Question

Consider the following two situations, and explain how would each situation affect a company's cash position?

- If firm reduces its inventory without adversely affecting sales, what effect will this have on the cash position?

- If firm reduces its DSO without adversely affecting sales, how would this affect its cash position?

Answer 1

When inventory is reduced without affecting sales, cash holding will be on the higher side because of lower purchase of inventory. But eventually, company will take steps to make sure that excess cash is not being held which can be invested elsewhere to generate returns.

When DSO(Days Sales Outstanding) is reduced without adversely affecting sales, this would mean that realisation of debtors would be faster and as a result cash holding will increase. However , over a period of time, company should either use this excess cash to invest in projects which will generate returns, else distribute it to the shareholders as cash dividends.