When using the Bardahl formula, an increase in accounts payable (while holding purchases and operating expenses constant) has which of the following effects on the working capital requirements? A) decrease B) increase C) no effect D) increase, decrease, or no effect, depending on other factors
The Correct Answer and Explanation is:
The correct answer is A) decrease.
Explanation:
The Bardahl formula is used to calculate the working capital requirements for a business. It helps estimate how much working capital is needed for daily operations based on variables like operating expenses, inventory levels, accounts receivable, and accounts payable.
The formula generally follows this logic:
Working Capital = Accounts Receivable + Inventory – Accounts Payable.
An increase in accounts payable, while holding other variables constant, will reduce the working capital requirements.
Here’s why:
- Accounts Payable: This represents the money a company owes to its suppliers. When accounts payable increases, it means the company can delay paying off its suppliers. Essentially, it reduces the immediate need for cash since the company doesn’t have to pay as quickly.
- Impact on Working Capital: Since accounts payable is subtracted from the working capital calculation, an increase in accounts payable lowers the amount of working capital the company needs to maintain. The company has more time to pay off its debts, which means it can use its cash for other operational needs or investments.
- Delayed Payments: Holding purchases and operating expenses constant means that even though the company is spending money, the increase in accounts payable allows the business to delay outflows, thereby decreasing the immediate need for working capital.
In summary, increasing accounts payable while keeping other factors the same lowers the amount of working capital required. This is because the business can use the additional time from delayed payments to manage its liquidity more efficiently.
