CAN ANYONE HELP ME RATIONALIZE THIS QUESTION WHICH I JUST GOT WRONG? When prices are rising, comparing with LIFO, FIFO results in A. lower working capital and higher cash flows. B. higher working capital and higher cash flows. C. lower working capital and lower cash flows. D. higher working capital and lower cash flows.
Rising Price FIFO COGS = 20 EI = 30 LIFO EI = 20 COGS = 30 So CA is greater under FIFO (Contains the EI). so FIFO has a higher Working Capital. (when compared to LIFO). Because COGS is lower under FIFO - you would pay more taxes so After tax Cash flows under FIFO would be lower. So is D the right answer?
Lifo will have lower inventory balance—> Lower working capital Lifo —> Higher COGS —> Lower Income —> Lower taxes —> Higher CF D Is that right?
CPK, that looks right to me.
FIFO, Rising Prices ---------------------- EI high --> Assets high --> WC = CA - CL therefore WC is high COGS low --> Income high --> Taxes high --> Cash outflow high --> lower cash flows D?? - Dinesh S EDIT: whhhoaa so many replies in just 5 minutes… you guys are fast
the answer D guys, thanks for the quick help!
Easy way to remember the impact on inventory (and therefore working capital) of FIFO versus LIFO is to remember that FIFO --> LISH (Last In Still Here) and LIFO --> FISH (First In Still Here). Therefore, if prices are rising, the most expensive units purchased will be the most recent. These will still be in inventory if you use LISH (FIFO). Therefore, FIFO will have the higher working capital. Now, you have eliminated two answers and have a 50/50 shot at a correct answer. Now to solve the other side, remember that your if the high cost items are in your ending inventory, then the older, lower cost items are in your COGS, which results in higer GP, and higher EBIT, which causes taxes to be higher, resulting in lower cash flows. This leaves you with D.