I read here “in the absence of taxes, there is no difference in the cash flow between LIFO and FIFO.”
I’m trying to wrap my head around that, because yes we know LIFO would give preferential tax savings in an increasing cost environment because COGS are higher and taxable income is lower. Without taxes… NI is still lower with LIFO as compared to FIFO in an increasing cost environment. What else am I missing? In CFO, the relatively greater amount of inventory under FIFO would decrease CFO by the difference in COGS (compared to LIFO) without taxes to worry about? Is that it?
You buy the same stuff for the same price under FIFO and LIFO (and average cost). You will the same stuff for the same price under FIFO and LIFO (and average cost). You have the same terms with your suppliers, and the same credit/collection policies with your customers. Thus, the cash flow is the same under FIFO and LIFO (and average cost).
Simply stated, you have to pay for the inventory when it’s bought not when it’s recognized as an expense.
That’s true. How does the introduction of taxes affect this - can we say for certain the cash flow from one method will be greater than the other?
Depends on what’s happening to the price of the goods purchased:
If prices are flat, no tax difference and no impact to CFO
Rising prices, LIFO leads to a higher COGs than if FIFO was used which leads to a lower tax liability (simply stated)
Decreasing prices , LIFO leads to lower COGs than if FIFO was used which leads to a higher tax liability (simply stated)
Both of these situtations depend on when the actual cash outflow occurs for the tax liability (may end up in AP and therefore no cash outlay in that period)
- Decrease Inventory by $3, let’s say; 2. Increase COGS by $3 3. Net Income will decrease by (-$3 * 35%) = -$1.95 4. Cash Flow from Ops. decreases by $1.95 (Net Income was reduced) 5. However, cash flow from ops. increases by $3 due to adjustment in inventory (a reduction), a working capital item 6. Net result in the cash flow from Ops is: -$1.95 + $3.0 = $1.05 (increase)
So, cash flow from ops. has increased $3.0, due to lesser working capital requirement (since inventory was reduced - LIFO) - positive impact on CF.
On the other hand, net income was reduced due to higher COGS (net of tax at 35%) - negative impact on cash flow of $1.95.
Net effect on cah from ops. = $1.05
What are your thoughts on this S2000magician
@OP I think you are mixing two different concepts.
CF are totally different than I/S. They are the reality. I/S on the other hand is completely assumptions based.
It is saying that whatever cost assumption method you use you are going to get the same cash flow at the end of the day. You can influence your COGS and your inventory by using FIFO or LIFO. But the cash you are getting will be the same.