Theoretical Framework

In creating shareholder value, cash management is anticipated to play a key role. It is the
reason why it is substantial to find new evidence of cash management behavioral magnitudes that
cause the creation or extermination of shareholder value. Cash management originally denotes
the liquidity of management in order to meet their day-to-day commitment (Collins & Jarvis,
2000). There are many businesses that do not put enough focus on managing the liquidity of the
firm. The product of poor focus on cash management often expresses that the financial assets are
bound. Instead of being bound, it could be used to invest in other areas. According to recent
studies they found that small businesses have a poor cash management attention (Denver, 2005).

Efficiency and effectiveness of liquidity management is very important for the survival of
firms, especially for smaller businesses (Sardakis et al, 2007). It is significant for smaller
companies because they can outlive without profit but will fail when they are not able to produce
payment. Liquidity means the level of cash and near cash assets held, together with cash in and
outflows of the assets (Ekanem, 2010).

A. Cash Flow Theory

The “theory” behind the model can best be explained within the framework of a “cash
flow”. Beaver (1966:80) writes: “The business is viewed as a reservoir of liquid assets, which is
supplied by inflows and drained by outflows. The reservoir serves as a cushion or buffer against
variations in the flows. The solvency of the business can be defined in terms of the probability
that the reservoir will be exhausted at which point the business will be unable to pay its
obligations as they mature (i.e., failure)”. It was argued that businesses with a positive cash flow
are able to raise their capital and borrow from the capital market, while businesses with a
negative or insufficient cash inflow are unable to borrow and therefore facing the risk of default.
According to this argument, a business is assumed to go profitable whenever the current year
profit or cash flow is positive.(Scott, 1981).

B. Gambler’s Ruin

Wilcox (1971) used the gambler’s ruin to develop his framework to predict default risk.
The model assumed that the business’ financial state could be defined as its adjusted cash
position or net liquidation at any time. According to the gambler’s ruin model the time of
profitability is based on the inflows and outflows of liquid resources.

In financial theory, researchers will be interested in how cash and other liquid assets affect
business value and the optimal capital structure of a business. Cash management is expected to
play a key role in creating business value. That is why it is important to find new evidence of
cash management behavioral dimensions that cause the creation or destruction of business value.