Question

QUESTION: The more predictable a firm's cash inflows, the more net working capital it will need.

ANSWER OPTIONS: True False You need to specifically state IN THE SUBJECT LINE if the answer is TRUE or FALSE.

EXAMPLES OF INADEQUATE RESPONSES: “I think the answer is False.” OR “The correct answer is “C.”

Postings must be no less than 200 words in length to be considered. Any posting less than 200 words in length will not be reviewed.

Answer 1

The statement is False.

Net working capital (Current Assets-Current Liabilities) acts as a cushion for unwarranted/unexpected operational funding requirements. For example, if a firm is not sure about the amount of cash it needs to pay to towards the production costs (due to high uncertainity in demand or erratic sales), it should have a higher cash reserve to avoid any disruptions in the production process. With the higher cash, the company may decide to invest in short term money market instruments to earn some interest and still remain liquid. With some advanced statistical tools, the company may even model stochastic cash flows. Generally, cash outflows can be predicted with relative certainty over the cash inflows which can sometimes be highly uncertain. Certainty in predictions allows a firm to match its inflows with outflows. However, we observe that most of the firms have a positive working capital (excess of current assets over current liabilities). It is primarily due to the fact that there is always a level of uncertainty in cash flows projections and if it turns out to be otherwise, a company may face technical insolvency. Hence, a current ratio of 1 in most industries is not desirable. Contingencies must always be accounted for by additional working capital or in other words, higher the uncertainty, higher is the working capital requirements.

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