CFA Level I · CFA Level I Exam · Financial Statement Forecasting in Equity Valuation
An analyst expects a firm's inventory turnover to improve due to better supply-chain management. Holding sales and COGS constant, the forecast effect on free cash flow to the firm is most likely:
Free cash flow to the firm would most likely increase. Higher inventory turnover means less inventory is needed to support the same cost of goods sold, so the investment in working capital falls and more cash is released.
- AA decrease because of lower inventory purchases
- BAn increase because of a smaller investment in working capitalCorrect
- CNo change because inventory is a non-cash item
Explanation
Higher turnover means less inventory is needed for the same COGS, reducing the working capital investment and raising FCFF. Inventory ties up cash, so it is not neutral.
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