Question

You are looking at the liquidity level of ABC firm. Its Cash on hand is $250,000, unused credit lines is $500,000, Average daily cash flow is $1,000,000, and Standard deviation (σ) of daily cash flow is $1,500,000.

            Calculate and explain the Lambda based on the information.  

Answer 1

Cash On Hand = 250,000
Unused Credit Lines = 500,000
Average Daily Cash Flow = 1,000,000
Standard Deviation = 1,500,000

Lambda Index = [(Cash on Hand + Unused Credit Lines + Avg Daily Cash Flow) / Standard Deviation]
= (250,000 + 500,000 + 1,000,000) / 1,500,000
= 1,750,000/1,500,000
Lambda Index = 1.16667 ~ 1.17

Lambda index uses initial cash reserves such as cash on hand, unused credit lines, marketable securities, etc. plus Expected Cash Inflow and divides the whole thing by the uncertainty in receiving those cash flows (also called the standard deviation). This gives us an answer in the form on index.
Higher the Lambda index, the better it is