22 - if the firm pays down accounts payable). Therefore,...

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Why do we consider changes in net working capital associated with a project to be cash inflows or outflows? Working capital is useful to show the operating liquidity of a company and how the company manages its business. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses (Nitzan, Bichler, 2009). Just as a firm must account for cash expenditures on fixed assets, it must also weigh the cash inflows and outflows associated with changes in net working capital. Net working capital equals the difference between current assets and current liabilities. The main components of net working capital are cash, inventory, receivables, and payables. Frequently, the term working capital is used to refer to what is more correctly known as “net working capital’. An increase in net working capital represents a cash outflow. Net working capital increases if current assets rise (e.g., if the firm buys more inventory) or if current liabilities fall (e.g.,
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Unformatted text preview: if the firm pays down accounts payable). Therefore, any increase in a current asset account or any decrease in a current liability account results in a cash outflow. Similarly, a decrease in net working capital represents a cash inflow. Net working capital decreases when current assets fall (as when a firm sells inventory) or when current liabilities increase (as when the firm borrows from suppliers). A decrease in any current asset or an increase in any current liability results in a cash outflow. The cash flow effect from a change in net working capital is always equal and opposite in sing to the change in net working capital. For example, an increase in inventory represents an investment or cash outflow, while a reduction in that inventory frees up that investment of capital and represents a cash inflow. Thus in capital budgeting we subtract changes in net working capital to arrive at the cash flows....
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