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Q: If a company recently installed an inventory management system which reduces the average inventory days,...

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If a company recently installed an inventory management system which reduces the average inventory days, how would working capital and free cash flow to firm be affected (assume sales and profit margins remain unchanged)? Briefly explain.

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Answer #1

The reduce in the average inventory days would decrease the working capital requirement and hence it increases the free cash flow to the firm.

With the new inventory management system, the company is selling its inventory faster than before. So, the cash that was tied up in inventory earlier is now free to use with the frequent churning of inventory.

The cash conversion cycle has improved with decrease in the average inventory days and this has a positive effect on the free cash flow to the firm.

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