Hi all
Quick question, pretty basic but just need someone to clarify for me. LIFO and FIFO with regards to leverage ratios, it discusses rising cost environment and how that affects increased inventory for LIFO which increases assets. But what about increased cash from sale of low cost and high prices. Doesn’t that affect cash and assets also (did not see it mentioend). Any help just clarifying would be great, I know it is rather simple !
Thx
J
the amount of cash you get from a sale isn’t afffected by the cost of the item. EG if you sell something for $100, that’s the cash you get, regardless if it cost you $20 or $90 to produce.
When you sell something, inventory is decreased and that amount is charged to COGS.
thanks Kia, just needed to see it in writing from someone, that helps
Wait a second. In rising prices LIFO produces LOWER assets since you have lower inventory values. FIFO produces higher.
So the cash you paid to buy inventory and produce goods isn’t real cash?
The only difference in cash flow that arises from the difference between LIFO and FIFO is in a rising cost environment the income tax from LIFO will be less, because of the higher value of COGS.
So disregarding the amount of taxes we look at two companies where one uses LIFO and one uses FIFO and have the purchase the exact same amount of Inventory, have equal dollar sales, and all other expenses are equal. The company using LIFO is going to recognize greater amount of COGS and therefore state lower income, because they’re putting the most recently purchased inventory into COGS and leaving the old cheap stuff in Assets. But since these two companies had the same dollar value of sales and the same dollar value of inventory purchases, then their cash flows should be equal. So to get from The different Income values back to cash flow we need to use the FCF= NI + NCC -NWC - FCInv . Assuming no NCC and FCInv, the only difference is going to be in the Change in NWC capital. So if the company using LIFO is going to end the year with a lower inventory amount, they will have a greater drop (negative vaule) in change in Net Working Capital. So we subtract the negative number (add back) the change in Net Working Capital to Income for the Company using LIFO and that gives us Cash Flow.
LIFO and FIFO are classification of available for sale inventory costs in between cost of sales and inventory. Cash is affected primarily by the tax savings through LIFO as LIFO COGS are higher and tax is lower. A part from that irrespective of inventory the cash is associated with revenue not with profit.
Of course it is. But using LIFO or FIFO doesn’t change the amount you paid for your inventory. Or the amount you receive from a sale. the only thing it changes is how you allocate the expense between inventory and COGS.
This affects cash flow by increasing (FIFO) or decreasing (LIFO) your tax bill, as others have said.
(that was meant to be a reply to 1logic)