A finance executive of XYZ company claims that “Increasing the firm's current ratio by accumulating more inventory is a sound strategy for improving…

4. (a) While accumulating more inventories may increase the current ratio (Current Assets / Current Liabilities), it does not necessarily improve working capital efficiency. The reasons are as follows: Inefficient Use of Funds: Increasing inventory ties up cash in unsold goods, which may lead to higher holding costs (storage, insurance, obsolescence). False Sense of Liquidity: Inventory is a less liquid current asset compared to cash or receivables. A high current ratio driven by inventory does not ensure actual liquidity. Decline in Inventory Turnover: More inventories may reduce the inventory turnover ratio, indicating poor inventory management. Risk of Obsolescence: Excess stock might become obsolete, especially in fast-moving industries (e.g., technology, fashion), resulting in losses. Working Capital Efficiency Metrics: Efficient working capital management focuses on optimizing the cash conversion cycle (CCC) not just boosting ratios. Stockpiling inventory may increase CCC, reducing efficiency. Hence, it may be concluded that increasing inventory inflates the current ratio but harms working capital efficiency by locking funds in slow-moving assets. True efficiency comes from balancing liquidity with turnover, not simply increasing asset size.