Difficulty: Medium

Average Score: 55%

A company is reviewing its financial position and wants to increase liquidity. Which action should help?

Rationale

Selling inventory for cash will help increase liquidity.

Increasing liquidity involves improving a company's ability to access cash quickly. Selling inventory for cash directly generates cash flow, enhancing the company's liquidity position and allowing it to meet short-term obligations more effectively.

A (Using cash to pay down debt) YOUR ANSWER

While paying down debt may improve long-term financial health and reduce interest expenses, it does not directly increase liquidity. This action utilizes available cash, which can reduce liquidity rather than enhance it, as it decreases the cash reserves needed for immediate operational needs.

B (Converting cash into long-term investments) YOUR ANSWER

Investing cash into long-term assets ties up funds for an extended period, diminishing immediate liquidity. While this may be beneficial for long-term growth, it does not assist in increasing the cash available for short-term liabilities or operational expenses, which is essential for maintaining liquidity.

C (Selling inventory for cash) CORRECT

Selling inventory for cash directly improves liquidity by converting an asset into liquid cash. This action enhances the cash flow, allowing the company to cover its short-term obligations and create a buffer for unanticipated expenses, thus significantly boosting liquidity.

D (Purchasing additional fixed assets) YOUR ANSWER

Acquiring fixed assets requires a significant cash outflow, which would decrease liquidity rather than improve it. This investment typically ties up cash for the long term and does not provide immediate cash flow, potentially putting the company at risk if it faces short-term financial pressures.

Conclusion

To enhance liquidity, a company should focus on actions that increase immediate cash availability. Selling inventory for cash is the most effective strategy, as it provides direct cash flow necessary for meeting short-term obligations. Other options, such as paying down debt or investing in fixed assets, can hinder liquidity by reducing available cash reserves needed for operational flexibility.

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