Indirect method to calculate CFO (inventory adjustment)

CFA Level I FRA
#1

I understand if inventory increases, regardless of sales (suppose sales is zero for easier understanding, so there is zero revenue), it means cash has been used so it affects CFO (cash flow from operating activities). For example, if the ending inventory is worth $100, and the beginning inventory is $80, $20 has to be deducted from Net income when calculating CFO using the indirect method;

However, if the ending inventory is worth of $60, and the beginning inventory is $80, it means $20 worth of inventory was sold. But isn’t this reflected in “revenue” and “COGS” already in the income statement? Why do we have to add $20 to net income?

Thank you for any insight!

#2

It’s not reflected in COGS, which is the point. COGS thinks that you spent $20 more cash than you really did.

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#3

Now I understand！ If the ending inventory is worth of $60, and the beginning inventory is $80, it means $20 worth of inventory was sold from the previous period on top of the ones purchased and sold this period. Then COGS would record “the ones purchased and sold this period”+$20, but the actual cash spent this period is only for “the ones purchased and sold this period”…so $20 needs to be added back to net income to calculate CFO.

Thank you for the great answer!

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#4

My pleasure.