Submitted by: Submitted by somayarhoda
Views: 291
Words: 864
Pages: 4
Category: Business and Industry
Date Submitted: 07/20/2013 08:06 PM
Ongoing dilemma between liquidity and profitability
If I think back to what we’ve always been taught, and the reasons we know why organizations and businesses are formed, is solely for the purpose of maximizing profitability and creating shareholder wealth. Simply put, managers are interested in measuring the operating performance of a business to determine management effectiveness, and shareholders are interested in dividends, of which both this information is obtained from the profitability of the organization. So where does liquidity come in, and why has it become an important measure for decision making? Liquidity essentially provides us with information as to whether the company can generate positive future cash flows, whether it can meet its short term financial obligations such as loans as they become due or pay dividends. Cash is the most liquid form of assets on the Balance Sheet and the liquidity of the company is based on how quickly they can convert their assets (stock, receivables, etc) into cash and at what price. Fraser (1998) best phrased it as “ there may be no more financial discipline that is more important, more misunderstood and often more overlooked than cash management.” Profitability provides us with an indication of how much the revenue exceeds the expenditure of the business. While the profitability provides guidance as to the organization’s long term growth and survival, liquidity is indicative of the immediate survival (Niresh, 2011). So this proves that profitability does not always equal liquidity of an organization. However, they are both important to the survival of any organization.
Relationship on this dilemma to accrual accounting
The movement from the cash basis of accounting to the accrual basis of accounting was due to a call for more transparency and accountability, and provides more useful information for decision making purposes. Cash accounting recognized cash inflows or outflows when cash changed hands, while accrual...