Function of Finance : Liquidity Desicion

Liquidity decision is concerned with the management of current assets. Basically, this is Working
Capital Management. Working Capital Management is concerned with the management of current
assets. It is concerned with short-term survival. Short term-survival is a prerequisite for long-term
survival.
When more funds are tied up in current assets, the firm would enjoy greater liquidity. In
consequence, the firm would not experience any difficulty in making payment of debts, as and
when they fall due. With excess liquidity, there would be no default in payments. So, there would
be no threat of insolvency for failure of payments. However, funds have economic cost. Idle current assets do not earn anything. Higher liquidity is at the cost of profitability. Profitability
would suffer with more idle funds. Investment in current assets affects the profitability, liquidity
and risk.  A proper balance must be maintained between liquidity and profitability of the
firm. This is the key area where finance manager has to play significant role. The strategy
is in ensuring a trade-off between liquidity and profitability. This is, indeed, a balancing act
and continuous process. It is a continuous process as the conditions and requirements of business
change, time to time. In accordance with the requirements of the firm, the liquidity has to vary
and in consequence, the profitability changes. This is the major dimension of liquidity decisionworking capital management. Working capital management is day to day problem to the finance
manager. His skills of financial management are put to test, daily.