Question

2. Excess inventory exists when a company inaccurately orders inventory and is left with more than the market demands or market demand dramatically falls after inventory is ordered. Having excess inventory is generally regarded as bad for business because of what it means for inventory turnover and the costs associated with managing it.

Required:

Discuss THREE (3) common justification to keep inventories low to ensure prudent working capital management.

Answer 1

Reduce Inventories to ensure prudent working capital Management: Prudent Capital Management is required for every company for the proper management of the cash and to make sure that there is no less or more working capital management. If there is less working capital , it means you are unable to pay your current liabilities with your current liabilities. If there is more working capital it means you are not properly utilising you working acpital in investing and other options. One of the ways for prudent working capital management is by reducing inventories.

Three Common Justifications to keep inventories low to ensure prudent working capital Management:

Decreases Accounts Payable: When you inventories are high whcih are not necessary, you need to pay more accounts payabale. So, if you keep the inventories low by reducing your accounts payable. Thus increses you working capital ensuring prudent working capital management.

Decreases Interest Payable: If you brought the inventories on Credit. You nne dto pay the interest till you repay it. So if you keep the inventories low, you can decrease your Interest payable on acounts which reduces your current liabilities ensuring prudent working capital amangement.

Increases your cash: If you keep your inventories low, then you are not paying the cash to the supplier for the inventories which are not required. So, it increases your cash which is part of your current Assets ensuring prudent woking capital management.

Apart from these you can also have the following advantages.

To increase profitability: If you maintain high inventory which is not necessary, it involves unnecesary costs to the company such as handling costs, spolage, interest rates if bought on ccredit. So, these increases the expenses against the income of the company which reduces the profitability and performance of the company. and also increases the interest payable which is part of current liabilitiesSo, to increase the profitability of the company, Keep the inventories low.

To increase Inventory Turnover: If you order the inventories in a lot which is not necessary for a company. It means you are keeping the inventory with you becaus you are not able to sell them. This decreases the Inventory Turnover ratio which reduces the performance of the company. Hence, to increase the inventory turnover ratio, you nne dto reduce the inventory.