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Banking--insurance-question-paper-2010-->View question

Asked On2017-10-29 14:53:43 by:Ashwath-Shetty

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Various factors determining the liquidity of Banks:
1.Uncertainty of Cash Flow Projections :

The primary factor affecting liquidity mix is the uncertainty regarding the cash inflow and outflow estimates. Cash flows cannot be predicted with utmost accuracy. Cash inflows include receipts from cash sales, collections from credit customers, disposal of old assets, proceeds from sale of investments, issuance of stock, procurement of loans etc. All these inflows cannot be predicted with 100% certainty. For example, the past records of accounts receivables may reveal an average collection period of 30-45 days. Based on the past data, one cannot really predict that all the accounts receivables would be collected by 45 days. If you estimate so and prepare the cash budget accordingly, you may at times find surplus availability of cash during some period for investment. It may so happen that one or two customers become bankrupt and their balances to be written off. Thus uncertainty prevails. Cash outflows include payment to creditors, payments to meet all the operating expenses, planned retirement of bonds or loans etc. There is also some amount of uncertainty regarding the period and magnitude of outflows. Thus, cash budget though serves as an important tool for estimating the surplus of cash, cannot be relied upon with 100% certainty for timing and magnitude of cash inflows and outflows, ultimately affecting liquidity mix.
2.Management Policies :

The liquidity mix is also determined by the policies and decisions of the management. It depends upon the risk-return perceptions and attitude of the management. If the management is risk-averse, it will prefer to maintain liquid cash balance lying idle without return than to invest in risky short-term securities. It may also invest some money in Treasury bill kind of securities that are risk-free. But if the management prefers a higher return over liquidity it may opt for high-risk high-return securities.
3.Ability to raise immediate funds :

If the company is enjoying such a position that it can raise funds immediately without taking a loan, it may opt to invest most of its surplus cash in short-term marketable securities or inter-company deposits and will have less cash balance. Such a situation arises if the company is a branch of a major company or if a parent company exists. A company that does not have this favorable position may opt to keep more cash balance.
4.Effective Cash Management and control of cash flows :

A company which has an efficient cash management system and has got a good control of both cash inflows and outflows will be better placed to invest its surplus cash in marketable securities or investments that earn a good return. 

Apart from the above factors, the other factors that affect the liquidity mix are yield, taxability, interest rate risk, financial risk, liquidity of security etc.

Answerd on:2018-06-05 Answerd By:SaiKiran


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