Hi, I know this should be easy but I can’t figure out by myself. Considering rising rates and rising inventory, the LIFO COGS is higher than FIFO. In that case, how does LIFO end up having higher cash flow? I understand that because COGS is higher, the income taxes are lower, but I can’t seem to figure out how the decrease in income tax (for LIFO) would offset the increase in COGS?? Thanks
It wont. The text just says that C/F would be higher than in the case of FIFO where the COGS are lower due to inventory valuation method. Lets say LIFO puts the inventory COGS at 400 and FIFO values the same COGS at 300, 1000 sales and other expense 100. Tax @30% LIFO EBT 500 TAX <150> Net Inc 350 The C/F are decreased by 150 FIFO EBT 600 TAX <180> Net Inc 420 The C/F are decreased by 180. Therefore LIFO contrbutes to higher C/Fs.
Good example. But for the example you give, doesn’t COGS also find a way into C/F statement (in the way of “cash paid to suppliers” which increases if COGS is higher, assuming no change in inventory and a/c payables) In that case, wouldn’t COGS from LIFO being higher, would lead to a reduced c/f than that of FIFO? maybe I am missing something more?
you are missing “ceteris paribus” if you’re paying more because of inflation for something, your cashflow is reduced. but that is not the question.
Can you please elaborate??
cash flow is more related to tax deducted. since LIFO has higher COGS, the income is lower, than tax deduction is lower. hence, the high cash flow. am I right?
“cash flow is more related to tax deducted.” … howz that? Wouldn’t COGS value have greater impact in bringing down the cash flow? for the example given above by ov25, wouldn’t cash flows be somewhat like this: for LIFO: --------- cash collections: 1000 cash to suppliers: (assuming no change in inventory and a/c payables): (400) cash interest: (100) cash taxes: (150) ----------net Cash Flow: 350 for FIFO: -------- cash collections: 1000 cash to suppliers: (assuming no change in inventory and a/c payables): (300) cash interest: (100) cash taxes: (180) ----------net Cash Flow: 420 So although the tax expense is higher in FIFO, the net cash flow seems to be higher. I know I seem to be making some mistake … but can’t figure out… help pls… thanks.
Cash paid to suppliers won’t change based on the inventory valuation method. Purchases = CoGS + End Inv - Beg Inv. In case of FIFO, COGS will be less and Inv will be more. In Case of LIFO, COGS will be higher and INV. will be less by the same amount. So the cash paid to Suppliers will always be the same. The only CF difference would be from the Tax.