In this article, we want to take a closer look at the theoretical background of companies, corporate goals and conflicting objectives, particularly in connection with maintaining liquidity. A crash course on the topic of companies and Cash position, if you will.

For those in a hurry: Maintaining liquidity as a permanent and core task 

• Every entrepreneur knows it: "The enterprise is considered an extremely complex, open, dynamic and social system." 
• The main objective of the company can be seen as the long-term maximisation of profit.
• One of the most important secondary conditions for the continued existence of the company is the maintenance of financial equilibrium or solvency.
• The basic goals of the company, maximum profit and financial equilibrium, have a negative or restrictive effect on each other.
• Just like Cash position , a breach of the ecological balance can jeopardize the continued existence of the company.

Company

In economics, private households, companies and the state are regarded as the will centres of any economy. In financial economics, companies are defined as "an economic unit that is geared towards continuity and directed by a centre of will, which participates in one or more sub-processes of the social production process". In economic terms, therefore, the entrepreneur is defined as the centre of will. This is actually quite an interesting insight, since the entrepreneurial will and thus the formation of the will is at the centre.

And it continues: "On the one hand, economic goods are acquired on their procurement markets and, after being transformed into more marketable products, these are sold on the relevant sales markets on the other. It is therefore a matter of acquiring, transforming and selling means. Whereby means are to be understood here quite objectively, i.e. as goods and also in the sense of services.

Let's move on to business administration. There, the object of knowledge is the enterprise. In market-oriented economic systems, the enterprise appears as a production household oriented towards the principle of profit, with the task of generating added value for its owners. Through the detailed study of the enterprise in business administration, the following definition has developed, based on systems theory:

"The enterprise is considered to be an extremely complex, open, dynamic and social system." A fact of which every entrepreneur is very aware.

Characteristic of this system is the multitude of connections to other systems, i.e. to the corporate environment. Exchanges of all kinds take place continuously and influence the company and its development - this is also referred to as the dynamic component.

Due to the multitude of changes or influences that arise in this way, the decision-makers (aka entrepreneurs or centres of will) are forced to constantly guarantee the achievement of the company's goals by means of guiding interventions. This is also understood as the social component of companies.

Relationships with other market partners have a significant impact on the company's continued existence, insofar as the consideration received must be sufficient to provide input factors. The principle of economic efficiency (i.e. to achieve a given goal with the least possible input of resources or to achieve the maximum with a given input of resources) should be observed as a basic principle of all decisions.

However, it can be observed that the application of this principle is strongly dependent on the development of the economy. In times of economic boom, i.e. good or satisfactory corporate development or profit generation, the principle of economic management is often neglected, whereas in times of negative corporate success it is readily recalled. In a somewhat different situation, we also experience such behaviour in the start-up sector in connection with liquidity decisions. While start-ups in "bootstrap" mode handle the available funds very consciously, the principle of economic efficiency can often be neglected after successful funding by external investors.

Corporate objective

Are there generally valid goals of the enterprise? If one assumes that the primary goal of a company is to survive economically, the question arises as to how this can be achieved.

The long-term maximisation of profit is often spoken of as a main goal of the enterprise. This is then understood to mean the achievement of maximum profitability or the creation of success potential. However, this objective depends on the economic system in which the company is embedded. This is true for market economy mechanisms. In this system, the basic assumption is that the economic unit and thus the entrepreneur are free to make their own decisions.

Although almost forgotten: In contrast, the organ principle prevails in centrally administered economic systems. This principle refers to the monetary (skimming of profits and receipt of subsidies) and non-monetary (commitment to economic plans) dependence of the enterprise. Due to the possibility of political subsidies or support, profit maximisation recedes strongly into the background.

An essential finding in the field of the analysis of corporate goals is that the principle of profit maximisation is not pursued unrestrictedly, but under consideration of subjective secondary conditions. The human component takes centre stage. Thus, there are a number of combinations of goals on which corporate decisions are based.

Most important secondary condition: Solvency

One of the most important secondary conditions for the continued existence of the company is the maintenance of financial equilibrium or solvency. This is the prerequisite, the restrictive secondary condition so to speak, for the pursuit of maximum profit, as this alone does not automatically promise secure Cash position "A profitable company must go under if it is illiquid, but a temporarily unprofitable company can remain liquid." Excuse me? Profitability is a figure that puts a result into perspective. Illiquidity is a point-in-time variable, absolute and unrelenting. A company is considered illiquid if it cannot pay its liabilities as they fall due. And in a first step, this has little to do with profitability. I will come to this later.

Due to the increasing awareness of the public and the resulting legal regulations, there has also been a considerable revaluation of ecological goals. Social pressure has developed that has recently led to changes in political power and will continue to do so. But why?

The principle of economic efficiency and thus long-term profit maximization and the secondary condition Cash position refer to the economic value creation of the company. This must be as efficient as possible. But: "Starting from this value creation, emissions, immissions and damage lead to operational damage creation, i.e. the perception of damage by society." Value creation / harm creation - it's starting to make more sense with the open, dynamic and complex system, isn't it?

The "elevation" of ecological goals to the rank of a restrictive secondary condition is justified when the consequences of non-compliance with these goals are pointed out: Shutdown of operations or interruption of operations, decline in demand, competition from environmentally friendly products, compulsion for technological innovation, and compulsion for product innovation.

Like Cash position, but to a limited extent, a breach of ecological balance can jeopardize the continued existence of the company. The area that exemplifies this threat is energy supply.

The data discussed in Germany on the phase-out of the coal industry has had a significant influence on corporate decisions for years. RWE, for example, has split itself into an "old" and a "new" division in recent years to take account of social changes.

Conflicting goals

With these three basic goals of the enterprise,

1. the pursuit of sufficient profit (profit-related component) and
2. the striving to maintain financial equilibrium (financial component) and
3. the pursuit of "ecological efficiency" (social component),

it is therefore a combination of goals. But in what way do these goals influence each other?

Target systems consist of various target relationships. The interdependencies of the individual goals are described as goal complementarities, goal conflicts and goal indifferences. It must therefore be taken into account whether objectives reinforce each other, whether they are in competition with each other or whether they are independent of each other. The greatest challenge in planning arises when coordinating the use of resources to achieve objectives in the case of prevailing or emerging conflicting objectives. For this reason, these relationships are of particular interest.

Competitors: Profitability and Cash position

"Classic competing goals are the pursuit of profitability and Cash position." This means that the basic objectives of the company, maximum profit and financial equilibrium, have a negative or restrictive effect on each other. The dilemma here is, among other things, a problem of temporal differences.

Profitability results from the ratio of earnings (in the form of profit, net income, etc.) to capital employed and is therefore a period problem. On the other hand, the payment-oriented concept of liquidity refers to the ability of a company to service its payment obligations at all times (i.e. at any point in time). The Cash position is therefore a point-in-time problem.

This can lead to a discrepancy between the timing of payments and the timing of the impact on success, resulting in a different assessment of success and liquidity. However, the assessment of the company's situation can subsequently be essential for decisions to be made. 

Preserving liquidity as a core task

In addition, measures to improve profitability can have a significant impact on Cash position and vice versa. The leverage effect plays an important role here. "If the profitability of the total capital employed in the company is higher than the cost of debt capital, the use of debt capital leads to an increase in the profitability of equity."

Subsequently, however, the injection of debt capital can lead to a liquidity bottleneck despite an improvement in the return on equity. This is the case when liabilities can no longer be serviced due to the increased absolute interest on borrowed capital. Such a situation is of course aggravated by a general rise in interest rates, be it in the refinancing of fixed-interest loans or by the immediate increase in debt service in the case of variable-interest debt. Optimising or exhausting the leverage effect can therefore be very harmful. Especially in the real estate sector (and in times of low interest rates), this is a very serious risk.

On the other hand, the desire to have a high cash balance to meet payment demands may result in an excessive cash reserve. "At a time when no disbursements need to be made, the cash balance may even be zero. A greater payment power than is necessitated by payment requirements is unnecessary and uneconomical from a profitability point of view." Financial management therefore recognises the maintenance of liquidity as a permanent and core task of financial management.

If we look at the relationship between ecological goals and other basic corporate goals, we can see that there are complementary goals. For example, an ecological orientation of the company can create potential for success and thus have a positive influence on the company in the long term. This can be seen above all in the start-up sector, where young companies gear their value creation to ecological aspects from the very beginning and can thus quickly tap into new target groups. Only in short-term areas of profit generation and cost savings can target conflicts arise, especially in companies that have been in existence for a long time.

For small and medium-sized enterprises with their characteristics of limited access to capital, but also due to their strong dependence on controlling entrepreneurs, Cash position is of paramount importance from these considerations.

Topics covered in the theory

Part 1: Company, objectives and Cash position

Part 2: Corporate governance and liquidity management

Part 3: Decisions and liquidity management

Part 4: Reporting in the company

Credits: Photo by Álvaro Serrano on Unsplash