I understood that LIFO liquidation causes increase in gross margin. But how does it decreases cash flow? If question says “cash flow”, does it mean CFO? I saw explanation that cash flow decrease because company pays more tax for low cost of goods sold in the case of liquidation. I am able to understand by visualizing the transaction. But I did not understand how it really affects cash flow statement to see bottom line to decrease in case of LIFO liquidation. For example, in case of LIFO liquidation, if they get net income $900 instead of $200 for non liquidation, even after tax payment, CFO will be more. Appreciate for any simple example with sample data.
an increase in tax burden will decrease CFO. the increase in NI (due to lower cogs) does not affect cash b/c NI includes cash and non cash items, due to the accrual concept. not sure if you are equating the increase in NI as an increase in CFO directly. i’ll take a shot at an example. without lifo liquidation: revenue = 50,000 cogs = (30,000) gross profit = 20,000 add’l expenses(incl depr) = (8,000) EBIT = 12,000 Int Exp = (2,000) EBT = 8,000 Taxes (30%) = (2,400) NI = 5,600 with lifo liquidation: revenue = 50,000 cogs = (25,000) gross profit = 25,000 add’l expenses(incl depr) = (8,000) EBIT = 17,000 Int Exp = (2,000) EBT = 15,000 Taxes (30%) = (4,500) NI = 10,500 CFO decreases by 2,100 due to the additional tax burden (as a result of higher gross profit).
Xavier, Your numbers aren’t exactly right - EBT up top is $10K, but the concept is solid. chinni - The $900 vs. $200 in your examle is not cash. When you adjust out for the chnage in the inventory and accounts payable accounts along with the other working capital changes, that difference will dissapear (assuming that when contrasting against a non-LIFO liquidation scenario the new inventory units were bought on credit, and not for cash.
cool, good catch.
Xavier1, Super I, Thanks a lot for explanation with an example. I appreciate for taking time to explain Chinni