Company A estimates that it needs 30% of sales in net working capital. In year 1, sales were $1 million and in year 2, sales were $2 million. Associated with the change in net working capital from year 1 to year 2 is a cash:

1) inflow of $300,000.
2) outflow of $300,000.
3) inflow of $600,000.
4) outflow of $600,000.

The answer is B.

Explanation:

Working capital is current assets minus current liabilities. Working capital is a measure of liquidity. It is a very important metric.

In year 1:

Sales $1,000,000

30% of sales in net working capital is:

0.3 x $1,000,000

$300,0000

In year 2:

Sales $2,000,000

30% of sales in net working capital is:

0.3 x $2,000,000

$600,0000

The change in working capital is:

$600,0000 - $300,0000

= $300,0000

Therefore, company A

needs to make a cash investment (outflow) of $300,000 to increase their net working capital from the sales in Year 1 to Year 2.

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