After-Tax Cash Flow under LIFO-- this SHOULD be so easy....

[KungFuPanda]

I have this problem understanding After-Tax cash flows under LIFO. “After Tax CFs under LIFO are HIGHER than FIFO.” This does not make sense to me–Yes, I understand you pay less taxes than FIFO because COGS is higher, operating profit is lower and therefore the taxable amount is lower.

If two firms (one LIFO, the other FIFO) have EBIT of 50 and 60 respectively, then yes LIFO firm has less tax due because their EBIT is lower, but the $$ amount of EBIT(1-T) is still lower than the FIFO firm (32.5 vs. 39 assuming T=.35) because the EBIT was lower to begin with… So how can we say that “After-tax CF is higher under LIFO” than if FIFO had been used ???

[sachin_patel]

@KungFuPanda

I have this problem understanding After-Tax cash flows under LIFO. “After Tax CFs under LIFO are HIGHER than FIFO.” This does not make sense to me–Yes, I understand you pay less taxes than FIFO because COGS is higher, operating profit is lower and therefore the taxable amount is lower.

If two firms (one LIFO, the other FIFO) have EBIT of 50 and 60 respectively, then yes LIFO firm has less tax due because their EBIT is lower, but the $$ amount of EBIT(1-T) is still lower than the FIFO firm (32.5 vs. 39 assuming T=.35) because the EBIT was lower to begin with… So how can we say that “After-tax CF is higher under LIFO” than if FIFO had been used ???

Remember, EBIT doesn’t mean cash. It could very well transfer to Receivables…

What you got from customers or what you paid for COGS doesn’t change.

The only thing changes is how much taxes you pay and that you control via telling IRS that my cost was higher or lower using LIFO or FIFO…

makes sense?

[cfa2014]

Read CFA BB (page-16, solution-4) and save yourself from these misconceptions

[KungFuPanda]

Got it. Thanks guys - back on track.

[S2000magician]

Before tax cash flow is the same under FIFO and LIFO: the inventory method doesn’t have an effect on when you purchase stuff, or for how much, or when you pay for it, or when you sell stuff, or for how much, or when you get paid.

The only (cash-flow) difference is in taxes, and that’s lower under LIFO (assuming rising costs).

[KungFuPanda]

@S2000magician

Before tax cash flow is the same under FIFO and LIFO: the inventory method doesn’t have an effect on when you purchase stuff, or for how much, or when you pay for it, or when you sell stuff, or for how much, or when you get paid.

The only (cash-flow) difference is in taxes, and that’s lower under LIFO (assuming rising costs).

Wow - i realize now that I really had that twisted up in my head… glad I asked the question today.

So in thinking about CFO in relation to the IS, is it safer to say that after-tax EBIT is simply a proxy for CFO, but the steps to get to CFO are very different? the IS is how we get to Net Income, and we happen to pass CFO along the way?

[nitish3861]

A simple example to illustrate that: For example, in your inventory there are 2 items (each cost $50 and $100). You sold 1 item @ $200 with tax 30%. With FIFO, your COGS will be $50 and the amount get taxed will be $45. Cash Outflow = -$150 (for the goods) Taxed = -$45 Cash Inflow = +$200 Total = $5 With LIFO, your COGS will be $100 and the amount you’ll get taxed will be $30. Cash Outflow = -$150 Taxed = -$30 Cash Inflow = +$200 Total = $20 Hence, LIFO has higher COGS ($100) and higher cashflow ($20)