How does borrowing $1 million long-term and investing the proceeds in inventory affect cash and net working capital?
When borrowing $1 million long-term and investing the proceeds in inventory, there are several impacts on cash and net working capital. Let's break it down step by step:
1. Borrowing $1 million:
- To obtain the funds, you would need to approach a financial institution like a bank or lender. They would assess your creditworthiness and terms of borrowing (interest rate, repayment period, etc.).
- Once approved, the lender would disburse the $1 million to your account. As a result, your cash balance increases by $1 million.
2. Investing in inventory:
- With the $1 million in hand, you can use it to purchase additional inventory for your business.
- As you invest the funds in inventory, your cash balance decreases accordingly. The exact amount depends on the cost of the inventory and any additional expenses associated with the purchase (e.g., shipping costs).
3. Impact on cash and net working capital:
- Cash: Initially, your cash balance increased by $1 million due to the loan, but then it decreased as you invested in inventory. The net impact on cash depends on the total cost of inventory and other associated expenses.
- Net Working Capital: Net working capital is calculated by subtracting current liabilities from current assets. Inventory is considered a current asset on the balance sheet. By investing the borrowed money in inventory, the value of your current assets (specifically, inventory) increases. However, if you do not pay off any current liabilities with the borrowed money, the net working capital may remain unchanged or even decrease if there are other factors affecting current liabilities.
It's important to note that managing cash and net working capital goes beyond this simple explanation, as it involves multiple factors and variables. Consulting with a financial advisor or accountant is recommended for a more comprehensive analysis tailored to your specific situation.