The positive correlation between variables cash level
and liquidity measured by different ratios is an indication that a change in the level of
cash is associated with a consistent and equivalent change in the level of liquidity.
3.2.2. Relation between liquidity level and profitability
We next investigated whether there was a relationship between liquidity level,
expressed in terms of the current-assets-to-current-liabilities ratio and profitability
expressed in terms of return on assets, and analysed the dependence between them.
Table 2 presents the correlation coefficients for liquidity and profitability ratios in
surveyed enterprises over the period 2010-2014.
The correlation coefficients between the variables current-assets-to-current-liabilities
ratio and the return on assets for S.M.E.s during the observed period have a negative
sign, which indicates that the correlation between current-assets-to-current-liabilities
ratio and return on assets is negative and weak. We have found a weak negative
dependence between liquidity expressed in terms of current-assets-to-current-liabilities
ratio and profitability expressed in terms of return on assets, indicating that as the values
of current-assets-to-current-liabilities ratio increase, the values of the return on
assets tend to decrease. We confirmed our hypothesis: there may be a negative correlation
among liquidity and profitability with the fact that a decrease in liquid assets triggers
an increase of profitability expressed in terms of return on assets.
We also examined the impact of liquidity on the profitability of Croatian S.M.E.s over
the period 2010-2014. The leverage variable has been included in the regression in order
to test whether and to what extent debt financing and interest expenses influence profitability.
Table 3 presents the regression estimators by using random effects regression.
The Hausman test and Breusch-Pagan Lagrangian test show that the random
effects model is preferable over O.L.S. and fixed-effects models.
We have found that liquidity and leverage ratios have an influence on the profitability
of examined S.M.E.s. The regression results indicate that the return on assets
variable of the examined enterprises decreases when the leverage variable increases.
Debt ratio has a negative and significant impact on profitability of examined enterprises.
We have found that liquidity measured by current ratio has a negative but not
significant impact on profitability of examined enterprises over the period 2010-2014.
Table 2. Correlation coefficients for liquidity and profitability ratios in Croatian surveyed SMEs
over the period 2010-2014.
3.3. Discussion
Our results of liquidity analysis of surveyed enterprises indicate that the ability of
S.M.E.s to meet their current liabilities from cash is acceptable and these enterprises
have a certain margin of safety to retain their good financial health as well as avoid
financial difficulties regarding not-payment of due current liabilities. We add that the
correlations between cash level and the liquidity measured by different liquidity ratios
all have the predictable sign. We confirm that during the observed period the correlation
between cash level and liquidity for surveyed S.M.E.s is positive and an increase
in the cash level triggers an increase of liquidity expressed in terms of liquidity ratios.
Our results are also consistent with an existing theory of liquidity, as we observe a
positive relationship between cash level and liquidity.
We have investigated whether there is a relationship between liquidity level,
expressed in terms of current-assets-to-current-liabilities ratio and profitability,
expressed in terms of return on assets. This study has provided empirical evidence
of a negative relationship between S.M.E.s' level of liquidity expressed in terms of
current-assets-to-current-liabilities ratio and return on assets. We confirm that during
the observed period the correlation between liquidity expressed in terms of current-
assets-to-current-liabilities ratio and return on assets for examined enterprises
is negative and weak and an increase in the current-assets-to-current-liabilities ratio
triggers a reduction of profitability. We can summarise that these findings support
the notion that the liquidity position depends on cash. The study has provided
empirical evidence that liquidity is negatively related to profitability and the findings
support the notion that a trade-off exists between the liquidity position and
profitability.
We have also found that liquidity measured by current-assets-to-current-liabilities
ratio has a negative but not significant impact on profitability of examined enterprises.
Finally, we can conclude that a high level of debt due to high interest payments
and increased risk will decrease the profitability of S.M.E.s.
The main objective of a liquidity policy as part of a financial policy is to assure
enough cash as well as quick conversion of other liquid assets into cash in order to
maintain solvency as well as improve profitability. The policy of liquidity has a great
impact on net income and profitability of S.M.E.s which can increase by minimising
the costs of financing liquid assets or by maximising the return on excess liquid
assets. Consequently, the policy of liquidity must aim to achieve and maintain an
optimal amount and structure of liquid assets which can be converted quickly into
cash. The S.M.E. can re-evaluate its liquidity policy as well as investment policy.
Excessively high liquidity may mean that management has not aggressively
searched for desirable capital investment opportunities. Maintaining a proper balance
between liquidity and profitability is important to the overall financial health of a
business and S.M.E.s. Effective liquidity management includes assuring adequate
liquidity of S.M.E.s as well as decreasing the amount of liquid assets needed to support
operations in order to invest surplus cash or to reduce costs of financing liquid
assets thus increasing net income and profitability.
4. Models
Before changing its liquidity policy, an S.M.E. has to weigh the profit potential against
the liquidity risk inherent in decreasing the amount of liquid assets for supporting
operations. Aggressive liquid asset management increases receivables turnover and
inventory turnover. An increasing receivables turnover is usually a positive sign, showing
the S.M.E. is successfully executing its credit policies and quickly turning its
accounts receivables into cash and an increase in receivables turnover (annual sales
being equal) will decrease the average amount of receivables. An increasing inventory
turnover is also a positive sign, showing the S.M.E. can quickly sell its inventories and
an increase in inventory turnover (annual cost of goods sold being equal) will reduce
the average amount of inventory. As lowering liquid assets can result in a reduction of
their sources of financing and costs of financing as well as in excess amount of liquid
assets for investment, it has a positive impact on profitability of S.M.E.s.
Using economic and mathematical principles, we have developed a new mathematical
model for calculating net savings through lowering the amount of liquid assets.
In developing this model, we have used the basic concept of comparing the benefits
of changing the amount of liquid assets versus the costs of financing liquid assets.
We have analysed benefits from increasing coefficients of turnover of liquid assets'
units resulting in a drop in the amount of liquid assets and on the basis of research
results we have developed a new model for calculating net savings from decreasing
the amount of liquid assets required.
Net annual savings through decreasing liquid assets can be defined as
net savings additional earnings_costs of financing _ 1_profit tax
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