Accounting Question from M&I
Hey guys! I was looking at Mergers and Inquisition's Interview guide and I came across this question.
- Now let’s say they sell the iPods for revenue of $20, at a cost of $10. Walk me through the 3 statements under this scenario.
A: Income Statement: Revenue is up by $20 and COGS is up by $10, so Gross Profit is up by $10 and Operating Income is up by $10 as well. Assuming a 40% tax rate, Net Income is up by $6. Cash Flow Statement: Net Income at the top is up by $6 and Inventory has decreased by $10 (since we just manufactured the inventory into real iPods), which is a net addition to cash flow – so Cash Flow from Operations is up by $16 overall.
Now this is jut part of the answer, but I don't understand why you have to count for decrease in inventory for cash flow statement. It makes sense accounting wise, because change in inventory is one of the items in the cash flow statement, but I'm having a hard time understanding that the company gained $16 in cash when it sold $20 worth of goods that cost $10 to make? Aren't we 'double counting' the sales?
Thank you for your help!!
Essentially, there was an "inflow" of cash of $16 from that sale. Not all of that is profit, of course. Since the cash flow statement reconciles to change in cash balance, you need the total inflow/outflow of cash (as opposed to the actual economic benefit).
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