LIFO vs FIFO on NI and CF

CFA Level I FRA
#1

Hi! So I know that under LIFO --> Higher COGS --> Lower Taxes (because your taxable income is lower) --> Lower Net Income. But why is it higher cash in the end? I mean shouldn’t net income already get adjusted for taxes? So your NI should be the same as CFO?

CFO = NI + Non cash charges - Change in WC. I just don’t see what items here will make CFO higher than its NI, hence have higher CF than FIFO?

Hope my question is clear here!

#2

If you pay less in taxes, you have more cash left.

Try it with some numbers:

LIFO:

  • Revenue = $100
  • COGS = $70
  • Gross Profit = $30
  • SG&A = $15
  • EBIT = $15
  • Interest = $5
  • EBT = $10
  • Taxes @ 30% = $3
  • Net Income = $7
  • CFO = $100 − $70 − $15 − $5 − $3 = $7

FIFO:

  • Revenue = $100
  • COGS = $60
  • Gross Profit = $40
  • SG&A = $15
  • EBIT = $25
  • Interest = $5
  • EBT = $20
  • Taxes @ 30% = $6
  • Net Income = $14
  • CFO = $100 − $70 − $15 − $5 − $6 = $4

Note that although FIFO COGS is only $60, the cash outflow is the same $70 as under LIFO: they had to replace the same goods at the same cost.

#3

Thanks S2000magician! You are spot-on with what I was looking for!!! I didn’t realize that when calculating FIFO’s CF, we would still be using the COGS under LIFO. Now it’s finally clear!

#4

My pleasure.

#5

on Point