Profitability at the expense of liquidity

Dear Padmanabhan,

   Liquidity crisis occurs not because the government does anything in which case others also would have been in a quandry. Others like Mobile store which started around the same time as Subhiksha is doing fine. Moreover working capital is not managed with low interst funds from banks. It comes through the subprime route running up to double digit rates. Usually what companies do is follow the process of 'compensating balance' loans for working capital meaning the interst is deducted in advance on top of certain amount the banks withholds before giving out the debt. Suppose if you need 1000 and bank rate for you not being worthwhile meaning one who hasn't created a name of themselves like lowly ratef firm then it will be subprime around 22% in India sometime back, then bank will withold 220+ say another 60 for compensation and give you 730 and after one year you will have to pay back the whole 1000 making the interst rate around 28%.

This has nothing to do with the government lowering rates etc; and banks following suit.

First of all having been trained abroad many of the words used by Indian professionals are alien to me. Liquidity in proper sense is used abroad in a market sense, either financial liquidity for market securities.

I persume what Padmanabhan is trying to convey is dip in sales or slow down which affects cash fow of the company and an underfinanced company depending soley on sales as source for monthly operations can be in trouble. In US they do this they have a monthly forecast for monthly cash flow and the excess is borrowed which keeps the cost of capital down. Here too we can follow that provided we have a forecast for cash at hand + monthly sales + receivables collected for the month - payables. If we have a deficit we finance it from a Bank else we have a surplus for the month all well and good.

 Edit: Actually the process followed is called the excess fund required for each month of operation for a financial year. It is (cash at the begining of month+a/r collected+ sales receipts) - (payables for the month + overhead expenses for the month like marketing and normal overheads + planned excess cash requirement for the begining of next month). If surplus or deficit no-financing or financing decision is taken. Then there is a whole gamut of process that originate from this. When planning for the financial year, once these targets are not met then retributivei actions are undertaken. There is collection discounts for those who pay early etc;. The whole Company processes can be designed around this. Like if sales are slackening a review of operations to the causes, the retributive actions if one finds what is wrong like a new product launched in the market which is eating into your market share, work of competiion, government regulations, even substitutes hiting market seens. Retributive actions include faster r&d to produce better product like product enhancement etc;.

In case of Subhiksha, I think they were discount retailers for Mobile phones and in some place they ran Departmental stores. In times like India is switching into modern retailing they were sticking with the old model of poor display and ration shop like attitude. Now Asim Premji has come to their risk and is pumping in some funds into their operations. Their model I think if at all it works will work only in villages and small towns and not in big cities where the real consumers live and work. So I think unless they change or doing any tampering with cashflow cycles will do any good to them. In fact I think they are retailers and they don't sell in credit too much. 

yes it is always a tradeoff between liquidity and profits..this is what is not thought in schools and collages to have liquid cash.even our curiculams fails to emphasis the importance of having enough liquid cash to ward off bad times.

many organisations have out of experience created reserves and fixed deposits just to see bad times out.we have not deviced a perfect formula to say this much would be enough and tis are for bad times.we tend to make a mistake of using funds ear marked for bad times to be used as and when required for our daily routine.

discipline in finace matters comes from the child hood.it cannot come over nite.it cannot be practiced overnite.it comes from the way we are brought up the way we have managed our finances from our child hood.

it is when we find that after so many cycles of ups and down in business that it was lack of liquidity that troubled the business.experience that we realise the need to have reserves which can be used for real bad times.but we keep digging in to those reserves all the time.

it could be a great business opportunities for insurance companies if they can have a insurance which could provide for liquidity at times like this yes offcourse it is for a cost all the time.may be some conditions apply..they would have a set of conditions that the bisiness should have to follow and even after that the business finds itself in liquidity crisis..providing liquidity at such times could be a massive business. and it would help in reducing the idle capital and help business in being better off and maximise the use of resources at there end.

may be there have to be some acctural studies done to find out how offen busineess fail because of lack of liquidity..and what is the cost so many organisations are paying to have enough liquidity for each busineess and how capital is getting blocked at each business..and how can we try to mitigate such a situation.it is seen that many a times it is the lack of liquidity which effects the prospect of very good management and business ideas.

we could think of having a insurance company coming up and take up the place.many banks do finance but there is a place for such a business.when we can have life insurance for people why not for business..people is a small amounts but when business fail it effects many people.many a business could be saved and many job could be saved. alla satyam.may be a managemnet take over for some time by such insurance comapnay which have a pool of management specialist..and liquidity etc idea can be exploreed and a new business area could come up.

Profitability at the cost of liquidity is not envisaged in any plan. While profitability flows from market conditions like demand in excess of supply and input costs, liquidity depends on variables in working capital cycle and sometimes may behave in misalignment with the growth of the organization. What I mean to say is that the liquidity conditions assumed in a business model may be driven by certain systemic issues that may lie beyond the control or model of the entrepreneur. The right return on capital is achieved by an appropriate mix of own capital and borrowed capital. And the mix does help in realizing a better scale of economy too. For instance, an enterprise focused on liquidity may sell less at credit or may borrow less or may have a strict just in time inventory model which may or may not help achieve customer objectives and overall may not get the scale advantages which a competing enterprise obtains from the marke environment, taking a conscious risk on liquidity. This is not to say that liquidity principle should be given a go by, but to emphasize the point that the liquidity issues of an enterprise need to be understood from the overarching business model, scales of economy, competition being a driver and of course, the diligence of the enterprise in assuming a risk exposure on its customers and counterparties. Once market conditions influence liquidity adversely, it is incumbent on the enterprise to tighten credit to its debtors,  lengthen credit on purchases a bit and forego a bit of topline and margin for the sake of a more orderly working capital cycle that is liquid enough. Such situations are an ideal opportunity for the enterprises to restructure their balance sheet, get out of non core assets, renegotiate their borrowings for a more sustainable credit arrangement and realise sustainability of the enterprise while remaining a profitable business. Subiksha may have been a case of mismanagement rather than liquidity lost on profitabillity alone. Or perhaps, they lost on both counts. They needed to revisit their business model ahead of their problems. I am not sure whether they did that. Interesting debate, thanks for that.