Answer:
Inventory build-up ties down cash flows. The implication is that cash flows are used up to produce more goods than consumers or buyers are ready to buy.
More inventory becomes available, filling up the warehouse. This situation impacts cash flows negatively. The entity will not be liquid to meet its maturing liability obligations. Suppliers are not being paid for raw materials. They would likely stop supplying. Workers are being owed salary arrears and they would call for industrial action. Some of them may discontinue work as a result. More expenses will be incurred to warehouse inventory, with the attendant pilferages, wear and tear, and the problem of obsolete goods. If the goods are perishable, the resulting stench will be too horrible and unbearable. Many farmers butchered cows, which were subsequently wasted.
This limits the company's ability to generate revenue from the inventory. It becomes unable to pay its due bills. If the fund for the inventory build-up was borrowed from external sources, then the interest accumulates on that borrowed money. This situation increases the financial cost that the company would incur, thereby increasing cost and reducing profitability.
Reduced profitability lowers investors confidence in the entity's management. It also affects the ability of the company to declare dividends. Dividends are declared out of profit. Even if some dividends were declared, the company's reduced cash flows will jeopardize its ability to settle the dividends with cash.
To mitigate the financial impact, companies should adopt inventory controls, including Just in Time, JIT. Demand for products should be anticipated and production planned accordingly, especially during this pandemic. Inventory production is usually financed through short-term funds. Companies should reconsider this practise at this time by going for long-term financing options. They should access the loans made available to companies by governments during this pandemic. Most of such emergency funds are offered at no or lower interest rates.
Explanation:
Inventory build-up happens when goods in the warehouse are not being sold. This limits the company's ability to generate revenue from the inventory. It becomes unable to pay its due bills. If the fund for the inventory build-up was borrowed from external sources, then the interest accumulates on that borrowed money. This situation increases the financial cost that the company would incur, even increasing holding cost, further reducing profitability.
Reduced profitability lowers investors confidence in the entity's management. It also affects the ability of the company to declare dividends. Dividends are declared out of profit. Even if some dividends were declared, the company's reduced cash flows will jeopardize its ability to settle the dividends with cash.
