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CA Intermediate · Financial Management and Strategic Management · Introduction to Working Capital Management

A firm shifts from a conservative to an aggressive current asset policy, with sales unchanged. Which is the most likely result?

An aggressive policy lowers the ratio of current assets to sales, which cuts the funds blocked and raises expected profitability. The trade-off is greater risk of liquidity shortages and stock-outs, since there is less cushion in cash, inventory and receivables.

  1. ALower current assets to sales ratio, higher expected return and higher risk of liquidity shortageCorrect
  2. BHigher current assets to sales ratio, higher expected return and lower risk
  3. CLower current assets to sales ratio, lower expected return and lower risk
  4. DHigher current assets to sales ratio, lower expected return and higher risk

Explanation

An aggressive policy holds fewer current assets for a given sales level. This reduces funds blocked and the carrying cost, so profitability rises, but the firm faces a higher risk of stock-outs and liquidity shortage. Option B describes benefits of a conservative policy wrongly combined with higher return.

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