The term business liquidity refers to the ability of a firm to generate cash both from within and outside to meet the cash requirements. It is no longer taken to mean a stock of net working capital or cash and its equivalents. It is a flow concept. Liquidity management in this sense is a much more inclusive term than working capital management and embraces in its fold the total operations of the firm including sales expenses investment and financing activities. It encompasses all these decisions and actions that are involved in creating and sustaining the ability of business enterprises to generate cash to meet its cash requirements. In practice, business liquidity is commonly perceived as a dynamic phenomenon and a function of cash flows to and from the business enterprise resulting from its operations rather than a stock of liquid or current assets held at a point in time. The flow of cash in a business firm may be conceived as circular, as it changes its form from one item to another and then returns to its original form. And this goes on, and on on a continuum basis in a business firm.

For a manufacturing organization, the circular flow of cash can be depicted as under:

circular flow of cash

The above diagram shows cash flow as a circular system of asset transformation. This contains both cash inflows and cash outflows. Interestingly, if both cash inflows and cash outflows in the organization match each other, there is no problem. But in actual practice, it is very rare to find a situation where periodic cash inflows and cash outflows have matched each other. It thus requires a proper system of cash flow management in order to provide adequate liquidity to the business. It is in this context that cash flow forecasting can prove a very useful aid to management.

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Working Capital Management Topics