The Research of Assessing Liquidity and Operational Efficiency

Abstract

A firm that can no longer pay its creditors-its bankers and suppliers-is illiquid and technically bankrupt, a situation that no manager wishes to face. Managers must make decisions that do not endanger their firm's liquidity-a term that refers to the firm's ability to meet its recurrent cash obligations toward various creditors. A firm's liquidity is driven by the structure of its balance sheet, namely, by the nature and composition of its assets and the way they are financed. To finance these investments, the firm uses a combination of short-term and long-term sources of funds. One way a firm can manage its balance sheet and enhance its liquidity is by using the matching strategy. This strategy requires that long-term investments be financed with long-term funds and short-term investments with short-term funds. We show in this chapter that the matching principle helps explain how a firm's liquidity should be measured and how liquidity is affected by managerial decisions.