Inventort writedown cash flow
#INVENTORT WRITEDOWN CASH FLOW FREE#
Plans which reward the management based upon return on equity (ROE) or other accrual measurements as well as the issuance of stock options provide incentive for the management to report the highest possible net income rather that attempting to produce the highest amount of free cash for the business. The most likely answer is due to the nature of of management compensation plans. So why do many companies choose to employ FIFO rather than LIFO inventory valuations. One of my favorite quotes by John Maynard Keynes states: "The avoidance of taxes is the only intellectual pursuit that carries any reward". LIFO inventory valuations however in the real world taxes are a major consideration.
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If taxes are factored out, cash flow is not affected by FIFO vs. Furthermore, cash flow is reduced since taxes are a cash charge and an increase in accrual earnings results in higher payments to Uncle Sam. As costs increase, current earnings and gross margins tend to be overstated when using FIFO rather than LIFO inventory accounting. Note that using LIFO inventory valuation is generally more conservative that using FIFO since the cost of inventory going forward is likely to increase. The following chart provides a summary of how FIFO and LIFO inventory accounting affects the financial statements of a company. I bet that just put you on pins and needles. More specifically, the article will explain how the aforementioned accounting principles affect the free cash which a business produces and how a proper understanding of these principles lends itself to a more accurate portrayal of a companies' true profitability than accrual accounting.Īt the end of the article I will divulge "the formula" which I believe describes the proper method for calculating the earnings yield of a business.
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Today's article will deal with inventory accounting, goodwill impairment, and amortization of intangible assets (try to say that three times real fast). In fact, after I took a grand total of two introductory accounting classes I was so beset with boredom that I switched my major from business to anthropology.įortunately for me, my interests turned back to finance since very few "bone diggers" or "human ethologists" can rub two nickels together in their old age although they probably have more interesting things to talk about at cocktail parties. When I was a young college student I would have never imagined that one day I would be pondering the amortization of intangibles and the effects of FIFO and LIFO accounting practices on financial statements. Warren Buffett from his 1983 Annual Letter