If using FIFO - (rising prices…), inventory is up…therefore assets are up and hence debt to equity ratio is low as equity is up. But why does equity increases when assets are up - whats the link??
With FIFO, inventory is up if you continue to buy it at the higher prices. Assuming that stays constant, and you sell inventory at a constant rate each month, equity will rise through retained earnings. Equity alone would not increase when buying inventory, nor would assets. Your just replacing cash with inventory. Equity will only rise as you sell it (as will assets)
Equity = Asset - Liability
Yea Net Income would be higher, which makes Retained Earnings higher. Retained Earnings is a component of equity.
A = L + E You expense less (as you are expensing your inventory at a lower cost), therefore, assets would show a higher balance. As you expense less, you would have a higher net income. Assuming that you don’t pay dividends, that amount would flow into equity as retained earnings. An interesting side-effect is that you would have higher taxes (due to higher EBIT) as a result of the lower expenses related to your inventory (FIFO v LIFO). As such, your quick ratio will have actually decreased (as you had to pay out more cash for your taxes). The accounting equation will remain balanced. Cash will decrease by the difference in taxes, inventory on the balance sheet will be higher, and equity will be higher: A (up because the higher inventory more than offsets the lower cash) = L (unchanged) + equity (increased due to the higher net income) EDIT: Everything said is relative to LIFO. It assumes rising prices and no LIFO Liquidation.